Protecting Your Secured Interest in Vehicle Loans When Members File Bankruptcy

by Jeffrey Bearss, Esq.

An important part of collection includes preserving the existing interest you already have in the asset.  Here is some advice that will immediately start saving your credit union thousands of dollars.  This is the scenario.  A member borrows money to purchase a car.  He buys the car, makes payments on the loan, and then files bankruptcy before paying the loan off.  You get notice of the bankruptcy petition.  Under bankruptcy law, known as the automatic stay, the credit union is prevented from taking any collection action whatsoever against the member.  At this point you will have stopped collection activity, since everyone is very careful about this.  You’ve done everything right so far.  When a member successfully completes a bankruptcy, at the end of the process he gets a discharge or order of discharge, which means that he is no longer liable for that debt, or the debt has been settled at a lesser amount by reason of the bankruptcy and he gets to keep the collateral without paying the full price. 

Now if a member starts a bankruptcy, but does not make his payments in the plan, or does not do what he is supposed to do to complete the bankruptcy, then his bankruptcy is dismissed.  That means the debtor has ruined his own bankruptcy somehow, the bankruptcy has failed, and the credit union has full rights of collection just as if the bankruptcy had never been filed.

Here is the problem.  Your staff member gets a notice one day from the bankruptcy court that the debtor’s bankruptcy has been dismissed.  It won’t say why or what happened.  It is just a very short order, one line that simply says that the bankruptcy was dismissed.  Up to this time, the credit union has this unpaid car loan while the debtor is still driving the vehicle and has not made payments on it for months due to the bankruptcy.  The debtor impaired his own bankruptcy for whatever reason, and his bankruptcy is dismissed.  You then get this order from the court saying that the bankruptcy is dismissed.  The debtor comes rushing into your branch waiving the bankruptcy court order of dismissal, and demands that you release the lien on his vehicle and provide a letter showing it is paid in full, thinking that the debt has been dismissed, not the bankruptcy.  The debtor may do this intentionally or unintentionally.  Your employee, being mindful of the automatic stay, and trying to do the right thing, mistakenly issues a release of lien and paid in full letter to the debtor.  Or an employee may inadvertently do this on his own, simply in response to receiving a dismissal in the mail.  The debtor then receives a free car, or a nearly free car as a result of the error. 

Needless to say, this can be a costly mistake.  The employee confused the phrase “bankruptcy discharged” with the phrase “bankruptcy dismissed.”  The words are similar, and the employee, trying to do the right thing and not wanting to get in trouble with the bankruptcy court, sees the court order indicating “bankruptcy dismissed,”  thinks that it means that the debt is dismissed, which it is not.  The correct terminology is that the debt is discharged, not dismissed.  The lien is released, the debtor has the paid in full letter in hand, and is long gone.  The mistake is discovered after the fact, and then we are contacted to sue the debtor for the remaining balance due on the car loan since the bankruptcy is dismissed and the debtor remains liable for the remaining balance due just as if the bankruptcy had never occurred.

When we file suit against the debtor, the debtor retains an attorney, and a full trial is held.  The cases do not settle beforehand because they have this document in their hand titled “release of lien,” and they also have a letter in hand which says their loan is paid in full.  As you can imagine, the debtor’s attorney has a field day with this during the trial. 

The rules of evidence state that written documents are given more weight that verbal testimony.  In this case, the verbal testimony is about an error, which is outweighed by the written documents, stating “release of lien” and “paid in full.”  At trial, it is difficult to overcome a written release of lien and paid in full document.  Fortunately, we were able to do so in two cases.  However, it took full trials to do so with witnesses appearing to testify.  The witness was put in the position of having to explain and prove to the judge why the written documents were inaccurate. 

The only instance you would release a lien is if the debtor pays the car loan in full, or if the debtor is in a bankruptcy and he has successfully completed his bankruptcy, in which case the court will issue an “order of discharge” as opposed to an ”order of dismissal.”  If it says “discharge,” that means the debt is discharged, and the lien should be released.  If it says “dismissal,” that means the debtor has failed to finish his bankruptcy, and the bankruptcy is dismissed.  The debt lives on, and it is fair game for collection.

If you have any questions on this matter, please contact Mr. Jeffrey Bearss, Esq. Jeffrey is an Associate in Consumer Collections; Credit Union and Subrogation Groups located in the Detroit office of Weltman, Weinberg & Reis Co., LPA. He can be reached at 248.786.3197 or via email at jbearss@weltman.com.

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One thought on “Protecting Your Secured Interest in Vehicle Loans When Members File Bankruptcy

  1. Just tumbled across this article while enjoying a coffee outside in the first sun I’ve seen in ages!

    I write a fair amount about the actual workings of banruptcy, but I find this article very interesting in that it reflects some hard realities of bankruptcy law in the real world.

    It never occurred to me that “dismissed” and “discharged” are so simillar, which I can now see that they are.

    Add to that a member of staff who may not be quite on the ball, (and I mean no disrespect, we are all human after all), allied to the barrier of automatic stay and the creditor’s need not to breach it, and there is a real big problem. Particularly if the debtor intentionally uses the word “discharged” instead of “dismissed”.

    However, in the latter case, could not the debtor be sued for fraud?

    Enjoyed the post, thanks.

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