New Challenges for Attorneys Signing Reaffirmation Agreements Meeting a Heightened Standard of Judicial Review

Duties of Debtor's Counsel

The attorney's declaration under Bankruptcy Code §524 that a reaffirmation agreement imposes
no "undue hardship" on the debtor client has always carried the potential for conflict unique to
bankruptcy law. Potentially, it pits the lawyer's duty to advocate for clients who wish to
reaffirm pre-petition debt, usually to retain goods that secure the debt, against the totally
independent duty under §524(c) to certify that a reaffirmation imposes "no undue hardship"
on the client. Reaffirmation abuses described in In re Latanowich and in the National Bankruptcy
Review Commission Final Report have spawned heightened judicial scrutiny of the attorney's
duties before signing the §524 declaration. In cases such as In re Hovestadt² and In re
Bruzzese,³ and especially the recent case of In re Melendez,⁴ judges have examined in detail the
lawyers' diligence, or lack thereof, in investigating whether their clients should sign a
reaffirmation agreement.

However, a new form of disclosure statement and reaffirmation agreement recently promulgated
by the Administrative Office of the U.S. Courts (AOUSC) has provided attorneys with a useful
tool for meeting their obligations. New Form B240 not only facilitates judicial review of reaffirmation agreements, but also informs the debtor
of the consequences of the reaffirmation and acts as a checklist for counsel to consider before
signing the §524(c) declaration. Form B240 has already been adopted as an official local form
in at least two jurisdictions, the Northern District of California and the District of
Massachusetts. We suggest that debtor's counsel use the form even if it is not required by local
rule.

Evolution of §524: Contradictory Roles

As initially enacted in 1978, §524 prescribed a formal reaffirmation process in order to
preserve the paramountcy of a debtor's discharge. It required a bankruptcy court to
determine, upon hearing and notice, whether a proposed reaffirmation agreement was in a
debtor's best interest and did not impose an "undue hardship" on a debtor or her dependents. A
hearing was required in every case.

Congress partially streamlined the reaffirmation procedure in 1984 by making reaffirmation
agreements negotiated with the assistance of counsel effective upon filing, subject to an
attorney's certifying that the agreement imposed no undue hardship on the debtor or a
dependent. Amendments enacted in 1994 further required the attorney to certify that she had
fully advised her client of the legal consequences of reaffirmation and default and that the
agreement represented a fully informed and voluntary decision.

While not vitiating the bankruptcy court's oversight of the reaffirmation process, amended
§524(c) shifted the onus of reviewing a reaffirmation agreement to the debtor's attorney. It
thus placed a debtor's attorney in a contradictory role—serving as the advocate for her client's
interests, but being required to "veto" the debtor's decision to reaffirm by not executing a
supporting affidavit if she believed, in the exercise of her independent judgment, that doing so
would impose an undue hardship.

For a time, courts were content to take attorney declarations at face value, opting not to question
their reasonableness under the circumstances. But some judges noticed that attorneys were
submitting statements supporting reaffirmation agreements where, for example, a debtor's
Schedule J monthly expenses exceeded her Schedule I monthly income, suggesting that the
attorneys' scrutiny was, at best, perfunctory. While some debtors might have deliberately
understated income and overstated expenses to avoid dismissal for substantial abuse under
§707(b), this was hardly an issue for the poorest debtors, some of whom were on welfare or
showed no income at all.

Circuit Split on "Ride Through"

If the debtor seeks to reaffirm in order to retain collateral, as opposed to obtaining new credit,
the dilemma may be exacerbated in those judicial circuits that do not allow a "ride
through"—the so-called "fourth option." Section 521(2)(A) requires a debtor, within 30 days
of the petition date, to file a statement as to whether he intends to surrender, reaffirm or
redeem estate property securing pre-petition consumer debt. Section 521(2)(B) requires the
debtor to perform his stated intention within 45 days. Four Circuit Courts of Appeal—the
Second, Fourth, Ninth and Tenth⁵—have held that a debtor who is current on payments has a
fourth option under §521 of continuing to make payments without either reaffirming the debt
or redeeming or surrendering the property, thereby "riding through" the bankruptcy and
converting the original obligation to a non-recourse loan.

However, the First, Fifth, Seventh and Eleventh Circuits⁶ have held that a debtor must elect
and then perform only one of the three options listed in §521—surrender, reaffirmation or
redemption. If a debtor wishes to keep the collateral and cannot afford to redeem for fair market
value or persuade the creditor to "ride along," his sole option is to reaffirm. Some cases have
held that a debtor and his attorney bear the burden of diligently performing his stated intention;
the court in In re Donnell⁷ recently indicated that the chapter 7 trustee, consistent with duties
imposed under §704(3), must monitor the debtor's progress in doing so. In In re Harris,⁸ the
court even held that a debtor's failure to effectuate intentions stated under §521 was a ground
for dismissal of the case "for cause" under §707(a). Thus, in those circuits that do not provide
a ride through, the options available to the debtor are fewer and the pressure on debtor's
counsel to sign a declaration supporting reaffirmation may be greater.

Hovestadt, Bruzzese and Melendez

In Hovestadt, Bruzzese and Melendez, the debtors sought to reaffirm pre-petition debts that they
could not repay with their post-discharge net income, as indicated by Schedules I and J. In
Hovestadt and Melendez, the debtors sought to reaffirm in order to keep consumer goods; in
Bruzzese, they sought to reaffirm as a prerequisite to obtaining additional post-discharge store
credit. Counsel in each case certified that reaffirmation imposed no "undue hardship" and that
the agreements were voluntary and informed.

The courts, after reviewing the agreements, issued orders requiring the debtors and their
attorneys to show cause why they should not be sanctioned for seeking to reaffirm, given the
debtors' inability to pay their living expenses, let alone the additional reaffirmed debts. In
Melendez, the court directed the show-cause orders to eight different debtors and their counsel.
Each court determined that, despite the 1984 amendments to the Bankruptcy Code, it had an
independent duty to review the debtors' reaffirmation agreements under §524(c).⁹

The courts ultimately struck the attorneys' supporting statements under Bankruptcy Rule
9011, nullifying the reaffirmation agreements, because the attorneys appeared to have ignored
the debtors' financial circumstances and failed to advise the debtors of alternatives to
reaffirmation, such as redemption under §722. The Melendez court held that Rule 9011
required attorneys to make a reasonable inquiry based upon "the totality of the circumstances"
before signing a §524(c) declaration. The Bruzzese court required the debtors' counsel to
refund $200 as "excessive compensation" for the services performed for the debtors in
connection with the case. Monetary sanctions were not levied against the attorneys in Hovestadt
or Melendez, but in both cases the court indicated it would consider doing so in the future.

The Melendez court held that, for a §524(c) declaration to pass muster under Rule 9011, a
debtor's attorney must (1) establish whether the debtor can pay the reaffirmed debt; (2)
review the security agreement and sales receipt; (3) verify the creditor's claim and determine
the extent, validity and perfection of the creditor's purported security interest; (4)
independently estimate the value of the collateral; (5) evaluate the risk of replevy by the
creditor; (6) discuss the relevant financial disclosures with the debtor; (7) ensure that the
agreement was entered into voluntarily and without creditor misrepresentations or coercion;
(8) ensure that the debtor understands the effect of the agreement and the consequences of
default; (9) ensure that the debtor is informed as to his options as to the collateral; and (10)
advise the debtor regarding alternative sources of credit.

Although daunting at first blush, the "to do" list can best be addressed by using a new
reaffirmation agreement form offered by the AOUSC.

The AOUSC's Form B240

On June 17, 1999, the AOUSC issued a proposed reaffirmation agreement, Form B240, which
addresses at least some of the concerns raised by Bruzzese and Melendez. An attorney who
follows the form will go a long way toward meeting her obligations of reasonable inquiry under
the circumstances and informing the client of the consequences of reaffirmation.

The form was developed as the result of a recommendation by the National Bankruptcy Review
Commission. In its final report issued Oct. 20, 1997, the commission recommended that the
U.S. Judicial Conference's Advisory Committee on Bankruptcy Rules "prescribe a form motion
for approval of reaffirmation agreements that contains information enabling the court and the
parties to determine the propriety of the agreement."¹⁰ Approval of the motion would not entail
a separate court order, the commission stated.

The commission reported that the use of reaffirmation agreements was far more prevalent than
previously estimated and that §524 did not always work as intended. The commission's report
cited a National Survey of Bankruptcy Debtors commissioned by Visa, which stated that 52
percent of the debtors reported reaffirming one or more debts and that 50 percent of the
reaffirmations filed were for unsecured, nominally secured or undersecured debt. As to the role
of debtor's counsel, the report stated:

Some debtors' attorneys refuse all requests for reaffirmations, while others believe that
debtors can benefit from carefully chosen reaffirmation agreements. However, other
attorneys apparently believe that they should not interfere in the reaffirmation decision. In
the absence of zealous, well-informed counsel, many debtors commit to significant
post-discharge obligations. The burden of economically unwise reaffirmations falls
especially hard on the debtors with the fewest resources to hire careful counsel.¹¹

Using the Form

Given the history of abuses and the trends in case law, debtors' counsel should negotiate
reaffirmation agreements more carefully. Clients and counsel both need to make informed and
defensible decisions where the monetary stakes may be small but the client's stake in her
property is critically important. The following is a brief discussion of how counsel can meet the
debtor's obligations and how the new form can be helpful.

Does reaffirmation impose an "undue hardship?" In evaluating whether a proposed
reaffirmation agreement imposes an "undue hardship," an attorney should first understand her
client's financial situation, as expressed in household income and expenses listed on Schedules I
and J, which she should be prepared to update as needed. While acknowledging that the
Bankruptcy Code does not define "undue hardship," the Melendez court generally offered that it
"would deem reaffirmation to cause a debtor 'undue hardship' where it would result in a
significant, but otherwise avoidable, obstacle to the attainment or retention of necessaries by
the debtor or the debtor's dependents."¹²

If the debtor will realize positive, post-discharge net income, neither the agreement nor the
certification should pose a problem because "payment of a reaffirmed debt cannot constitute an
undue hardship where the funds come from disposable income."¹³ However, if the debtor's
post-discharge expenses will exceed his income and/or the debt exceeds the likely value of any
collateral securing it, the attorney should consider other factors that implicate whether the
debtor's decision to reaffirm is both fully informed and voluntary.

Counsel should consider the type of collateral involved. If the collateral is the debtor's residence
or automobile, reaffirmation may be more justifiable "because those [are] items of
indisputable necessity and substantial value regardless of the terms offered by the creditor and
because failure of the debtor would likely result in foreclosure and replevy..."¹⁴ But for
collateral such as household items, the attorney must evaluate necessity in light of the
replacement cost, "taking into consideration age, obsolescence or other factors that might
render it valueless..."¹⁵

Critically important is an evaluation of whether the creditor will seek to replevy or foreclose
on the collateral, and if it does, whether the client has an alternative. Ultimately, evaluating the
likelihood of repossession is a crucial, and perhaps the most difficult, element of the attorney's
advice.¹⁶

Is the agreement informed and voluntary? The cover page alone of Form B240 helps an attorney
meet her obligation to assure that a reaffirmation agreement is informed and voluntary. The
form's first page is a plainly worded, "Notice to Debtor." It advises that (1) the agreement
gives up the protection of the bankruptcy discharge; (2) the creditor can act to collect the
debts; (3) there is a right of recession; (4) the debtor is not obligated to enter into the
agreement; (5) the debtor can pay the debt without signing the agreement; and (6) there is a
right of redemption.

The attorney should explain the financial terms of the reaffirmation agreement, including
interest on the debt and other associated costs. Form B240 encourages such an explanation by
requiring disclosure of the amount of the debt reaffirmed and the composition of that debt, such
as whether it includes accrued interest, attorney's fees or late fees. It also requires disclosure
of the interest rate, the monthly payment amount, the date upon which payments start, and the
number and amount of payments if paid according to schedule. Further, the form requires
attachment of all court judgments, security agreements and evidence of perfection.

Bruzzese and Melendez require the attorney to check the valuation of the collateral rather than
accept the creditor's statement of value. The form, however, merely requires a creditor's
statement describing the collateral, with assertions regarding value and lien validity. Counsel
would be well advised to go beyond the requirements of the form, with respect to collateral
valuation, to ensure that the requirements of case law are met.

Did the attorney advise on legal consequences? Finally, the attorney should explain the legal
consequences of reaffirmation default, discuss alternatives to reaffirmation such as
redemption, and ensure that the debtor is voluntarily entering the agreement without coercion.
The form's "Notice to Debtor" explains that the agreement gives up the protection of the
bankruptcy discharge and that the creditor may be able to take the debtor's property or wages if
payment is not made. The form requires the debtor to state why she chose not to redeem and
whether she was represented by counsel in the negotiations.

If the attorney performs this entire analysis, which would be aided by the completion of Form
B240, both the interests of the client in deciding whether to reaffirm and the duty of the lawyer
to determine whether the reaffirmation imposes an undue hardship will be served. However, if
after completing the form and a due diligence analysis the attorney cannot, in the exercise of
independent judgment, execute a declaration supporting reaffirmation, she might consider
refusing to affix her signature and filing the reaffirmation agreement without the declaration,
thereby letting the court decide the matter.

In summary, reaffirmation agreements and attorneys' declarations are under increased judicial
scrutiny. The emerging standard for a consumer debtor's attorney counsels a more cautious and
informed approach to reaffirmation. Use of the new Form B240 should aid attorneys in
discharging their duties to both the client and the court, while allowing §524(c) to operate as
intended.

Footnotes

¹ The views expressed in this article are those of the authors and should not necessarily be attributed to the U.S. Department of Justice or the U.S. Trustee Program. Return to article

² 193 B.R. 382 (Bankr. D. Mass. 1996). Return to article

³ 214 B.R. 444 (E.D.N.Y. 1997). Return to article

⁴ 224 B.R. 252 (Bankr. D. Mass. 1998); 235 B.R. 173 (Bankr. D. Mass. 1999). Return to article

⁵ See Capital Communications Federal Credit Union v. Boodrow (In re Boodrow), 126 F.3d 43, 53 (2d Cir. 1997), cert. denied, 118 S.Ct. 1055 (1998); Home
Owners Funding Corp. of America v. Belanger (In re Belanger), 962 F.2d 345, 347-348 (4th Cir. 1992); McClellan Federal Credit Union v. Parker (In re Parker),
139 F.3d 668, 672-673 (9th Cir. 1998), cert. denied, 119 S.Ct. 592 (1998); and Lowry Federal Credit Union v. West, 882 F.2d 1543, 1546-1547 (10th
Cir. 1989). Return to article

⁶ See Bank of Boston v. Burr (In re Burr), 160 F.3d 843 (1st Cir. 1998); Johnson v. Sun Fin. Co. (In re Johnson), 89 F.3d 249, 250-252 (5th Cir. 1996); In
re Edwards, 901 F.2d 1383, 1385-1387 (7th Cir. 1990); and Taylor v. AGE Federal Credit Union (In re Taylor), 3 F.3d 1512, 1516-1517 (11th Cir. 1993). Return to article

⁷ 234 B.R. 567 (Bankr. D. N.H. 1999). Return to article

⁸ 226 B.R. 924, 926 (Bankr. S.D. Fla. 1998). Return to article

⁹ Recently, the district court for the District of Massachusetts, concurring with the position of the U.S. Trustee, affirmed that bankruptcy courts "possess an independent obligation to ensure that the elements of §524(c) are satisfied," even when reaffirmation agreements are accompanied by attorneys' declarations. In re Nanton, __B.R.__, 1999 WL 781674, Sept. 24, 1999. Return to article

¹⁰ Final Report of the National Bankruptcy Review Commission at 145-146. Return to article

¹¹ Id. at 154. Return to article

¹² In re Melendez, 224 B.R. at 261. Return to article

¹³ Id. at 270, n. 23. Return to article

¹⁴ Id. at 181, n. 2. Return to article

¹⁵ Id. at 197-199. Return to article

¹⁶ Id.; 224 B.R. at 273, n. 30. Return to article