Debtors Beware Reaffirmation Agreements Can Be Hard to Rescind

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Mar 2001

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The grounds for setting aside reaffirmation agreements are limited after the time to
rescind has expired. Reaffirmation agreements are not favored by bankruptcy courts and
are strictly construed based on conventional contract principles.<a href="#1" name="1a">1</a>

Debtor's counsel should generally discourage reaffirmation of unsecured debts.<a href="#2" name="2a">2</a> Section
524(c) and (d) governs the requirements of reaffirmation agreements and their
enforceability ("The rules governing enforcement of reaffirmation agreements are
intended to protect debtors from compromising their fresh start by making unwise
agreements to repay dischargable debts.").<a href="#3" name="3a">3</a>

Reaffirmation agreements generally constitute a new contract between the chapter 7
debtor and the creditor, are generally construed by their plain language and legally
bind the debtors to pay pre-petition debts that would otherwise be discharged.<a href="#4" name="4a">4</a>
Neither party can be compelled to enter into a reaffirmation agreement, and either may
condition their approval of the reaffirmation within the law of reasonableness.<a href="#5" name="5a">5</a> It
has also been held that the court cannot issue a rule prohibiting the reaffirmation
of unsecured debt.<a href="#6" name="6a">6</a>

The requirements of the reaffirmation agreement are set out in §524(c). A
reaffirmation agreement is not subject to court review if the debtor is represented by
an attorney during the course of negotiating the agreement. The only time that the
court reviews a proposed reaffirmation agreement is when the debtor is not represented
by an attorney and when the agreement is based in whole or in part on a consumer
debt that is not secured by real property of the debtor.<a href="#7" name="7a">7</a> The debtor may rescind
the agreement prior to discharge or within 60 days after the agreement is filed with
the court, whichever occurs later.<a href="#8" name="8a">8</a>

Under what authority may the court set aside the reaffirmation agreement? In view
of the fact that the reaffirmation agreement is construed based on contract principles
and the parties are free to contract any reasonable language, the courts have been
loathe to modify the contract in the absence of a showing of mutual mistake. Upon
conclusion of the 60-day time period to rescind the reaffirmation agreement, the
agreement becomes legally binding on the debtor to pay pre-petition debts that would
otherwise be dischargable, and the bankruptcy court is powerless to provide a remedy
after the expiration of the rescission period.<a href="#9" name="9a">9</a>

<h3>Changed Financial Circumstances</h3>

In the case of <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Curcio, 242 B.R. 192 (Bankr. S.D. Fla.
1999)</a>, the court rejected a chapter 7 debtor's request to rescind a reaffirmation
agreement when the debtor's financial circumstances had changed after the entry of the
agreement and after the finding that it would not impose undue hardship. The court
held that the agreement becomes enforceable to the same extent as if the debtor had
never filed for bankruptcy relief and that the court was powerless to set aside the
agreement. This was in keeping with an earlier Florida decision, <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re McCrelass,

141 Br. 223 (Bankr. N.D. Fla., 1992)</a>, in which the court held
that a reaffirmation agreement could not be rescinded after the time period even though
there was a finding, after the expiration of the time to rescind the agreement, that
continued performance under the agreement would impose an undue hardship on the debtor.

<h3>Mutual Mistake</h3>

Generally speaking, the courts will only allow a reaffirmation to be rescinded after
the statutory time period when there has been a mutual mistake. This has generally
arisen in cases involving the debtor executing a reaffirmation agreement and the
subsequent avoidance by the trustee of the secured creditors' lien. The question became
whether the debtor continued to be liable under the reaffirmation agreement even though
the time to rescind the agreement had expired. In the case of <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Beaton,
211 B.R. 755 (Bankr. N.D. Ala., 1997)</a>, the court recognized that
the debtor's reaffirmation was based on the mistaken belief of the debtor and mortgagee
that the trustee had abandoned the real properties that secured the reaffirmed debts.
It was patently obvious that the debtor would not have reaffirmed the debt if it was
merely an unsecured claim. Accordingly, the court agreed that the debtors could
rescind the reaffirmation agreement on the basis of mutual mistake.<a href="#10" name="10a">10</a>

In the case of <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Ollie, 207 B.R. 586 (Bankr. W.D. Tenn.
1997)</a>, the creditor moved to rescind the agreement on the grounds of a unilateral
mistake when the creditor's attorney thought that the reaffirmation agreement was related
to a non-purchase money account and the creditor indicated that it would not have
reaffirmed the purchase money account for less than the full amount owing. The debtor,
however, was unaware of the creditor's mistake. The court held that it would only
set aside the reaffirmation contract based on the unilateral mistake if enforcement would
make the contract unconscionable, which the court declined to find in this case since
the debtor received no windfall on account of the mistake.

In a more recent interesting twist, the 9th Circuit BAP in the case of <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…
re Reinertson, 241 B.R. 451 (9th Circuit BAP, 1999)</a>, reversed the
bankruptcy court's order vacating its approval of the reaffirmation agreement on the
grounds that an order can be set aside only for a mistake up to one year after the
entry of the order under Rule 60(b) of the Federal Rules of Civil Procedure.
Here, the requested relief from the order was more than one year after the entry
of the order approving the reaffirmation agreement. However, the 9th Circuit BAP
specifically did not address the issue of the authority of the bankruptcy court to
rescind the reaffirmation agreement or to limit the enforcement of the reaffirmation
agreement, in view of the avoidance of the creditors security interest in the motor
vehicle as preferential.

<h3>Conclusion</h3>

Reaffirmation agreements are interpreted according to ordinary contract terms and,
in the absence of mutual mistake, the contracts will be interpreted according to their
plain language. Accordingly, attorneys for both debtors and creditors should take great
care in the decision to reaffirm a debt and in the wording of such agreements.

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<h3>Footnotes</h3>

<a name="1">1</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… of Turner, 156 F.3d 713 (7th Cir. 1998)</a>. <a href="#1a">Return to article</a>

<a name="2">2</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… of Nidiver, 217 B.R. 581 (Bankr. D. Neb. 1998)</a>. <a href="#2a">Return to article</a>

<a name="3">3</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Nations Credit Financial Services Corp., 233 B.R. 98, 107 (N.D. Cal. 1999)</a>. <a href="#3a">Return to article</a>

<a name="4">4</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Saunders, 169 B.R. 192 (Bankr. W.D. Mo. 1994)</a>. <a href="#4a">Return to article</a>

<a name="5">5</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Jefferson, 144 B.R. 620 (Bankr. D. R.I. 1992)</a>. <a href="#5a">Return to article</a>

<a name="6">6</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Kinion, 207 F.3d 751 (5th Circuit, 2000)</a>. <a href="#6a">Return to article</a>

<a name="7">7</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §524(d)(2)</a>. <a href="#7a">Return to article</a>

<a name="8">8</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §524(c)(4)</a>. <a href="#8a">Return to article</a>

<a name="9">9</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Saunders, 169 B.R. 192 (Bankr. W.D. Mo. 1994)</a>. <a href="#9a">Return to article</a>

<a name="10">10</a> See, also, <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Hitt, 137 B.R. 401 (Bankr. D. Mont. 1992)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Ford Motor Credit Co. (In
re Mandrell), 50 B.R. 593 (Bankr. M.D. Tenn. 1985)</a>; and <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Eassa, 19 B.R. 153 (Bankr. S.D. Ohio. 1982)</a>. <a href="#10a">Return to article</a>

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Journal Authors

Thomas E. Ray

Journal Date

Thursday, March 1, 2001 - 12:00

Bankruptcy Rule

2001