Redeeming Personal Property in a Chapter 7 Case
Summary: Many debtors—and a few attorneys—are unaware that the Bankruptcy Code provides a way for debtors in a chapter 7 case to "redeem tangible personal property intended primarily for personal, family, or household use, from a lien securing a dischargeable consumer debt, if such property is exempted [by the debtor] . . . or has been abandoned . . . [by the trustee], by paying the holder of such lien the amount of the allowed secured claim of such holder that is secured by such lien in full at the time of redemption." 11 U.S.C. § 722. There is quite a bit to unpack here, but at bottom, almost any non-commercial physical personal property subject to a security interest can be exempted and redeemed in a chapter 7 case.
Many debtors—and a few attorneys—are unaware that the Bankruptcy Code provides a way for debtors in a chapter 7 case to "redeem tangible personal property intended primarily for personal, family, or household use, from a lien securing a dischargeable consumer debt, if such property is exempted [by the debtor] . . . or has been abandoned . . . [by the trustee], by paying the holder of such lien the amount of the allowed secured claim of such holder that is secured by such lien in full at the time of redemption." 11 U.S.C. § 722. There is quite a bit to unpack here, but at bottom, almost any non-commercial physical personal property subject to a security interest can be exempted and redeemed in a chapter 7 case.
It's important to note that this section only applies in chapter 7 cases, and it expressly does not apply to intangible property (such as intellectual property, leases, or other contracts). Nor does it apply to real property such as the debtor's home or other real estate. Finally, it does not apply to any property not intended for personal, family, or household use, such as the debtor's business or property of such a business. The most common property subject to redemption is the debtor's personal automobile.
The Bankruptcy Code also requires that the property redeemed from a lien relate to "consumer debt" (as that term is defined in 11 U.S.C. § 101(8) to "mean debt incurred by an individual primarily for a personal, family, or household purpose") and be dischargeable (thus ruling out cases in which the loan was obtained through fraud or on the basis of a loan application containing "materially false" written statements (see generally, 11 U.S.C. § 523)).
Exemption is not a significant bar to redemption because redemption is used in negative equity situations, when the debtor is upside-down on the property—that is, when the value of the property is less than the outstanding loan amount. In such situations, there is no equity to exempt, and so even in cases in which there is property to distribute to creditors, upside-down property can always be exempted. The key is for the debtor to do so in the schedules—either as filed or amended.
As to the mechanics of redemption, the debtor must usually obtain financing—often by way of what is often referred to in the industry as a "722 redemption loan"—to repay the lender the value of the collateral. This is what section 722, in conjunction with 11 U.S.C. § 506(a)(1) (setting forth the value of an "allowed" "secured claim"), means in practical terms by "paying the holder of such lien the amount of the allowed secured claim of such holder that is secured by such lien." Three issues arise in this context. First, may the debtor use nonexempt funds—ordinarily reserved to pay the claims of other creditors, such as general unsecured creditors—to fund the redemption? No Bankruptcy Code provision appears to expressly prohibit this, though such an transaction would undoubtedly be carefully scrutinized pursuant to 11 U.S.C. § 547 as a preference and 11 U.S.C. § 707(b) as abusive. In most cases, however, debtors do not have cash on hand or other assets, property of the estate or traceable thereto (since after-acquired property is not generally property of the estate and therefore not required to be exempted), in an amount sufficient to redeem property, or to make a significant contribution towards redemption, so that the issue is moot in most cases. Second, as a practical matter, redemption loans are often made on unfavorable terms at high interest, and attorneys and lenders usually add their fees to the loan's principal. Thus, there must be sufficient savings to the debtor (measured in terms of the difference between the outstanding loan balance and the value of the redeemed property), or utility of the redeemed property vis-à-vis a substitute, to justify the costs of redemption. Third is the issue of valuation. In the context of redemption, this is probably the most contested issue, and courts have struggled to determine value, as some apply a wholesale standard, while others apply a replacement standard (cf. In re Perez, 318 B.R. 742, 747 (Bankr. M.D. Fla. 2005) (applying a "wholesale/liquidation-value standard" after a lengthy discussion in view of Associates Commercial Corp. v. Rash, 520 U.S. 953 (1997)); In re Pearsall, 441 B.R. 267 (Bankr. N.D. Ohio 2010) (applying the replacement value standard of Rash)).
Finally, court approval may be required pursuant to Fed. R. Bankr. P. 6008: "On motion by the debtor, trustee, or debtor in possession and after hearing on notice as the court may direct, the court may authorize the redemption of property from a lien or from a sale to enforce a lien in accordance with applicable law." (A 2001 New York case, Sears, Roebuck & Co. v. Spivey, 265 B.R. 357 (E.D.N.Y. 2001), declined to require a motion, while Pearsall, 441 B.R. at 272, noted in dicta that "[r]elief under § 722 must be requested by motion[,]" citing Rule 6008. It is this author's opinion that the latter represents the safer course of action for debtor's counsel, and is perhaps more in keeping with the bankruptcy court's authority pursuant to 11 U.S.C. § 105 and inherent powers to oversee bankruptcy proceedings, and in case the creditor objects—for instance, on valuation grounds.) An interesting caveat is that property may be redeemed "from a sale to enforce a lien." Fed. R. Bankr. P. 6008. This statement, however, is unclear as to whether a sale could be reversed (the process of redemption "from a sale" could logically mean either from a planned sale or from a previously-consummated sale).
In sum, redemption in a chapter 7 case, in appropriate situations, can relieve a debtor of burdensome installment payments while benefiting from the liquidation provisions of chapter 7 (not, e.g., requiring years of payments through a chapter 13 plan).
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