Compliance Blog

Generally, once a bankruptcy case closes, the bankruptcy judge issues an order of discharge and the debtor is discharged of all dischargeable debts. Once a debt has been discharged, a credit union is barred from attempting to collect on that debt. However, if your credit union has a security interest in the debtor’s property, all may not be lost. A bankruptcy discharge does not normally void a creditor’s security interest in the debtor’s property. As such, while a creditor cannot hold a debtor personally liable on a discharged debt, it may still act to enforce its security interest in the property that secured the debt.

If a credit union wants to enforce a lien post-discharge, it may want to take care to avoid the appearance of taking action against the discharged member personally, such as communicating to the member that they owe a debt and are delinquent. Collecting or appearing to collect from the discharged debtor could very well land the credit union in some hot water. Furthermore, if a credit union uses a third-party vendor to enforce its security interest, it may want to review the vendor’s procedures for dealing with discharged members to help ensure that the credit union does not become liable through the vendor’s actions. That is why it is important to work with a local attorney you trust when enforcing a security interest, such as through foreclosure, against a discharged debtor.

Credit unions may also want to note that enforcing the security interest is not the only option. While it is prohibited to take action against a member, a credit union may still accept voluntary payments from a discharged member in exchange for agreeing to not enforce their lien on the member’s property. Credit unions should be careful that staff understand that the credit union is not collecting from the discharged debtor and that the discharged debtor is not personally liable to the credit union. If a credit union is accepting payments that, but for the discharge, would have been pursuant to a residential mortgage loan, the credit union may want to review Regulation Z, section 1026.41(e) and (f) to see whether the credit union is required to send a periodic statement and what the periodic statement should include. This NAFCU blog discusses this requirement in greater detail.

While enforcing a security interest and collecting voluntary payments are fine options, an even better option may be to avoid discharge altogether. If you think so, you may want to consider a reaffirmation agreement. In a reaffirmation agreement, the debtor agrees to repay a debt that would otherwise be discharged. Generally, debtors only reaffirm secured credit and only if they want to keep the property securing the loan. A reaffirmation agreement can reaffirm all or some of the debt owed to a credit union and it is up to the credit union and debtor to negotiate the details.

If a debtor and credit union would like to reaffirm a debt, they will need to file documents with the court. Unfortunately, what documents to file depends on where the bankruptcy court is located. A court in West Virginia and a court in Utah may have different requirements and procedures for filing a reaffirmation agreement and these requirements may be difficult to navigate. As such, if a credit union wants to reaffirm a debt, they may want to speak to counsel sooner rather than later. Don’t expect the debtor to reach out, even if they would like to reaffirm.

Please note that there are other exceptions and requirements regarding discharge that were not discussed above. If a credit union is unsure of how to proceed post-bankruptcy, it should speak to counsel for advice.

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