Redemption Of Secured Collateral In A Chapter 7 Bankruptcy

Overland Park Bankruptcy Attorney

It is not well known, but a debtor in a Chapter 7 bankruptcy can redeem secured property using Section 722 of the Bankruptcy Code.  What does it mean to “redeem” property?  Redemption means that a secured debt on some secured collateral (e.g., car, boat, trailer, furniture, etc) can be paid off completely by paying the loan to the fair market value of the collateral, rather than the full loan balance.  In the process, the debtor can save literally thousands of dollars.

How this works can be illustrated by an example.  Suppose a debtor has a car that is only worth (using a valuation from, say, Kelly Blue Book or NADA) $5500.  Yet the loan on the car has a balance of about $11500.  Now suppose the debtor files a Chapter 7 bankruptcy. The debtor can “redeem” the collateral, and own it free and clear of the lien, by paying off the car loan in one lump sum of $5500.

The debtor receives the discharge as well as the title on the car, and the loan is fully paid off.  Basically, using the bankruptcy, the creditor is paid in full to the value of the collateral, rather than to the loan balance.  This can be done to any secured collateral (except a debtor’s personal residence), such as boats, trailers, furniture, household goods, etc.

Some conditions need to be met before this can happen.  First, a valuation has to be decided on.  In Kansas and Missouri, for example, car values are regularly assessed using either Kelly Blue Book or NADA values, depending on the state.  The issue here is often that the parties (creditor and debtor) may disagree on what a piece of collateral is actually worth.  Still, creditors understand the time value of money, and more often than not are willing to be very reasonable when they know they are getting a large lump sum.  As the old adage says, money talks.  Creditors understand this.

In addition, the property must either be exempt or the Trustee must abandon his interest in it.  For redemption under Section 722, the Trustee must either abandon his interest in the property, or it must be exempt.  Court approval would also need to be sought, which is usually not a problem.  The filing of a motion with an opportunity for objection deadline, stating the details of the redemption, will accomplish this purpose.  The major hurdle in redemption is, of course, the ability of a debtor to raise a relatively large amount of cash to complete the redemption.

Note that a redemption is not the same thing as a cramdown.  In both instances, the collateral is being paid to fair market value.  But in a redemption, the collateral is being paid off all at once; in a cramdown, the payoff takes place over time in a Chapter 13 or Chapter 11.

In most instances, debtors are able to get help from friends, family, or some other collateral source to pay off a redemption.  The payment cannot be done by installments; one lump sum is needed.  Although there are lending agencies that are willing to provide loans for this purpose, in practice we see that most people get the funds from a relative or other personal source.  The benefits of a redemption can often just be too good to pass up.  While not every debtor is able to do a redemption, it can happen in certain circumstances.  It is well known that boats, trailers, cars, jewelry, and household good depreciate tremendously in a short period of time.  Redemption is a way of using this financial reality to your advantage, and contributing to your fresh start.

Read More:  Cramdowns In A Chapter 13 Bankruptcy