One of the purposes of a bankruptcy reorganization (individual or corporate) is for the debtor to shed himself or herself of obligations that are no longer helping the debtor. Often, secured collateral is dragging down the debtor, and preventing him from getting a fresh start.
In personal cases, sometimes car loans, home loans, equipment loans, and other types of secured collateral needs to be “surrendered” (i.e., given back) to the lender. In business cases, it often happens that business equipment or real estate of all types will need to be given back to the lender. The surrender of collateral can present some issues that should be kept in mind.
In a Chapter 7 liquidation, the debtor simply declares his intention with regard to the collateral when the case is filed. If surrender is the preferred option, then the collateral (car, house, boat, trailer, equipment, etc) is turned over to the creditor. In practice, this means that the creditor is contacted and some type of coordination is made for the pickup of the collateral (i.e., a repossession).
While the collateral is in the debtor’s possession, insurance should be maintained, and the collateral should be adequately safeguarded from wastage or destruction. If the Chapter 7 case is an asset case (i.e., if the trustee has discovered assets to distribute to the unsecured creditors) then the secured creditor may file a deficiency claim to share pro rata in the dividend to the unsecured creditors.
However, surrendering collateral in Chapter 13 or Chapter 11 cases presents another nuance. In these types of bankruptcies, a debt has the option of asking to “surrender In lieu” of the entire debt. What does this mean? Surrendering in lieu of a debt means that the secured creditor can only repossess the collateral; it cannot file a “deficiency claim” in the case. A deficiency claim is a general unsecured claim that represents the remainder of the loan balance after the secured collateral is repossessed and sold off. If a debtor surrenders in lieu of the debt, and the Chapter 11 or Chapter 13 plan is confirmed as such, then the creditor cannot share in any possible dividend that may be provided for the unsecured creditors. And in some instances, this can be a big deal, especially in plans where the general unsecured creditors are receiving a large dividend. However, it is our experience that if a secured creditor objects to “surrender in lieu” language in a plan, bankruptcy judges are usually willing to permit them to file a deficiency claim.
But this is not always the case. Creditors need to be reviewing plans carefully to see how their debts are being treated. Failing to object to their treatment can mean that, once the plan is confirmed, they are bound by the plan’s language. In In Re Basham, 167 B.R. 903 (W.D. Mo. 1994), the bankruptcy court specifically approved the res judicata effect of a confirmed plan providing for surrender in lieu of the entire debt. Under Basham, the court enunciated the principle that when a plan calls for surrender in full satisfaction of a creditor’s claim, that creditor is barred from filing a post-repossession deficiency claim. I have been involved in bankruptcy litigation in which a large institutional creditor’s repeated failure to object to my client’s Chapter 13 plan enabled us to achieve a very favorable outcome for her reorganization. In our situation, using the “surrender in lieu” language was a tremendous benefit to my client.
Under In Re Carter, 390 B.R. 648 (W.D. Mo. 2008), Judge Federman made it clear that “surrender” meant a “return of property and a relinquishing of possession or control to the holder of the claim.” It did not require that a debtor transfer title by executing and delivering a title or deed to effectuate surrender. Taken together, the Basham and Carter cases stand for the idea that when a plan calls for “surrender in lieu” of a debt, and the secured creditor fails to object, then the creditor is bound by the terms of the confirmed plan and can no longer file any deficiency claim. Essentially, at that point the creditor is not really even a party to the case. For a debtor, then, “surrendering in lieu” can be a powerful tool in certain situations.