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Sixth Circuit: Creditor did not Violate Chapter 7 Discharge Injunction While Negotiating Release of Lien

FinancesOnce a Chapter 7 debtor receives a discharge of personal debts, creditors are enjoined from taking action to collect, recover, or offset such debts. However, unlike personal debts, liens held by secured creditors “ride through” bankruptcy. The underlying debt secured by the lien may be extinguished, but as long as the lien is valid it survives the bankruptcy.

In a recent case, Duane L. Bentley v. OneMain Financial Group, LLC,[1] the Bankruptcy Appellate Panel of the Sixth Circuit (the “BAP”) considered whether a lien holder, OneMain Financial Group, LLC (“Creditor”), violated the discharge injunction when it, according to the Debtor, refused to release its lien on a vehicle that the Debtor surrendered during his Chapter 7 case. The lower courts ruled in favor of the Creditor, finding that the Creditor’s actions did not violate the discharge injunction, and the BAP affirmed.

Case Background

In 2017, the Debtor received a loan from the Creditor and granted Creditor a lien on a vehicle Debtor purchased. In 2018, the Debtor filed a Chapter 7 bankruptcy petition The Debtor’s schedules included the Creditor’s $8,000 claim secured by the vehicle, which Debtor valued at $150. The Debtor stated his intention to surrender the vehicle to the Creditor with his petition. The Debtor did not reaffirm the debt to the Creditor before entry of his discharge, and the Creditor’s lien was not avoided or eliminated in the bankruptcy. The Creditor received notice of entry of the discharge, and the Debtor never paid the balance of Creditor’s claim.

Following the discharge, the Debtor and Creditor engaged in several conversations concerning the vehicle lien. The Debtor sought to have the Creditor release its lien in order to sell or dispose of the vehicle, which the Debtor alleged had only $150 in value. The Creditor indicated its willingness to release the lien, but only in exchange for any value paid by a buyer or salvage yard for the vehicle.

No deal was reached between the parties, and the Debtor filed a motion to reopen its bankruptcy case for the purpose of pursuing Creditor for an alleged violation of the discharge injunction. The case was reopened and both parties filed motions for summary judgment. The Creditor’s motion, which argued that it did not violate the discharge injunction, was granted. The Debtor appealed to the district court, which affirmed, and appealed again to the BAP.

The Court’s Analysis

Section 524(a)(2) of the Bankruptcy Code, which is meant to give a debtor a “fresh start,” provides that a discharge “operates as an injunction against the commencement or continuation of an action, the employment of process, or an act, to collect, recover or offset any . . . debt [discharged under section 727 . . . of this title] as a personal liability of the debtor, whether or not discharge of such debt is waived[.]”

While the discharge injunction prevents a creditor from attempting to collect a discharged debt “as a personal liability of the debtor,” it does not affect a creditor’s in rem rights, such as a valid lien, in the collateral. Liens ride through the bankruptcy, despite the discharge. To the extent a court finds that a creditor has violated the discharge injunction, it can enforce the injunction through its civil contempt power and, in appropriate circumstances, impose sanctions.

In this case, the Debtor argued “that Creditor’s failure to release its lien on the Vehicle was objectively coercive and constituted a sanctionable violation of the discharge injunction.” The Debtor relied upon a case (Pratt v. GMAC (In re Pratt)) from the U.S. Court of Appeals for the First Circuit in support of its argument. In Pratt, which also involved a lender with a lien on a vehicle, the First Circuit concluded that the lender had objectively coerced the debtor into repaying a discharged debt as a personal liability. However, in the Pratt case the lender refused to release its lien until the loan balance for what was described as a “worthless vehicle” was paid in full.

The BAP rejected the Debtor’s attempt to point to Pratt as the basis for finding that the Creditor violated the discharge injunction. The BAP explained that the critical facts of each case made them dissimilar, stating that the Debtor “distorts the factual differences between his case and those in Pratt and misconstrues the First Circuit’s holding.” For one, the vehicle in Pratt was worthless, while the vehicle at issue in this case was listed as worth $150 on Debtor’s schedules. In addition, unlike in the current case, the creditor in Pratt refused to release the lien unless and until the debtors paid the full amount discharged in the Chapter 7 case. In this case, the Creditor merely responded to offers proposed by the Debtor, and never demanded that the full loan balance (previously discharged) be paid.

The BAP addressed several other flaws in the Debtor’s argument. The overarching conclusion the BAP reached, in upholding the lower court decisions in favor of the Creditor, is that a creditor with a valid lien that rides through the bankruptcy may negotiate a settlement with a debtor before releasing its lien. Determining whether a creditor violates the discharge injunction during such negotiations requires a factual analysis. In this case, the BAP found that the Creditor, who did not condition its release of its lien on full repayment of the loan and merely responded to offers and posed options for resolving the matter, acted properly.

If you have any questions about this case, or bankruptcy issues in general, please contact Patricia Scott at 517.371.8132 or at pscott@fosterswift.com.

[1] Case No. 19-8026 (6th Cir. BAP, Decided July 8, 2020).

Categories: 6th Circuit Court of Appeals, Chapter 7

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 concentrates her practice in the areas of Bankruptcy, Finance, Collections, Real Estate, and Commercial Litigation. In the bankruptcy area she represents creditors and Chapter 7 Trustees in all aspects of bankruptcy. Patricia also represents small and mid-sized businesses to large corporations in multi-faceted litigation matters in state and federal court. Her work with financial institutions includes collections, loan workouts, foreclosures, receiverships and various complex banking and finance issues. 

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