Chapter 7 Bankruptcy: What Happens With Car Financing?

When a debtor files Chapter 7 bankruptcy in California, the debtor will likely be requested to reaffirm their car financing debt.  Most consumer credit agreements for cars include a provision that defines filing bankruptcy as an act of default.  If the debtor is current on payments, and the only default is filing bankruptcy, this is known as “ipso facto” default.  Unlike some states, California does not have a law that prohibits a creditor from enforcing ipso facto default in a consumer credit agreement.  So a creditor, like Ford Motor Company, can enforce an ipso facto default in California.  In other words, the creditor can repo the car if the debtor files a chapter 7 bankruptcy and does not agree to complete and sign a Reaffirmation Agreement.

If the debtor signs a reaffirmation agreement that is approved by the bankruptcy court, the "ipso facto" default dissolves.  To execute a Reaffirmation Agreement in Chapter 7 means the debtor is agreeing that he/she will owe an outstanding balance on the car.  The order that discharges the debtor's other debts will not apply to the reaffirmed car loan debt.

A debtor does not have to reaffirm the debt.  Sometimes its better to not reaffirm debt, especially when the financing terms are very expensive compared to the present value of the car.  For instance, if a car is financed for $15,000 at 5% interest with 4 years of payments remaining, and the car is only worth $8,000, it would be in the debtor's interest to not reaffirm the debt.

If the debtor refuses to timely enter into a reaffirmation agreement, then the automatic stay terminates on day 31, as per 362(h).  That means that the creditor would have recourse to repo the car anytime thereafter.  

Sometimes, the bankruptcy Judges in Fresno will not let a debtor reaffirm a car loan debt.   A judge can find undue hardship to the debtor if the debtor would take on the old car loan debt. If this happens, the car could be repo'd by the car lender, as explained above.  Just because the lender has the legal right to repo a car, does not mean that it will.  Many times a car lender will hold off on exercising this right so long as the debtor is current with payments.  The choice of whether a car gets repo'd in this scenario, is entirely up to the lender.  The debtor has no legal right to prevent a repo.

Picture by Moyan Brenn on Flickr