Assumption of a Lease vs. Reaffirmation

A reaffirmation agreement continues the personal liability of a debtor in secured property after the bankruptcy discharge. A reaffirmation agreement must be approved by the bankruptcy court before it is effective. Essentially, if the debtor purchases a vehicle with financing, and wants to keep it after bankruptcy, he will be asked to execute a reaffirmation agreement by the lender. According to 11 U.S.C. § 521(a)(6), if the debtor fails to reaffirm or redeem the vehicle within 45 days after the first 341 Meeting of Creditors, the automatic stay is terminated and the lender may repossess the vehicle – even if the debtor is current on the payments!  See In re Dumont, 581 F. 3d 1104 (9th Cir. 2009).

Assuming or rejecting leases (and executory contracts) in bankruptcy is detailed in Section 365. This Section and area of the law has been described as “psychedelic.” See In re Drexel Burnham Lambert Group, Inc., 138 B.R. 687 (Bankr. S.D.N.Y. 1992) (quoting Westbrook, A Functional Analysis of Executory Contracts, 74 Minn. L. Rev. 227, 228 (1989)). The part relevant to personal property is found in Section 365(p):

If a lease of personal property is rejected or not timely assumed . . . the leased property is no longer property of the estate and the stay under section 362 (a) is automatically terminated. . . . If the debtor in a case under chapter 7 is an individual, the debtor may notify the creditor in writing that the debtor desires to assume the lease. Upon being so notified, the creditor may, at its option, notify the debtor that it is willing to have the lease assumed by the debtor and may condition such assumption on cure of any outstanding default on terms set by the contract. . . .

When read together with the relevant part of § 365(d):

In a case under chapter 7 of this title, if the [debtor inheriting the trustee’s power to assume the lease pursuant to § 365(p)] does not assume or reject an executory contract or unexpired lease of . . . . personal property of the debtor within 60 days after the order for relief, or within such additional time as the court, for cause, within such 60-day period, fixes, then such contract or lease is deemed rejected.

Section 365 requires the debtor to assume a lease in personal property, rather than to reaffirm the lease.

All courts agree that the bankruptcy court plays no part in the assumption or rejection of a debtor’s personal property lease, but there is confusion over whether assumption of a lease continues any personal liability after discharge. Collier explains it this way:

If the debtor then assumes the lease, the liability under the lease will be assumed by the debtor and not the estate. However, because there is no reaffirmation of the lease debt, it is not entirely clear what this means. Personal liability on the lease will ordinarily be discharged if the chapter 7 discharge is entered, presumably even if the lease is assumed.

See 1-15 Collier Consumer Bankruptcy Practice Guide ¶ 15.04[8].

Courts are split in the interpretation of Section 365 in regard to personal liability. The majority of courts find that assumption of a lease is not the same as reaffirmation, and, therefore, the debtor’s personal obligation under the lease is extinguished by the discharge. See, e.g., In re Eader, 426 B.R. 164 (Bankr.D.Md. 2010); and In re Creighton, 427 B.R. 24 (Bankr.D.Mass. 2007). These courts point to the necessity of a reaffirmation agreement under Section 524(c) and Federal Rule of Bankruptcy Procedure 4008 to continue the debtor’s personal obligation, and that the bankruptcy discharges “personal liability of the debtor, whether or not discharge of such debt is waived.” See 11 U.S.C. § 524(a)(2).

A minority of courts find that assumption of a lease binds the debtor to the original lease terms and the discharge has no effect on the debtor’s assumed obligation. The court in In Re Mortensen, 444 B.R. 225 (Bankr. E.D.N.Y. 2011), found:

Once a lease is assumed, it is assumed cum onere and the Debtor is bound to accept the obligations and the benefits. See NLRB v. Bildisco and Bildisco, 465 U.S. 513, 531-32, 104 S.Ct. 1188, 79 L.Ed.2d 482 (1984); and In re Shangra-La, Inc., 167 F.3d 843, 849 (4th Cir.1999) (citation omitted). In exchange for the right to retain the lessor’s property for her use, the Debtor cannot assert that the Debtor has been discharged of her obligations under the Lease the discharge injunction simply does not apply.

Most courts will find that assuming a lease creates a kind of non-recourse situation. The debtor is entitled to keep and use the leased property, but has no personal liability for default. Lenders, especially auto finance companies, have different perspectives on leased vehicles in bankruptcy. Some lenders require short lease assumption documents, while others compel the debtor to file a reaffirmation of the lease obligation with the bankruptcy court.

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