Be Careful With Post-Discharge Debts

Section 524 of the Bankruptcy Code states that a pre-bankruptcy debt survives discharge when a reaffirmation agreement is executed between the debtor and creditor and filed with the bankruptcy court. But is that the only way? Bankruptcy courts have historically agreed that absent the reaffirmation agreement, a post-petition agreement to repay a discharged debt is not a valid affirmation agreement even where the new debt contains additional consideration. In other words, if the debtor makes a post-bankruptcy agreement that includes re-obligating himself to pay a discharged debt, the creditor cannot enforce the agreement if the debtor breaches.

Recently the Sixth Circuit has recently gone the other direction which may indicate a shift in the prevailing thought. The U.S. Bankruptcy Court for the Northern District of Ohio has adopted and applied a “new consideration” argument. In In re Heirholzer, 170 B.R. 938 (Bankr. N.D. Ohio 1994), the debtor discharged his personal obligation for his home mortgage in bankruptcy and the lender started making plans to foreclose. After the mortgage debt was discharge, the debtor executed a new promissory note and mortgage three weeks to prevent the bank from foreclosing on his property. Subsequently, the debtor defaulted on his payments and the bank obtained a personal judgment against him. The debtor challenged the judgment, stating that it represented debt that had been discharged in his bankruptcy.

The Northern Ohio Bankruptcy Court determined that the post-bankruptcy promissory note did not constitute a previously discharged debt. The court focused on the fact that the second promissory note established a new and enforceable contract – the lender agreed to forebear a foreclosure on the home in exchange for the new promissory note. Recognizing that the bank had “every right to proceed in foreclosure on the mortgage,” the court found that the “decision to forego foreclosure represent[ed] new and sufficient consideration to support a binding post-discharge obligation.” As such, the second promissory note represented a valid debt and the deficiency judgment against the debtor was up held.

Recently, the U.S. Bankruptcy Appellate Panel for the Sixth Circuit Court of Appeals adopted Heirholzer’s “new consideration” exception. In In re Martin, No. 11-8052, 2012 Bankr. LEXIS 806 (6th Cir. B.A.P.Mar. 7, 2012), the court stated that “[e]xecuting a new promissory note to repay a debt that was discharged in order to avoid a foreclosure on debtor’s home is new consideration that supports a finding of a valid post-discharge agreement.” In the Sixth Circuit, if all a lender gives a debtor is the forbearance of its execution rights, a new agreement can be enforceable personally against a debtor despite a bankruptcy discharge.

Bankruptcy debtors need to be aware not only of the existing case law concerning bankruptcy issues, but also the trends that courts in other circuits are taking. If this particular trend takes hold in other circuits, it will cast doubt on the protection afforded by the bankruptcy discharge.