The Ninth Circuit found that a debtor who assumes a lease under Section 365(p) of the Bankruptcy Code waives her right to discharge of debt arising out of that lease. Bobka v. Toyota Motor Credit Corp., No. 18-55688 (9th Cir. Aug. 3, 2020).
The debtor filed her chapter 7 petition in 2016. She had an ongoing lease with Toyota Motor Credit on her Toyota Rav4. The trustee opted not to assume the lease. In September 2016, the debtor called Toyota about keeping the vehicle. Toyota agreed and sent her and her attorney a lease assumption agreement. She did not return the agreement until December 5, well more than 30 days after she orally told Toyota she wanted to keep the vehicle. The next day, the debtor received her bankruptcy discharge.
Subsequently the debtor fell behind on the lease payments and ultimately surrendered the vehicle to Toyota. She did not pay her overdue balance from the lease and argued that the debt was discharged in bankruptcy and that her assumption of the lease was ineffective.
In the face of Toyota’s continued efforts to collect the outstanding payments, the debtor filed a motion for sanctions in the bankruptcy court. She alleged Toyota violated the automatic stay by sending her the lease assumption agreement and the discharge injunction for its collection efforts. The debtor argued that lease obligations only survive discharge if they are reaffirmed under Section 524(c).
The bankruptcy court rejected the debtor’s claims, concluding that a lease assumption under section 365(p) need not comply with the reaffirmation procedures of section 524(c). The bankruptcy court also held that the debtor had successfully assumed the lease, despite the procedural infirmities in her agreement with Toyota. The district court affirmed.
On appeal, the Ninth Circuit began with the question “whether a lease assumption can survive discharge even though it is not reaffirmed.” Specifically, the Ninth Circuit addressed the conflict between sections 365(p) and 524(c).
Section 365(p), enacted in 2005, marked a change in lease assumption. Prior to that date, only the trustee could opt to assume an ongoing lease and, if the trustee elected to do so, the estate remained liable under the lease without regard to the debtor’s discharge. Trustees typically choose not to assume leases because doing so rarely benefits the estate. Section 365(p), however, created the alternative of allowing a debtor to assume a lease rejected by the trustee. Procedural requirements for assuming a lease by a debtor are minimal and, unlike the requirements for affirmation, do not mandate court oversight or any official protections for the debtor.
Reaffirmation of a debt under section 524(c) creates an exception from discharge with respect to that debt. But, because discharge is the sine qua non of bankruptcy for the debtor, section 524(c) lists a series of requirements that must be met before a debtor can be said to have waived her right to discharge, including extensive disclosures by the creditor and an affidavit from the debtor’s attorney that that the agreement does not impose undue hardship on the debtor. If the debtor is unrepresented, the court must determine whether reaffirmation imposes an undue hardship and whether it is in the best interest of the debtor.
Based on the different texts and purposes of the two provisions, the debtor maintained, and NACBA/NCBRC argued as amicus, that lease assumption and affirmation are separate things. Lease assumption is a method by which the parties to the lease can opt to continue the lease during bankruptcy with no effect on discharge. Reaffirmation, on the other hand, creates an explicit exception to discharge.
Despite the differences in protections for the debtor, the Ninth Circuit found that lease assumption under section 365(p) has the same effect as a reaffirmation under section 524(c): waiver of discharge.
First, the court held that requiring debtors to reaffirm a lease assumption would make section 365(p)’s safe harbor provisions superfluous. Section 365(p)(2)(C) provides that negotiations for lease assumption will not violate the automatic stay or the discharge injunction. The court reasoned that, “[i]f a lease assumption must be reaffirmed to survive discharge—a process that must be completed ‘before the granting of the discharge,’ id. § 524(c)(1)—then, logically, the negotiation of a lease assumption could never violate the post-discharge injunction.” The court concluded that the safe harbor would be rendered surplusage if reaffirmation is necessary for a lease assumption to survive bankruptcy.
Second, the court cited the rule of statutory construction that the specific governs the general. Here, section 365(p) specifically addresses the procedures applicable to individual debtors’ assumptions of leases over personal property. The court found that these procedures control over the more general reaffirmation procedures of section 524(c).
Next, the court looked to other provisions in the Code for evidence that Congress did not intend to require debtors to both assume the lease under 365 and reaffirm under 524. As an example, the court noted that section 362(h) offers a debtor the option of redeeming, reaffirming or assuming a lease. The court concluded that this language would not make sense if a debtor had to reaffirm when she assumed a lease. In another example, the court pointed to section 524(k) which includes disclosures a creditor must make to a debtor before reaffirmation. Because some of those disclosures do not make sense in the context of a lease assumption, the court concluded that a debtor who assumes a lease need not also reaffirm.
The Court concluded that it was not be ludicrous to interpret a consumer protection statute to allow a chapter 7 debtor to bypass judicial review of a lease assumption. The court found it could not depart from a natural reading of the statutory text to advance better policy. Further, the court held the result was not absurd because not all agreements subject to section 524(c) require judicial approval. See Section 524(c)(6)(B).
The Ninth Circuit also addressed whether the parties’ failure to comply with the procedures of section 365(p) nullifies the agreement to assume the lease.
The court summarized the requirements of section 365(p) as (1) the debtor must “notify the creditor in writing that the debtor desires to assume the lease”; (2) the creditor may then “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”; and (3) “[i]f, not later than 30 days after notice is provided . . . the debtor notifies the lessor in writing that the lease is assumed,” then “the liability under the lease will be assumed by the debtor and not by the estate.” 11 U.S.C. § 365(p)(2)(A)–(B)..
In this case only the second requirement was met. The debtor requested the assumption verbally instead of in writing. Further the assumption was not returned within 30 days of her verbal notice.
The court concluded that the parties mutually waived section 365(p)’s writing and timing requirements.
The court pointed out that there are no other circuit opinions on these issues and that bankruptcy court opinions are divided.
Practice pointers:
- If you are addressing this issue de novo in your district, contact NCBRC. NCBRC’s amicus brief in this case persuasively discusses alternate interpretation of the interplay between section 365(p) and 524(c) which afford greater protection of debtors.
- Warn your clients about the potential effects of section 365(p) on their liability.
- Failure to comply with the timeliness requirements of section 365(p) may not be a defense to liability.
Tags: lease assumption, reaffirmation
