Bankruptcy and Pawnbrokers: What to Do When Your Customer Files for Bankruptcy

by Kurt Kline, Esq.1

Many pawnbrokers have been affected by the rise in customer bankruptcy filings. What to do when your customer, the customer’s attorney or a bankruptcy trustee, notifies you that the customer has filed bankruptcy can be a critical part of a pawnbroker’s business plan. As more customers succumb to the pressures of the current employment and economic crisis, knowing what to do once a customer files for bankruptcy may become more important.

Pawnbrokers need to protect themselves in the event of customers’ bankruptcy filings. If the pawnbroker makes the wrong move regarding a bankrupt customer’s pawned property, he or she may become liable for the value of the pawned property or may be assessed other sanctions by the court supervising the bankruptcy proceeding. In order to assure that you are handling your rights regarding a bankrupt customer’s pawned property in the proper manner, and that title to the property can pass to you following your customer’s default, there are a few simple steps to follow.

• Make sure you have fully complied with your state and local laws regarding pawn transactions and that you get advice from your lawyer about extra steps that the bankruptcy laws may require.

• Make sure you follow state and local laws regarding any waiting period or notice requirements before title to the pawned property vests with the pawnbroker.

• Contact a local attorney who is an expert in bankruptcy and creditors’ rights.

• Discuss whether the attorney is knowledgeable about both bankruptcy law and state or local pawn laws; both are important in handling bankruptcy issues dealing with pawned property.

• Make sure you follow any rulings of the bankruptcy court regarding the customer’s pawned property.

• Be certain that your lawyer points out to the bankruptcy trustee the special redemption time period provided for the trustee under the 2005 bankruptcy code amendment that is pertinent to your right to foreclose on pawn collateral. Unless the trustee redeems the property

1 Kurt Kline is a 2008 graduate of the Maurer School of Law at Indiana University. He is admitted to practice in the state of Michigan and practices in Grand Rapids. Mr. Kline has been assisting the NPA with answers to bankruptcy related questions since June, 2009.

within the time period allowed, the pawnbroker’s right to foreclose can be exercised.

• If you need to challenge a bankruptcy court ruling regarding a customer’s case – such as a ruling putting the pawned property into a reorganization plan, or requiring you to return the pawned property to the customer without being paid in full for the pawn transaction first, you or your lawyer must challenge that ruling within ten (10) days of the court ruling that adversely affects your claim to the property. To do so, remember your appeal must be filed within ten (10) days of the ruling.

I. Make Sure You Understand and Already Follow Applicable State Laws Governing Pawn Transactions

Protecting your rights in a customer’s bankruptcy proceeding requires some knowledge of bankruptcy law and procedure as well as compliance with state law requirements regarding foreclosure on pawn collateral. Some customers will try to use bankruptcy to protect property that they have pawned – to get the property back without repaying the funds advanced, to try to pay off the pawn loan on a modified schedule, or to defeat your ability to foreclose and resell the property in satisfaction of the pawn transaction.

Once a customer has declared bankruptcy and, most likely, has retained the services of an attorney, the pawn transaction involving that customer’s property will almost certainly be looked at and scrutinized closely by his or her attorney.

While the federal bankruptcy laws take pawn collateral out of the bankrupt’s estate if certain conditions occur, i

• Keep abreast of state and local laws regarding pawnbrokers and pawned property.

the customer’s attorney may still try and find a way to retrieve their client’s property that has been pledged in any secured transaction, whether or not it is considered part of the bankruptcy estate. Make sure to check with your attorney, state pawnbrokers’ association and the NPA to make sure you are following your applicable pawn regulations and laws.

• Double check to make sure you are operating in accordance with state and local laws regarding pawned property before you are embroiled in bankruptcy proceedings, and particularly that you understand how bankruptcy might change your right to give notice of default and foreclosure, or the timing of such a notice.

II. Beginning of A Bankruptcy Proceeding and The Automatic Stay

When a person files for bankruptcy, several things happen. First, the court appoints a trustee to represent the interests of any unsecured creditors of the bankrupt person. Second, the bankrupt person’s property becomes part of the bankruptcy estate, with exceptions including a special exception for pawned property discussed below. And, third, an automatic stay goes into effect.

This section of this article describes the automatic stay briefly and then discusses a 2005 amendment of the federal bankruptcy code that assists pawnbrokers in getting pawned collateral out of the bankruptcy proceeding.

A. The Automatic Stay

The automatic stay stops all collection proceedings the moment the bankruptcy case is filed. This means that if you were about to foreclose on pawned collateral of the bankrupt consumer you should wait until the time periods described below have passed.

Stopping collection efforts includes halting any notice of foreclosure you might have been preparing to send to a customer who had failed to redeem the loan collateral, and also includes halting the foreclosure itself until an applicable grace period has expired.

However, it does not mean that you cannot use the special rules for pawn transactions that came as part of the 2005 amendment to the Bankruptcy Code. The automatic stay does not apply to pawned property once it is no longer considered part of the bankrupt estate – following the latter of the 60-day federal or state-mandated period for redemption of the property, described in the next section of this article.

B. The 2005 Amendments to the Bankruptcy Code

The 2005 revisions to the federal Bankruptcy Code make it clear that pawned property is NOT a part of the bankrupt estateii if the bankruptcy trustee does not assert a claim to the property in the first 60 days after the customer files their bankruptcy petition or longer if the state allows additional time after the customer’s failure to redeem. The pawnbroker need only wait 60 days from the date of the customer’s bankruptcy filing, or the loan termination date as determined by state or local law, WHICHEVER PERIOD EXPIRES LATER. Thereafter, the pawnbroker will be able to assume title to the pawned property and dispose of it as the state or local law allowsiii. The debtor, or the bankruptcy trustee, must exercise their right to redeem the property (meaning that the debtor or the trustee would have to pay the pawnbroker all of the charges associated with the pawn transaction at one time)

within the LATTER of either 60 days from the customer’s bankruptcy filing date, or the time period allowed for pawn loan redemptions as mandated by state or local authorities.

Example: The bankruptcy petition is filed on the September 1st. Under the Bankruptcy Code, the customer’s or trustee’s right to redeem the property would expire sixty (60) days after that date, or on October 30th. If the customer or trustee has not repaid the pawn transaction in full by the close of business on October 30th, they may not claim the property for the estate unless state pawn law allows a longer time for redemptions. This would happen if a state allowed a 90-day grace period, rather than a 60-day period. In that case, the customer or trustee could redeem the property from the pawnbroker if one of them acted before November 29th. If the customer or trustee does not act, the property is eligible for foreclosure by the pawnbroker.

Once the applicable waiting period expires without redemption by the trustee or the customer, title to the pawned property passes by operation of law to the pawnbroker. In some states, of course, the pawnbroker must hold a foreclosure sale instead of merely waiting for the grace period to expire. However, it may be wise to contact a local attorney to make sure you have taken all steps necessary to assume title to the pawned property before selling or otherwise disposing of it.

There is a possibility that you may need to make an argument to the bankruptcy court explaining why the pawned property is not part of the bankruptcy estate. Because the 2005 amendments to the federal bankruptcy laws discussed in this article only apply to pawn transactions – including the new section 541(b)(8), you may need an attorney to explain to the court and the trustee the effects of these changes on pawned property. The interplay between sections 108(b) and new 541(b)(8) gives the trustee or the pawn customer a chance to redeem the pawned property. The trustee is likely to redeem pawned collateral only when the value of the collateral exceeds the amount of the pawn transaction including accrued charges. Redemption requires paying all accrued pawn charges to the date of redemption.

Here are some pointers on how these provisions work. If the customer or trustee does redeem the pawned property within the later of the 60-day period prescribed the Bankruptcy Code section 108(b) or the applicable state or local law, title to the pawned property does NOT pass to the pawnbroker.

• Section 541(b)(8) keeps the pawned collateral out of the bankruptcy estate.

• Section 108(b) limits the time you have to wait to foreclose on the property, as described above, because it forces the trustee to make a decision in a timely manner.

• Because sections 108(b) and 541(b)(8) work to keep pawn collateral out of the estate, it should not be eligible for inclusion in a reorganization plan by a Chapter 11 or 13 petitioner. If your customer seeks to include the pawn collateral in a reorganization plan, ask your lawyer to assist with a motion opposing its inclusion in the plan.

III. Contact Your Local Attorney

Of course, you should always contact a local attorney for advice on what to do when a customer files for bankruptcy. Your attorney will double-check local, state, and federal laws to make sure you are in compliance with regulations regarding pawn transactions, bankruptcies, and the applicable time period before title to the customer’s pawned property passes to the pawnbroker. He or she will also be able to advise you on your rights as a creditor when a customer files for bankruptcy. Your attorney will make any arguments on your behalf that are necessary and keep you apprised of any court appearances, or other arrangements, you may need to make. Finally, your attorney will be able to advise you on when proper title to the pawned property has passed and when the pawnbroker can dispose of the property as he or she wishes.

Your attorney will advise on what you should do after being contacted by a customer’s attorney or a bankruptcy trustee concerning the customer’s pawned property. Your attorney will advise you on any court appearances you may need to attend and help you prepare an argument in case the trustee or customer try to claim the pawned property as part of the bankruptcy estate.

Your attorney may have to prepare a brief explaining to the court why pawned property is not part of the bankruptcy estate. He or she may also need to explain to the court the interaction between 11 U.S.C. 541 and 11 U.S.C. 108(b), and any local or state statutory period governing the amount of time that must pass, without redemption, before proper title to the pawned property passes to the pawnbroker. The 2005 revisions to federal bankruptcy law favor pawnbrokers in that pawned property is not considered part of a bankruptcy estate, however, your attorney may need to argue this point before the bankruptcy court.

You can find an attorney that specializes in bankruptcy and creditor’s rights issues through your local or state Bar Association. Most State Bar Associations have lawyer referral services that will help match you up with an attorney who specializes in bankruptcy, collections, or both. If not, a simple web search or look through the yellow pages will help you to find bankruptcy and/or creditor’s rights attorneys who deal with many of these issues on a day-to-day basis.

It is important to find competent counsel to guide you through the bankruptcy process, protect your rights in the pawn transaction, and let you know when proper title to the pawned property has passed from the customer to the pawnbroker.

It is also important that the pawnbroker keep abreast of developments regarding the bankrupt customer and the pawned property. You may need to make court appearances, arguments, or both. Your attorney will keep you abreast of any appearances required of creditors and any arguments creditors may need to make.

• Contact your local attorney to advise you on bankruptcy proceedings and to make any arguments or court filings on behalf of the pawnbroker.

• Make sure to keep abreast of bankruptcy proceedings regarding pawned property.

• You may need to attend the bankruptcy proceeding.

• Your attorney will make any arguments necessary on your behalf.

IV. Wait for Clearance from Your Attorney Before Selling Pawned Property

Your attorney will advise you when you may exercise your right to proper title of the pawned property. This will help you avoid the risk of sanctions by the bankruptcy court or a conversion action brought by the customer who originally pawned the property.

i See Stephen Elias, The New Bankruptcy: Will it Work for You?, p. 85, Nolo, 3d Edition, 2009. ii 11 U.S.C. 541(b)(8). iii 11 U.S.C. 108(b).