Disposal of Secured Property Prior to Bankruptcy

When the borrower on a secured loan against property, such as a mortgage on a home or a car loan, files bankruptcy, the debt is discharged against the property, but the security interest remains. Thus in the case of a car loan after the bankruptcy, the bank may repossess the car, if the borrower fails to make payments, but the bank may not go after the borrower for any deficiency, if they fail to sell the car for the entire amount of the loan.

The question that sometimes arises is what happens, if the borrower has disposed of secured property prior to filing bankruptcy. In the case of a house the mortgage holder could still foreclose on the house, and I suspect they would. What happens though, when a smaller item such as a television or a refrigerator is given away or thrown out before the bankruptcy. The legal answer is that the security interest stays with the property, and if you go bankrupt the retailer could trace down the computer you gave to your Aunt Millie for her birthday and demand it back. The practical answer is that with most types of property it is not worth the effort to trace the property to the new owner, and in affect the debt is discharged.

If the debt is large enough to make it worth while though, which is more likely to be the case in business bankruptcies than consumer bankruptcies, the secured creditor may have an additional remedy. Disposing of property in violation of the terms of the secured loan agreement is conversion, which is a tort. Under Federal Bankruptcy Law, if a debtor has committed a willful and malicious tort the creditor may bring an action in bankruptcy court to declare the debt nondischargeable.