The debtor in a Chapter 13 bankruptcy case brought in Illinois bought a car within 910 days of his bankruptcy filing which was financed by a purchase money security interest . As part of the transaction, the debtor traded in his old car, in which he had approximately $8,000 of negative equity (meaning that he owed more on the old car then what it was worth) and therefore the financing of the new car included the "negative equity" in the old car. The bankruptcy court denied a cramdown of the debtor's Chapter 13 plan that excluded this negative equity from the creditor's purchase money security interest in the car and this direct appeal followed.
By way of background, and as you may recall, a bankruptcy "cramdown" refers to the procedure by which a debtor in a Chapter 13 bankruptcy is allowed to retain certain secured property, leaving the creditor with a bifurcated claim that is treated as secured to the extent of the present market value of the property (as calculated by the bankruptcy court), and unsecured as to any amount in excess of that value. The debtor then makes payments to the creditor equivalent to the market value of the property. In 2005, Congress amended Chapter 13 of the Bankruptcy Code by adding the "hanging paragraph" (so called because the paragraph is unnumbered), which prevents the bifurcation of a secured claim potentially into secured and unsecured portions when the creditor has a "purchase money security interest" in a motor vehicle acquired for the debtor's personal use within 910 days of the debtor's bankruptcy filing.
In affirming the bankruptcy court's holding, the issue before the appellate court was whether or not a purchase money security interest in a car includes negative equity, thus making it not subject to the cramdown procedure under the "hanging paragraph." The Bankruptcy Code does not define a purchase money security interest and accordingly, because the rights enforced in bankruptcy are rights created by state law, the Court looked to the definition of purchase money security interest under Article 9 of the Uniform Commercial Code, in force in Illinois.
Although the definition of purchase money security interest in Article 9 of the UCC does not explicitly mention negative equity, the Court looked to a comment to the definition, which states that "the 'price' of the collateral or the 'value given to enable' includes obligations for expenses incurred in connection with acquiring rights in the collateral." As applied to the negative equity at issue in this case, the Court concluded that negative equity "is an obligation assumed by the buyer of the car in connection with his acquiring ownership," thus making it part of the creditor's purchase money security interest. The Court also found that including negative equity in a purchase money security interest in a car is consistent with the Illinois Motor Vehicle Retail Installment Sales Act, which provides that negative equity is indeed a common element of a credit purchase of a car.
The Seventh Circuit went on to discuss the effect this ruling would have on a Chapter 13 debtor's other creditors, given that certain purchase money security interests enjoy priority should the purchaser default. Ultimately, the Court noted that the justification for allowing the creditor with a purchase money security interest to enlarge his secured interest to include negative equity to the prejudice of the debtor's other creditors is the fact that including negative equity into the purchase money security interest "may be essential to the flourishing of the important market that consists of the sale of cars on credit." Furthermore, including negative equity as part of the purchase money security interest eliminates problems that make the secured creditor worse off, such as depreciation and misvaluation of the car by a bankruptcy judge.
Ralph T. Wutscher
Kahrl Wutscher LLP
The Loop Center Building
105 W. Madison Street, Suite 2100
Chicago, Illinois 60602
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From: Ralph T. Wutscher [mailto:rwutscher@krw-llp.com]
Sent: Sunday, October 04, 2009 4:12 PM
To: 'Ralph Wutscher'
Subject: FYI: 8th Cir Says Creditor's PMSI Extends to "Negative Equity" in "910 Vehicle"
Like the Tenth Circuit in our prior update (below), the U.S. Court of Appeals for the Eighth Circuit recently held that the negative equity financing held by a creditor on a trade-in vehicle was part of a purchase money security interest. A creditor who holds a purchase-money security interest is entitled to protection under "hanging paragraph" of 11 U.S.C. § 1325(a). A copy of the opinion is attached.
In a fact pattern nearly identical to Ford v. Ford Motor Co. from the Tenth Circuit, the parties also disputed whether automobile debt could be bifurcated under 11 U.S.C. § 506(a) into secured and unsecured claims. The unsecured claim would be used to discharge the negative equity held in a trade-in vehicle.
The Eighth Circuit Court of Appeals conducted a similar analysis as the Tenth Circuit. The Court focused on the reach and definition of "purchase money security interest" as well as whether negative equity was "an integral part of" and "inextricably intertwined" with the sales transaction. The Eighth Circuit sided with the Tenth Circuit in concluding that the trade-in exchange is essentially a single transaction. Therefore, Plaintiffs may not bifurcate the debt for the purpose of a cramdown under 11 U.S.C. § 506(a) when the creditor has a PMSI in the full amount of the debt.
Ralph T. Wutscher
Kahrl Wutscher LLP
The Loop Center Building
105 W. Madison Street, Suite 2100
Chicago, Illinois 60602
Direct: (312) 551-9320
Fax: (866) 581-9302
Mobile: (312) 493-0874
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From: Ralph T. Wutscher [mailto:rwutscher@krw-llp.com]
Sent: Thursday, October 01, 2009 7:47 PM
To: 'Ralph Wutscher'
Subject: FYI: 10th Cir Says Creditor's PMSI Extends to "Negative Equity" in "910 Vehicle"
The Tenth Circuit United States Court of Appeals recently held that the negative equity financing held by a creditor on a trade-in vehicle was part of a purchase money security interest. A creditor who holds a purchase-money security interest is entitled to protection under "hanging paragraph" of 11 U.S.C. § 1325(a). A copy of the opinion is attached.
The debtors financed their purchased of a new vehicle. They also traded in their old vehicle, in which they had negative equity. Less than four months later, the debtors filed for Chapter 13 bankruptcy, and sought to bifurcate their automobile debt under 11 U.S.C. § 506(a) into secured and unsecured claims. The unsecured claim would be the portion of the debt used to discharge the negative equity in the trade-in.
The bankruptcy court concluded that negative equity financing was part of the creditor's purchase money security interest (PMSI) under the "hanging paragraph" in 11 U.S.C. § 1325(a) and could not be bifurcated and "crammed down" pursuant to 11 U.S.C. § 506(a).
In upholding the lower court's decision, the Tenth Circuit focused on the reach of "purchase money security interest," considering the term is not defined in the Bankruptcy Code nor the Bankruptcy Abuse Prevention and Consumer Protection Act, which amended the Bankruptcy Code and created the "hanging paragraph" under 11 U.S.C. § 1325(a).
The Court interpreted the term under state law, presuming that was the Congressional intent. The Court also analyzed whether paying off negative equity in a trade-in car was part of the "price" of the new car or part of the "value given to enable" acquisition of the new car. The Court concluded that the trade-in exchange is essentially a single transaction.
Therefore, according to the Tenth Circuit, debtors may not bifurcate the debt for the purpose of a cramdown under 11 U.S.C. § 506(a) when the creditor has a PMSI in the full amount of the debt.
Ralph T. Wutscher
Kahrl Wutscher LLP
The Loop Center Building
105 W. Madison Street, Suite 2100
Chicago, Illinois 60602
Direct: (312) 551-9320
Fax: (866) 581-9302
Mobile: (312) 493-0874
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From: Ralph T. Wutscher [mailto:rwutscher@krw-llp.com]
Sent: Saturday, May 23, 2009 6:33 PM
To: Ralph T. Wutscher
Subject: FYI: 4th Cir Says Creditor's PMSI Extends to "Negative Equity" in "910 Vehicle"
The only issue in this case, therefore, is whether the debt was secured by a "purchase money security interest." 11 U.S.C. § 1325(a). In particular, the parties disputed whether the portion of the debt relating to the negative equity in the debtors' trade-in gave rise to a purchase money security interest. Thus, this appeal involved the question of how the hanging paragraph applies to a secured claim when a portion of that claim relates to the financing of "negative equity" (which, in a car transaction, refers to the difference between the value of a vehicle that the buyer trades in and the amount of the buyer's preexisting debt on that trade-in).
The Court concluded that a creditor does have a "purchase money security interest" for the portion of its claim relating to negative equity. The Court reasoned that negative equity financing is integral to the debtor's acquisition of a new car and because this result effectuates Congress's intent in the hanging paragraph. The Court declined to rule as to the proper treatment of a debt that includes non-purchase money components.
Ralph T. Wutscher
Kahrl Wutscher LLP
105 W. Madison Street, Suite 2100
Chicago, Illinois 60602
Direct: (312) 551-9320
Fax: (866) 581-9302
Mobile: (312) 493-0874
RWutscher@kahrlwutscherllp.com
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From: Ralph T. Wutscher [mailto:rwutscher@rw-llp.com]
Sent: Thursday, June 12, 2008 4:40 PM
To: Ralph T. Wutscher
Subject: FYI: 10th Cir Says Chpt 13 Debtor's Surrender of a "910 Vehicle" Does Not Prevent Unsecured Claim
The U.S. Court of Appeals for the Tenth Circuit recently held that a Chapter 13 debtor's surrender of a "910 vehicle" (i.e., a vehicle the debtor purchased within the 910 days preceding filing) does not prevent the creditor from filing an unsecured claim for deficiency based on state law. A copy of the opinion is attached.
The debtors purchased vehicles for their personal use less than 910 days before filing bankruptcy petitions under Chapter 13. The debtors entered into retail installment contracts which were assigned to the bankruptcy creditor.
When the debtors filed for bankruptcy, each of the vehicles was worth less than the balance due. In their Chapter 13 plans, both debtors proposed to surrender the vehicle in full satisfaction of the creditor's claim. The creditor objected to confirmation of the plan, arguing that surrendering the vehicle would not fully satisfy the claim, and that it may assert an unsecured claim based on state law for any deficiency following liquidation.
As you may recall, generally, a debtor exercising the retention option under § 1325(a)(5)(B), also known as "cram down," keeps the collateral securing the debt and satisfies the debt by making monthly payments equal to the present value of the collateral, rather than the remaining balance on the loan.
The "cram down" is the result of § 1325(a)(B)(ii)'s requirement that the debtor pay the present value of the creditor's claim and § 506(a)'s provision for judicial valuation of claims secured by collateral. Under § 506(a), a claim secured by a lien is separated, or bifurcated, into a secured portion reflecting the value of the property and an unsecured portion reflecting the remaining debt or deficiency. When a claim is bifurcated under § 506(a), the debtor may retain the collateral and meet the requirements of § 1325(a)(5)(B) by making payments only on the secured portion of the bifurcated claim. As a result of this process, an undersecured creditor may seek payment of a deficiency only as an unsecured creditor.
Since the BAPCPA, the hanging paragraph in Section 1325(a) has prevented the valuation of certain claims under Section 506(a), including so-called "910 car claims" (a claim secured by an automobile purchased less than 910 days before a Chapter 13 filing). Under the BAPCPA, a debtor who keeps a 910 vehicle under Section 1325(a)(5)(B) must now pay the entire claim as filed, and the 910 car claim is treated as fully secured.
Here, however, the debtors surrendered the vehicles under § 1325(a)(5)(C). Because a 910 car claim is treated as fully secured when a debtor retains the vehicle under the BAPCPA, the bankruptcy court and the Bankruptcy Appellate Panel reasoned that it must also be treated as fully secured when the debtor surrenders the vehicle. Following this logic, surrender fully satisfies the claim and precludes an unsecured claim for a deficiency.
Although courts agree that the hanging paragraph now prevents the application of § 506 to 910 car claims under § 1325(a)(5), they have reached different conclusions concerning the effect of this change on cases involving the surrender of a 910 vehicle. In the present case, the bankruptcy court and the Bankruptcy Appellate Panel adopted the majority view among bankruptcy courts -- both courts concluded that, because a 910 car claim is no longer subject to bifurcation into secured and unsecured claims under § 506(a), the debtor's surrender of the vehicle under §1325(a)(5)(C) satisfies the entire claim, and the creditor may not pursue an unsecured claim, based on state law, to recover a deficiency.
However, the Tenth Circuit joined the growing number of courts adopting the view that, by making § 506 inapplicable to 910 car claims, the hanging paragraph in the BAPCPA does not abrogate a creditor's right to assert a deficiency claim authorized by state law.
Thus, the court held that: (1) by choosing to surrender a 910 vehicle under § 1325(a)(5)(C), a debtor satisfies the requirements for plan confirmation under § 1325(a)(5) with respect to that particular allowed secured claim; and (2) whether the creditor may bring an unsecured claim to recover a deficiency after sale of the vehicle depends on the underlying contract and state law.
Let me know if you have any questions. Thanks.
Roberts Wutscher, LLP
105 W. Madison Street, Suite 2100
Chicago, Illinois 60602
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