Nathan Goralnik, the Over-encumbered Trade-in in Chapter 13

• Publication year: 2011

THE OVER-ENCUMBERED TRADE-IN IN CHAPTER 13

Nathan Goralnik*

ABSTRACT

The “hanging paragraph” in Bankruptcy Code § 1325(a) requires many debtors hoping to retain a vehicle under a chapter 13 plan to repay the full value of their auto lender’s secured claim, even if that claim is undersecured. This protection is limited to creditors with a purchase-money security interest in the debtor’s vehicle. Accordingly, bankruptcy courts reviewing a chapter 13 plan must consider the validity of an objecting creditor’s purchase-money security interest. This issue has proven controversial in cases where the lender financed both the debtor’s newly purchased vehicle and excess debt (“negative equity”) a trade-in vehicle. The highly general language of the Uniform Commercial Code affords few clues to the purchase-money status of financed negative equity. To break the impasse, this Article draws on heretofore- neglected evidence from the UCC’s text and drafting history that lends substance to the “consumer compromise” embodied in Revised Article 9. These materials indicate that the UCC maintains strict requirements for according purchase-money status to a consumer loan, and would not accord purchase-money status to financed negative equity. If this conclusion is at odds with the expectations of the drafters of the hanging paragraph, it suggests that they erred in hinging the applicability of a rule of federal bankruptcy law on a loan’s purchase-money status under state law.

* Associate, Quinn Emanuel Urquhart & Sullivan, LLP; J.D., Yale Law School, 2012. This Article has

benefited from Eric Brunstad’s generous support and inimitable teaching, and from the inspired efforts of the Emory Bankruptcy Developments Journal’s staff. I owe special thanks to Steve Ferketic for his commitment to this project.

INTRODUCTION 16

1. NEGATIVE EQUITY UNDER THE HANGING PARAGRAPH: THREE APPROACHES 22

2. IS REFINANCED NEGATIVE EQUITY “PURCHASE MONEY?” 26

   1. Does Federal Law Regulate the Content of “Purchase Money”? 27

   2. “Purchase-Money Obligation” in Article 9 31

      1. Purchase Money as “Part of the Price of the Collateral” 32

      2. Purchase Money as “Value Given to Enable” 35

   3. Parsing Official Comment 3 39

   4. Negative Equity and the Consumer Compromise 43

3. DUAL-STATUS OBLIGATIONS UNDER THE HANGING PARAGRAPH 50

4. CONCLUDING OBSERVATIONS 56

INTRODUCTION

Among the important changes wrought by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”) was to make it more expensive for debtors to retain a personal vehicle in chapter 13. Previously, a debtor could “bifurcate” her auto loan under § 506 of the Bankruptcy Code (the “Code”), which provides that a lien creditor has a secured claim only to the extent of the collateral’s replacement value; any

deficiency is unsecured.1 Accordingly, a chapter 13 debtor could “cram down”

a plan allowing her to retain her vehicle without repaying the full balance of her car loan.2 Since cars depreciate rapidly once driven off the dealer’s lot,3 bifurcation often left auto lenders undersecured and exposed to significant losses in chapter 13.4 In response, BAPCPA amended chapter 13’s

1. 11 U.S.C. § 506(a)(1) (2006) (a lien holder’s allowed claim is secured to the extent of the collateral’s replacement value).

2. Id. § 1325(a)(5)(B)(ii) (permitting confirmation if “the value . . . distributed under the plan . . . is not

   less than the allowed amount of such claim”).

3. See H.R. REP. NO. 106-123, pt. 1, at 128 (1999) (“Even though the vehicle is one day old, the amount of the secured creditor’s claim is, under current law, limited to the value of the automobile taking into account the immediate effect of depreciation upon purchase.”); see also Sumit Agarwal et al., Asymmetric Information and the Automobile Loan Market 14 (Am. Econ. Ass’n, Conf. Paper, 2005) (“Given the significant depreciation in auto values upon purchase, many borrowers have an auto loan balance greater than the current

   car value.”).

4. See William C. Whitford, A History of the Automobile Lender Provisions of BAPCPA, 2007 U. ILL. L. REV. 143, 146 (2007). Moreover, the applicable discount rate “could be far to the south of the interest rate

   confirmation requirements to prevent many debtors from stripping down their car loans under § 506.5 However, the text and history of the new provision leave considerable uncertainty around the precise obligations of a chapter 13 debtor seeking to retain a vehicle over her auto lender’s objection.

   
   

   Lawmakers proposed a number of measures to protect consumer lenders from cramdown during the drafting of BAPCPA.6 The first House bills introduced in 1997 and 1998 would have protected both the principal balance and the contract interest rate from cramdown in an individual case under any

   Code chapter to the extent that the claim was attributable to a purchase-money loan for personal property acquired within 180 days of filing.7 A competing Senate draft contained two significant anti-cramdown provisions. The first was similar to the House proposal, but incorporated a shorter, ninety-day lookback period.8 A second provision, added on behalf of the automobile finance industry,9 would have prohibited bifurcation altogether in chapter 13 cases.10 A later Senate draft, also applicable to chapter 13, would have precluded bifurcation of any claim for a personal automobile loan incurred within five years of bankruptcy.11

   
   

   agreed to by the debtor in the security agreement.” David Gray Carlson, Cars and Homes in Chapter 13 After the 2005 Amendments to the Bankruptcy Code, 14 AM. BANKR. INST. L. REV. 301, 340 (2006).

5. Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub. L. No. 109-8, § 306(b), 119

   Stat. 23, 80 (codified as amended at 11 U.S.C. § 1325(a) (2006)) (“[S]ection 506 shall not apply to a[n allowed] claim . . . if the creditor has a purchase money security interest securing the debt that is the subject of the claim, the debt was incurred within the 910-day [period] preceding the date of the filing of the petition, and the collateral for that debt consists of a motor vehicle . . . acquired for the personal use of the debtor . . . .”).

6. For the legislative history of BAPCPA’s automobile-lending provisions, see In re Hayes, 376 B.R.

   655, 675 n.29 (Bankr. M.D. Tenn. 2007); Whitford, supra note 4, at 164–86. For the general legislative history of BAPCPA, see generally Susan Jensen, A Legislative History of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, 79 AM. BANKR. L.J. 485 (2005).

7. Bankruptcy Reform Act of 1998, H.R. 3150, 105th Cong. § 128 (1998); Responsible Borrower

   Protection Bankruptcy Act, H.R. 2500, 105th Cong. § 110 (1997).

8. Consumer Bankruptcy Reform Act of 1998, S. 1301, 105th Cong. § 302(c) (as reported by S. Comm. on the Judiciary, June 4, 1998); see S. REP. No. 105-253, at 32 (1998).

9. See Whitford, supra note 4, at 177 (citing Harry Stoffer, Lobbyists Push Industry’s Problems with ‘Cramdown’ into the Spotlight, AUTOMOTIVE NEWS, Oct. 26, 1998, at 28).

10. S. 1301, § 302(a) (providing that § 506 shall not apply to “an allowed claim . . . that is secured . . . by reason of a lien on property”); see S. REP. No. 105-253, at 33.

11. S. REP. NO. 106-49, at 224 (1999) (“[S]ection 506 shall not apply to a[n allowed] claim . . . if the debt . . . was incurred within the 5-year period preceding the filing of the petition and the collateral for that debt consists of a motor vehicle . . . acquired for the personal use of the debtor . . . .”).

    The narrower language ultimately adopted emerged in a 2001 draft provision entitled “Restoring the Foundation for Secured Credit.”12 Finally enacted as an unnumbered “hanging paragraph” following Code § 1325(a), it provided that in the context of cramdown in chapter 13,

    
    

    section 506 shall not apply to a[n allowed] claim . . . if the creditor has a purchase money security interest securing the debt that is the subject of the claim, the debt was incurred within the 910-day [period] preceding the date of the filing of the petition, and the collateral for that debt consists of a motor vehicle . . . acquired for the

    personal use of the debtor.13

    
    

    Courts have interpreted the hanging paragraph as preventing a chapter 13 debtor from bifurcating a purchase-money loan for a personal vehicle incurred within 910 days of bankruptcy.14 Yet this language, described by scholars as “most peculiar”15 and even “bizarre,”16 has generated “confusion and incoherence in the law.”17 A casual reading of the hanging paragraph unearths

    a tangle of errors, ambiguities, and caveats.18 For example, even the core

    
    

12. Bankruptcy Abuse Prevention and Consumer Protection Act of 2001, H.R. 333, 107th Cong. § 306(b) (2002) (as reported by H. Comm. On the Judiciary, Feb. 26, 2001); see H.R. REP. NO. 107-617, at 210 (2002) (Conf. Rep.).

13. Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub. L. No. 109-8, § 306(b), 119

    Stat. 23, 80 (codified as amended at 11 U.S.C. § 1325(a) (2006)). For other types of purchase-money collateral, the hanging paragraph precludes application of § 506 “if the debt was incurred during the 1-year period preceding [the bankruptcy] filing.” Id.

14. See, e.g., In re Pruitt, 401 B.R. 546, 562 (Bankr. D. Conn. 2009) (“[A] debtor who proposes in her

    Chapter 13 plan to retain a 910–Vehicle pursuant to 1325(a)(5)(B) may not engage in Cram–Down, but rather, in order to fully satisfy the 910–Vehicle Claim, must now pay the present value of the entire, deemed unitary claim, not just the actually secured component of that claim, as might otherwise have been characterized under Section 506.”).

15. Carlson, supra note 4, at 340.

16. Jean Braucher, Rash and Ride-Through Redux: The Terms for Holding on to Cars, Homes and Other Collateral Under the 2005 Act, 13 AM. BANKR. INST. L. REV. 457, 472 (2005).

17. AmeriCredit Fin. Servs., Inc. v. Long (In re Long), 519 F.3d 288, 292 (6th Cir. 2008).

18. For example, one immediately notices that the statute is difficult to cite: its scriveners omitted an alphanumeric designation. Dianne C. Kerns, Cram-A-Lot: The Quest Continues, AM...