The Lawletter Vol 34, No 11, November 19, 2010
Tim Snider —Senior Attorney, Bankruptcy
In many consumer transactions involving the purchase of a motor vehicle, the buyer trades in an older vehicle as part of the consideration for the deal. The traded vehicle usually is subject to a secured lien for the balance of the unpaid purchase price. In fact, about a third of all motor vehicle purchases involve trade-ins of vehicles subject to outstanding and unpaid loans. When the buyer trades the vehicle, the lender pays off the existing loan on the traded vehicle, rolls over the amount of the payoff into the financing for the purchased vehicle, and claims a lien against the purchased vehicle for the entire amount of the loan. The payoff is termed "negative equity" attributable to the amount of the paid-off loan. Can the lender who has provided a purchase money loan to the buyer claim the negative equity as part of its priority secured claim when the buyer files for bankruptcy, or must the loan be bifurcated into secured and unsecured portions?
The outcome is dependent in part on state law, specifically the definition of a "purchase money security interest" contained in revised Article 9 of the Uniform Commercial Code ("U.C.C.") (adopted by all 50 states), see U.C.C. § 9-103, and in part by the Bankruptcy Code, see 11 U.S.C. § 1325. At least eight of the circuits have held that the lender who financed the purchase of the newer vehicle may claim the "negative equity" resulting from the disposition of the traded vehicle as part of its secured claim. In other words, the lender's claim is not bifurcated into secured and unsecured portions. See Nuvell Credit Corp. v. Westfall (In re Westfall), 599 F.3d 498 (6th Cir. 2010); In re Howard, 597 F.3d 852 (7th Cir. 2010); Reiber v. GMAC, LLC (In re Peaslee), 585 F.3d 53 (2d Cir. 2009) (per curiam) (adopting the response to a certified question of a divided New York Court of Appeals in In re Peaslee, 13 N.Y.3d 75, 913 N.E.2d 387, 885 N.Y.S.2d 1 (2009)); Ford Motor Credit Co. v. Dale (In re Dale), 582 F.3d 568 (5th Cir. 2009); Ford Motor Credit Co. v. Mierkowski (In re Mierkowski), 580 F.3d 740 (8th Cir. 2009); Ford v. Ford Motor Credit Co. (In re Ford), 574 F.3d 1279 (10th Cir. 2009); In re Price, 562 F.3d 618 (4th Cir. 2009); Graupner v. Nuvell Credit Corp. (In re Graupner), 537 F.3d 1295 (11th Cir. 2008).
Prior to the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA"), 11 U.S.C. § 1325(a)(5)(B) had permitted a bankruptcy debtor to bifurcate the secured creditor's claim into secured and unsecured portions, with the secured amount determined by the newer vehicle's fair market value on the petition date, and the excess classified as an unsecured claim. The BAPCPA, however, includes a provision that has become known as the "hanging paragraph," because it was given no number. It provides as follows:
For purposes of paragraph (5), section 506 shall not apply to a claim described in that paragraph 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 [sic] preceding the date of the filing of the petition, and the collateral for that debt consists of a motor vehicle (as defined in section 30102 of title 49) acquired for the personal use of the debtor, or if collateral for that debt consists of any other thing of value, if the debt was incurred during the 1-year period preceding that filing. 11 U.S.C. § 1325(a)(*).
Most controversial of the four elements required to satisfy the hanging paragraph's exemption from the debtor's right to bifurcate the claim into secured and unsecured components (thus "cramming down" the unsecured portion) is whether the lender's claim qualifies as a purchase money security interest. Under the U.C.C.'s definition, a transaction qualifies as a purchase money security interest if the obligor incurred the underlying obligation (1) as all or part of the price of the collateral, or (2) for value given to enable the debtor to acquire rights in, or the use of, the collateral. The circuits that have adopted the creditor-friendly position prohibiting cramdown generally agree that the kind of consumer transaction involving the purchase of a motor vehicle outlined above satisfies both the "price" test and the "value given" test. See In re Westfall, 599 F.3d at 503.
Only the Ninth Circuit disagrees. In In re Penrod, 611 F.3d 1158 (9th Cir. 2010), the debtor purchased a 2005 Ford Taurus from a California Ford dealership in 2005. The price of the car was approximately $25,600. The debtor traded in her 1999 Ford Explorer and paid approximately $1,000 down for her new vehicle. She owed over $13,000 on the Explorer, and she received $6,000 in credit for the vehicle. Therefore, there was over $7,000 in "negative equity" on the trade-in vehicle. The dealership paid off the remaining balance on the Explorer and added the negative equity to the amount financed. The debtor financed approximately $31,700 in order to purchase a vehicle that cost approximately $25,600. The dealership subsequently assigned the contract to AmeriCredit Financial Services.
Some 523 days after purchasing the Ford Taurus, the debtor filed for bankruptcy protection under Chapter 13. She still owed $25,675 to AmeriCredit, which included the negative equity from the Ford Explorer. In her Chapter 13 plan, the debtor proposed to bifurcate AmeriCredit's claim into secured and unsecured portions. AmeriCredit objected to the plan, claiming it had a purchase money security interest in the entire amount, including the negative equity.
The court consciously adopted a position resulting in a split with the other circuits. It held, in reasoning that is difficult to follow, that the transaction at issue satisfied none of the requirements for the creation of a purchase money security interest in the negative equity in the traded vehicle. The court reasoned that no "new value" is given with respect to the negative equity arising from the traded vehicle, and, thus, it cannot satisfy the U.C.C.'s definition of a purchase money security interest. To accept the court's position necessarily requires that it be assumed that Congress intended no change in existing law when enacting the BAPCPA, an outcome that can be squared with neither the language of the hanging paragraph nor the legislative history and context of the BAPCPA. Moreover, the court's application of U.C.C. § 9-301 is at odds with state law generally applying that provision of revised Article 9.
It is an issue that may one day end up in the lap of the Supreme Court unless Congress clarifies its intent in enacting the BAPCPA, which, in all fairness, is not a model of clarity.