Automobile's Negative Equity Is Included In The Purchase Money Security Interest And Not Subject To Cramdown in Chapter 13
IN RE: HOWARD (March 1, 2010)
Aubrey Howard purchased a $30,000 car. He made a down payment of $4,500 and traded in his old car. Although his old car was worth $14,500, he still owed $22,500. He therefore financed $35,500 (the purchase price minus the down payment plus the $8,000 in negative equity plus $2,000 in taxes and fees). Later (within 910 days), he filed for Chapter 13 bankruptcy. An issue presented to the bankruptcy court was whether the $8,000 in negative equity was subject to the court's cramdown power. The bankruptcy court ruled that negative equity is included in a purchase money security interest and is therefore not subject to the court's cramdown power. Howard appeals.
In their opinion, Judges Posner, Flaum, and Williams affirmed. The Court began its opinion with a short lesson on bankruptcy. "Cramdown" refers to the bankruptcy court practice of determining the value of secured collateral, allowing the debtor to force the creditor to accept a payment schedule equal to the determined value, and converting any excess loan balance to an unsecured claim. Cramdown favors the debtor to the disadvantage of the creditor. In addition, cramdown creates another payment obligation and exposes the creditor to a possible second default. In response to creditors' complaints, Congress amended the bankruptcy law. The law now prohibits a cramdown in Chapter 13 cases to reduce a purchase money security interest in an automobile acquired for personal use, if the debt was incurred within 910 days of the bankruptcy filing. The Court looked to state law for the definition of a purchase money security interest. As defined in the UCC, a purchase money security interest includes the price of an item and also "obligations for expenses incurred" in connection with the acquisition of the item. For example, the Court noted that a loan could provide for the payment of attorney's fees in the event of default. In that case, the fees would be included in the purchase money security interest. The Court also cited to the Illinois Motor Vehicle Retail Installment Sales Act which, although it does not purport to prescribe what is or is not included in a purchase money security interest, does define "amount financed" as including negative equity. The inclusion of negative equity in "amount financed" was evidence to the Court that negative equity was common in automobile purchases. Finally, the Court considered what effect including negative equity in purchase money security interests would have on other creditors. Concluding that purchase money security interests need not be narrowly defined to protect other creditors and that including negative equity in purchase money security interest was important to the automobile sales market, the Court held that negative equity is not subject to cramdown power.
Michael Rigney practices in the law offices of GVC Ltd. in Chicago. In this blog, he reports on select