Recent Entries

Hanging Paragraph of §1325: What Is Not Included?

By Keri P. Ebeck, Attorney

If a debtor purchases a new vehicle and thirty days later files a Chapter 13 bankruptcy, should the debtor get the benefit of the substantial depreciation of the vehicle’s value? No, the addition of the Hanging Paragraph of §1325 was designed to prevent this type of perceived abuse by debtors.

The Hanging Paragraph of §1325 provides that:

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-days 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. §1325(a)(*)

The question stemming from this section of the Bankruptcy Code that is not clear and have Courts grappling with how to handle is: what is included or what is not included in the “purchase money security interest”?  For purposes of this article, it will focus on the popular, negative equity of a vehicle purchase and GAP insurance.

Negative equity exists when a debtor purchases a new vehicle and the dealer agrees to finance the negative equity of the trade-in vehicle as part of the new loan. The problem exists when the debtor turns around and files a Chapter 13 bankruptcy. Should the negative equity of the trade-in vehicle be classified as part of the purchase money security interest? There is no definition of “purchase money security interest” in the Bankruptcy Code; therefore the Courts are in agreement that it requires a look to state law to determine the meaning of the term.  Some states actually include in the state law definition of “cash sales price” that negative equity is included, such as New York, Georgia and California.[1]  For those states that do not explicitly define what is included in the sale, the Courts must review the states’ Uniformed Commercial Code, state law statutes,  and its legislative intent to determine if negative equity is part of the purchase money security interest.  “A purchase-money security interest exists if the collateral is the item purchased and it secures its own price.”[2]  The Court in In Re Mancini, concluded that “the payoff concerns a different vehicle and, usually, a different lender. Nothing in the UCC or its comments leads me to believe that the payment of an antecedent debt, such as negative equity, should be included as part of the creditor’s purchase money security interest.”[3]  In review of most cases, unless the States specifically have included or amended their state law statutes or UCC to include negative equity in the definition of a purchase money security interest, it is not included. “A majority of reported decisions conclude that a loan to payoff “negative equity” is not included in a purchase money security interest in a new car for purposes of the hanging sentence.[4]

The Courts have also looked to the addition available to debtors at the time of the vehicle purchase of GAP Insurance. GAP Insurance is defined as insurance to cover the difference between the vehicle’s value and the amount owed to the creditor.  Like its counter part, negative equity, the Courts once again look to the State specific UCC and statutes to determine if it is included. As GAP insurance was not part of the purchase price as it was “neither mandatory, a component of the loan agreement, nor a value-enhancing add-on”[5] , it is determined in most jurisdictions as not being a part of the purchase money security interest. The Court in In Re Mancini concluded, “Gap insurance is not part of the ‘price’ of the collateral, nor is it part of the value ‘given to enable the debtor to acquire rights in or use of the collateral.’” [6]  Therefore, it is clear that most Courts are making the determination that if it is not specifically authorized under State law, both negative equity and GAP Insurance are not included in the purchase money security interest.

What happens once the Court determines that the negative equity or GAP insurance is not included? Is the entire claim subject to the cramdown or is it only a certain amount? The Courts have adopted two rules on the above issue. The first is known as the “transformation rule”: “if an item of collateral protections to secure not only its own purchase price but also that of other items, the security interest that existed before the ‘add on’ procedures is transformed into non-purchase-money status.”[7]  Therefore, the lien would now be subject to cramdown outside of the purview of the Hanging Paragraph of §1325.  The second rule is known as “dual status”, which by definition states that the existence of the nonpurchase money interest does not defeat or destroy the entire claims’ status under the 910 rule. “A purchase- money security interest in a quantity of goods can remain such ‘to the extent’ it secures the price of the item, even through it may also secure the payment of other articles.”[8]  Most jurisdictions have adopted the “dual status” rule as it is more in line of how the Hanging Paragraph of §1325 was designed to protect creditors against cramdown of their claims. The Court in In Re Johnson concluded that “applying the dual purpose rule is more consistent with congressional intent…”[9]  The Court went on to state that “simply, application of the transformation rule is too severe.”[10]  The all or nothing of the transformation rule leaves little protection for creditors, while the dual status rule implements what Congress had intended with §1325.

While creditors may allow consumers/debtors to finance more than the actual collateral, whether or not it creates a purchase money security interest and how it will be treated in the bankruptcy is really a determination for the Court. Creditors should be aware of such issues, but it should not deter them from lending or exercising their rights in a bankruptcy.

 

[1] In Re Johnson, 380 B.R. 236
[2] Pristas v. Landaus of Plymouth, Inc., 742 F.2d. 797 (1984)
[3] In Re Mancini, MDPA Case No. 07-02236
[4] In Re Hayes, 376 B.R. 655
[5] In Re Honcoop, 377 B.R. 719
[6] In Re Mancini, MDPA Case No. 07-02236
[7] Pristas v. Landaus of Plymouth, Inc., 742 F.2d. 797 (1984)
[8] Id.
[9] In Re Johnson, 380 B.R. 236
[10] Id.

Eastern District of Michigan New Model Plan Update for Chapter 13 Cases

By Cheryl D. Cook, Attorney

As you may be aware, the Eastern District of Michigan adopted a new Model Chapter 13 Plan that became effective January 1, 2013.  A copy of that model plan can be found at the Eastern District Bankruptcy Court website:  http://www.mieb.uscourts.gov/sites/default/files/forms/Chapter_13_Model_Plan.pdf

The new model plan contains a prominent notice advising creditors:

YOUR RIGHTS MAY BE AFFECTED.  THIS PLAN MAY BE CONFIRMED AND BECOME BINDING WITHOUT FURTHER NOTICE OR HEARING UNLESS A TIMELY WRITTEN OBJECTION IS FILED.  READ THIS DOCUMENT CAREFULLY AND SEEK THE ADVICE OF AN ATTORNEY. 

In light of the U.S. Supreme Court decision in United Student Aid Funds, Inc. v Espinosa, 559 U. S. ___, 130 S.Ct. 1367, ___ L.Ed.2d. ___ (2010), this notice is intended to give creditors ample warning of the effect of the failure to timely object to plan treatment. 

Within the time specified by the Court, creditors should carefully review the provisions of the plan (or forward it to their attorneys for review) to determine whether an objection is required.  In the Eastern District of Michigan, the Court will actually schedule a specified deadline for objections.  Failure to timely file an objection is likely to result in a waiver of that objection, so it is critical that creditors perform this review right away. 

Under the section labeled “Additional Terms, Conditions and Provisions,” the model plan specifies the order of payment of claims by class, and it contains a provision specifying that Class 5.1 and Class 6.1 creditors will receive equal monthly payments to the extent that funds are available at the date of each disbursement. 

In addition, according to discussions at a recent bankruptcy conference, Trustees administering this plan interpret the recent Rule 3002.1, read in conjunction with the new model plan, to require a timely proof of claim from secured creditors, as well as unsecured creditors. 

In the past, secured creditors may have delayed filing a proof of claim in reliance on their perfected lien, and Trustees would pay those claims according to the debtor’s plan.  The Trustees in the Eastern District of Michigan seem to be looking at Rule 3002.1 as imposing an affirmative requirement that such secured claim holders must file a formal proof of claim by the claims bar date, based on the new requirements for filing supplements to the proof of claim.[1]  

Cheryl is an attorney in Bankruptcy located in the Detroit office who can be reached at 248-989-3089 and chcook@weltman.com.

[1]Fed. R. Bankr. P. 3002.1 requires creditors holding claims that are secured by a security interest in the debtor’s principal residence, and which are provided for under §1322(b)(5) of the debtor’s Chapter 13 Plan to file payment change notices and post-petition fee/expense/charge notices.

Maybe You Can Strip It Off or Down, But You Can’t Void That Lien

By Monette W. Cope, Attorney

In the ceaseless quest to eliminate liens, debtors in both Chapter 7 and Chapter 13 recently challenged the Supreme Court’s decision in  Dewsnup v. Timm[1]  and attempted to void partially or wholly unsecured liens under Section 506(d) of the Bankruptcy Code. Previously, it was unclear whether Dewsnup applied in Chapter 13 cases because it was decided in a Chapter 7.  Both the Tenth and the Seventh Circuits now say the Code Section operates the same in both Chapters.

A bit of a refresher on Dewsnup:    A Chapter 7 debtor sought to void the unsecured portion of a mortgage lien on her residence.  She argued that the unsecured claim was void by law.  To get there, she first looked to Section 506(a)[2]  which states that an “allowed claim that is secured” by a lien is secured only to the extent of the value of the collateral. She then paired §506(a) with Section 506(d)[3] , which states “to the extent that a lien secures a claim…that is not an allowed secured claim, such lien is void”. (Italics added).  The crux of her argument was that the unsecured portion of the mortgage lien was void because it was not “an allowed secured claim”.

The Supreme Court didn’t agree in large part because it found that Congress, when drafting the Code, did not intend to abandon the ancient bankruptcy maxim that liens pass through bankruptcy unaffected.  The definition of “allowed secured claim” in §506(d) is not the same as what defines a secured claim in §506(a).  

 An “allowed secured claim” §506(d) is defined by Section 502[4] .   Claims are “allowed” unless objected to, and §502(b) provides an exclusive list of grounds on which bankruptcy courts may disallow proofs of claims. Claims may not be disallowed simply because the lien is wholly or partially unsecured.  Claims are “secured” if the underlying lien is valid under state law. 

Therefore, an “allowed secured claim” under §506(d) is one that has a valid state law lien and has not been disallowed under §502.  Liens are only void under §506(d)  if the claim was disallowed under §502. 

Three Circuit Court decisions just affirmed Dewsnup’s reasoning and stated it applies equally in Chapter 7 and Chapter 13.  In the Tenth Circuit, in Woolsey[5],  Chapter 13 debtors sought to strip a wholly unsecured mortgage lien using 506(d) and argued that the term “allowed secured claim” in 506(d) had a different meaning in Chapter 13 than in Chapter 7. In Chapter 13, secured claims are valued under §506(a), and so if a claim was not a secured claim under that section, then it was not an “allowed secured claim” under §506(d), and so was void.  After all, Chapter 13 debtors can strip wholly unsecured mortgage liens using Section 1322(b)(2)[6]  and §506(a).  While the Tenth Circuit strongly indicated it disagreed with the Supreme Court’s reasoning in Dewsnup, it was bound by that decision, and further bound by precedent that the same words in the same statute could not have different meanings in different contexts, otherwise the statute could ultimately have no meaning. Ultimately, the court held Chapter 13 debtors cannot use §506(d) to strip wholly unsecured mortgage liens.

The Seventh Circuit recently issued two opinions, one in a Chapter 7 case and the other in a Chapter 13 which also affirmed Dewsnup’s reasoning.  In Ryan[7] , the Seventh Circuit held that §506(d) may not be used in Chapter 13 to void a partially secured IRS lien. In that case, the Chapter 13 debtor argued that the unsecured portion of an IRS lien that attached to all of the debtor’s property, both real estate and personal property, was void under §506(d). He used the same argument as in Woolsey, that §506(d) and §506(a) must be read together, and that “allowed secured claim” has a different meaning in Chapter 13 than in Chapter 7.  The Seventh Circuit found that §506(d) applied equally in both chapters, and cited Woolsey in holding that statutes must be interpreted uniformly.

In Palomar,[8]  a Chapter 7 debtor sought to use §506(d) to strip down a wholly secured mortgage.  The court, finding that the only difference between Palomar and Dewsnup was that Palomar wanted to completely strip off an unsecured lien while Dewsnup only wanted to strip a lien down to its secured value, held that §506(d) does not void an unsecured lien when the underlying claim is not disallowed under §502.

Chapter 13 debtors may still strip off wholly unsecured mortgage liens using §506(a) and §1322(b)(2), and may be able to strip down other liens under §506(a) §1325(b)(5), but cannot void those liens under §506(d).  Chapter 7 debtors may not strip down or strip off mortgage liens using §506(d), as liens pass through Chapter 7 unaffected.  Dewsnup is still good law and it is clear now that it applies in both Chapter 13 and Chapter 7 cases.

Monette is a Junior Partner in Bankruptcy located in the Chicago office who can be reached at 312.253.9614 and mcope@weltman.com.
[1]Dewsnup v. Timm, 502 U.S. 410 (S. Ct. 1992)
[2]11 U.S.C.§506(a)
[3]11 U.S.C.§506(d)
[4]11 U.S.C.§502(a) and (b)
[5]In re Woolsey, 696 F.3d 1266 (10th Cir 2012)
[6]11 U.S.C.§1322(b)(2)
[7]Ryan v. USA, In re Ryan, 2013 U.S. App. LEXIS 13710 (7th Cir. 2013)
[8]Palomar v. First American Bank, In re Palomar, 2013 U.S. App. LEXIS 13997 (7th Cir. 2013)

New Local Bankruptcy Rules Effective January 1st in the Eastern District of Kentucky

By J. Erin McCabe, Attorney

An order was signed on December 4, 2012 promulgating new local bankruptcy rules in the Eastern District of Kentucky, effective January 1, 2013.  These changes affect both creditors and debtors alike. Highlights of the rule changes include:

  • Objection deadlines to Chapter 13 plans are now limited to seven (7) days past the first date set for the Meeting of the Creditors.
  • Any waiver of the 14-day stay after the granting of relief under FRBP 4001(a)(3) shall include an affidavit setting forth the basis for relief. Given the time and costs involved with obtaining an affidavit, it might not make sense to seek such a waiver of the 14-day stay in most cases.
  • If the deadline for objecting to a creditor’s motion for relief expires prior to the Meeting of the Creditors, as originally noticed, then both the motion and the order tendered to the court must include the following language:

The trustee will have 14 days from the conclusion of the Meeting of the Creditors to object to abandonment of the property of the estate that is subject of its motion. If no objection or motion for extension of time is filed prior to the expiration of this 14 day period, then the property will be deemed abandoned on the 15th day following the Meeting of the Creditors, subject to FRBP 9006(a)(1).

These are just of few of the local rule changes going into effect in 2013.  Creditors must be diligent, especially in reviewing plans for objection deadlines.

If you should have any questions on this matter, please contact J. Erin McCabe. Erin is an attorney practicing in WWR’s Bankruptcy unit and is located in the Cincinnati office. He can be reached at 513.629.2674 and jmccabe@weltman.com.

Eastern District of Michigan’s New Model Plan for Chapter 13 Cases

By Cheryl D. Cook, Attorney

Effective January 1, 2013, debtors seeking protection under Chapter 13 of the Bankruptcy Code must use a new model plan which was adopted by order of the Court on October 24, 2012.  A copy of the new model plan can be found by going here.

According to the Court’s notice:

The Chapter 13 Trustees for the Eastern District of Michigan, after consultation with and after soliciting comments from the consumer bankruptcy bar in this district, have drafted and recommended to the Court a new Chapter 13 model plan for use in the Bankruptcy Court for the Eastern District of Michigan.

Importantly, the new model plan contains a prominent notice advising creditors:

YOUR RIGHTS MAY BE AFFECTED.  THIS PLAN MAY BE CONFIRMED AND BECOME BINDING WITHOUT FURTHER NOTICE OR HEARING UNLESS A TIMELY WRITTEN OBJECTION IS FILED.  READ THIS DOCUMENT CAREFULLY AND SEEK THE ADVICE OF AN ATTORNEY. 

In light of the U.S. Supreme Court decision in United Student Aid Funds, Inc. v Espinosa, 559 U. S. 2010 WL 102, 7825 (U.S. March 23, 2010), this notice seems intended to give creditors ample warning of the effect of the failure to timely object to plan treatment. 

This means that when creditors receive a Chapter 13 plan, it is imperative that they review the plan for treatment of their claims (or forward it to their attorneys for such review).  Timing for objections in the Eastern District of Michigan is set by the Court; an untimely objection will be overruled.  Once the Chapter 13 plan is confirmed, the confirmation order changes the contractual relationship between parties.

Proper review of a proposed Chapter 13 plan has to include identification of whether the creditor’s claim is secured or unsecured, whether the debtor’s proposed treatment is consistent with the creditor’s intentions or account documents, and whether the plan is feasible – i.e., whether the debtor can afford to do what he is proposing to do in his plan. 

A couple of items to note specifically: 

  • Although, under the new model plan, a debtor may propose plan provisions different than those contained in the new model plan, the debtor must identify each provision that is different from the new model plan in Section I.B. of their plan, which appears on the first page of the plan. 
  • Further, under the section labelled “Additional Terms, Conditions and Provisions,” the Model Plan specifies the order of payment of claims by class, and it contains a provision specifying that Class 5.1 and Class 6.1 creditors will receive equal monthly payments to the extent that funds are available at the date of each disbursement. 
  • Subparagraph I of this Additional Terms section also requires creditors to apply all disbursements under the Plan only in the manner consistent with the terms of the Plan and to the account(s) or obligation(s) as designated on the voucher or check provided to the creditor with each disbursement. 
  • Arrearages on secured claims are identified as separate claims in the Trustees’ ledgers, so the Trustees will send a separate check for arrearage than for the regular monthly payment on a secured claim.  Those payments are to be applied to the account specified on the check. 

Plans can attempt to change items such as the interest rate applied to the loan, secured versus unsecured status, the amount of arrearage that the debtor is going to pay, the duration of the plan payments, and whether a junior mortgage loan will be stripped from the real estate securing it.  Therefore, it is important to analyze the proposal to reorganize the debtor’s obligations before the objection deadline. 

If you have any questions on this matter, please contact Cheryl D. Cook, Esq.  Ms. Cook is an attorney in the Bankruptcy Group located in the Detroit office. She can be reached at 248.989.3089 and chcook@weltman.com.