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On March 24, 2010 the Sixth Circuit Court of appeals which covers Ohio, Michigan, Kentucky, and Tennessee, in line with a recent decision in the Seventh and past decisions of the Second, Fourth, Fifth, Tenth, and Eleventh Circuit Courts of Appeal, ruled that negative equity is purchase money and cannot be crammed down through bankruptcy proceedings.
Under bankruptcy law, a debtor cannot cram down a secured claim 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 some vehicle purchase transactions, debtors trade in a vehicle in order to purchase a new vehicle. If there is a difference between the value of the vehicle that the buyer trades in and the amount of the buyer’s preexisting debt, this shortfall is financed into the purchase of the new vehicle. This is referred to as negative equity. Debtor attorneys have argued that the negative equity is not considered purchase money, therefore a debtor can cram down the difference of the value of the negative equity financed into the new car purchase.
The decision, which affects the Sixth Circuit Court, ensures that debtors must pay the negative equity amount as fully secured in their Chapter 13 bankruptcy. The favorable ruling for creditors now encompasses 26 states.
If you have any question, please contact David Yunghans directly at 513-723-2211 or via email at .
Under Bankruptcy law, a debtor cannot cram down a secured claim when the creditor has a purchase money security interest in a motor vehicle acquired for the debtor’s personal use within 910 days of a debtor’s bankruptcy filing. In some vehicle purchase transactions, debtors trade-in a vehicle in order to purchase a new vehicle. If there is a difference between the value of the vehicle that the buyer trades in and the amount of the buyer’s preexisting debt, the difference is financed into the purchase of the new vehicle. This is referred to as negative equity. Debtor attorneys have argued that negative equity is not considered purchase money, and therefore a debtor can cram down the value of the negative equity financed into the new car purchase.
This issue recently came before the 10th Circuit Court of Appeals. The issue before the court was whether under the hanging paragraph of 11 U.S.C. 1325(a) a creditor has a purchase money security interest in the negative equity of the trade-in vehicle. In line with the decisions of the 11th, 2nd, and 4th Circuit Courts of Appeal, the 10th Circuit Court of Appeals ruled that a creditor does have a purchase money security interest in negative equity. Suddenly what was once the minority rule is quickly becoming the majority. Now 14 states follow that negative equity is purchase money. Creditors should consult legal counsel for advice on the these rulings.
Negative equity is created when a debtor owes more on a trade-in than the actual value of the trade-in. This negative equity is then rolled into the purchase of the new vehicle. Under the 910-day rule, debtors cannot cram down a purchase money security interest in a motor vehicle acquired for the personal use of the debtor incurred within 910 days of filing for bankruptcy, or a debt incurred during the 1-year period preceding that filing. An initial reading of the 910-day rule favors creditors, as debtors cannot cram down a newly purchased vehicle to the replacement value. However, the rule as interpreted by many bankruptcy courts has created a murky area of law.
Debtor attorneys have successfully argued that a new vehicle loan containing negative equity can be crammed down, as the negative equity is not considered purchase money securing the loan. Although debtor attorneys at first were successful in arguing that negative equity is not purchase money, several Circuit Courts of Appeal have now held the opposite. The 11th, 2nd, and most recently the 4th Circuit Courts of Appeal have ruled in favor of creditors. The issue is currently before the 6th Circuit Court of Appeals.
The three lines of analysis courts have followed in determining whether negative equity is purchase money are: 1) dual-status rule, 2) transformation rule, and 3) negative equity is purchase money. Under the dual-status rule, a debtor can cram down the amount of negative equity financed in the purchase of the new vehicle. Under the transformation rule, the financing of negative equity “transforms” the entire loan into non-purchase money, therefore the debtor can cram-down the loan amount to the actual fair market value of the vehicle. Lastly, courts have held the negative equity rolled into the new loan is purchase money and cannot be crammed down.
Courts ruling that negative equity is purchase money follow their state law definition of purchase money under Article 9 of the Uniform Commercial Code. Most recently in the Southern District of Ohio, Judge Hopkins ruled that, “as long as some portion of the transaction is secured by a purchase money security”, the loan cannot be crammed down. This ruling has taken the interpretation of what is considered purchase money one step further. In favor of creditors, the ruling relied upon the plan language of the statute rather than state or federal law.
Although interpretation of the 910-day rule by bankruptcy courts has created murky waters, which creditors must navigate, the rulings of the Circuit Courts indicate the waters again may become passable. It seems that soon the majority rule will likely hold negative equity as purchase money, which cannot be crammed down.
If you have any questions on this information, please contact David H. Yunghans, Esq., an associate focused on bankruptcy located in the Cincinnati office of Weltman, Weinberg & Reis Co., L.P.A. David can be reached at (513) 723-2211 or via e-mail at .
