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10th Circuit Court of Appeals Rules Negative Equity is Purchase Money

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.

Can A Debtor Cram Down Negative Equity Financed Through A Newly Purchased Vehicle?

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 dyunghans@weltman.com.

Document Challenges To Motions For Relief From Stay In Chicago

There are ten bankruptcy judges in the Northern District of Illinois (Chicago).  Only one of these judges, Judge Schmetterer, has a standing order requiring supporting documents be filed with motions for relief.

Copies of the note and security interest must be filed as exhibits to the motion.  If the collateral is real estate, a recorded copy of the mortgage is required.  If it is a vehicle, the title is required, and if equipment, the UCC statement must be attached. None of the judges at this point require recorded assignments that show the moving party is the true party in interest, but Judge Schmetterer does require the relationship between the moving party and the original creditor be explained in the motion.

While vehicle titles and UCC statements are rarely challenged, debtor’s attorneys are increasingly asking for recorded documents and assignments or servicing agreements to prove that the moving party is the true party in interest.  This trend has been driven somewhat by activist attorneys, but perhaps as much or more so by debtors who have been paying attention to the media and surfing the net on the troubles some mortgage holders may have in proving they are the real party in interest.

It is always the best practice to send your attorney the note and/or security agreement, evidence of security, and any assignments or documents showing a servicing agreement. However, not every loan is equipped with a perfect portfolio of documents.  This is a problem only when the court requires them or debtors demand them.  In these cases, your WWR attorney will work with you to overcome or satisfy the debtors’ demands.