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 firstname.lastname@example.org.