Strip-Tease? No More Stripping Down Many Auto Loans

Forgive the title, but purchase money security interests on vehicles generally do not make for gripping headlines. Congress, though, found them interesting enough that the treatment of such loans in bankruptcy has been modified under BAPCPA.

Prior to the new reform act, Chapter 13 debtors who owned cars that were "underwater" (the debt on the vehicle exceeded its value) and who wished to keep the car were able to "strip down" the lender's claim under 11 U.S.C. 506(a)(1) -- reduce the secured portion of the lender's claim to the value of the vehicle, and pay that amount with interest during the term of the Chapter 13 plan, while treating the balance of the claim as an unsecured claim (only a fraction of which typically gets paid in a Ch. 13 plan). BAPCPA made an amendment to Section 1325 of the Bankruptcy Code which provides that "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-day [sic] preceding the date of the filing of the petition, and the collateral for that debt consists of a motor vehicle ... 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 the filing." (It's unclear whether to refer to this provision as 1325(a)(9) -- although that's where the language was added, it has nothing at all to do with the pre-existing portion of 1325(a)(9). I'll refer to it as "1325(a)(*)").

In other words, if a car was bought for personal use within 910 days of the bankruptcy filing, 506 (which governs the determination of secured status) does not apply. This would appear to mean that debtors can no longer strip down auto loans using 506(a)(1) if the car was bought in the past 910 days.

In In re Johnson, __ B.R. __, 2006 WL 270231 (Bankr. M.D.N.C. 2/2/06), the debtor took the interesting tack of arguing that if 506 does not apply, then any claim arising from such a loan must be an unsecured claim - a special kind of unsecured claim that must be paid at least the liquidation value of the vehicle. The creditor, GMAC, argued to the contrary that the language was ambiguous, but that its only logical reading is to create special treatment for 910-day vehicle loans such that the bifurcation provision of 506(a) cannot be applied to them. In support, GMAC argued "that the purpose of enacting BAPCPA was to put more money in the hands of such creditors" (points for candor?) and that the debtors' reading would not fulfill this purpose.

The court was persuaded by GMAC's argument, and found that 1325(a)(*) precludes the strip-down of purchase money security loans on vehicles purchased within 910 days of the petition date. As a result, the debtor has to repay the full amount of the vehicle loan, with interest. The court did note, however, that under 11 U.S.C. 1322(b)(2), the debtor may still modify the term and interest rate of the loan.

This latter point was discussed in greater detail in In re Robinson, __ B.R. __, 2006 WL 349801 (Bankr. W.D. Mo. 2/10/06). Judge Federman, like Judge Waldrep in Johnson, concluded that the debtor could not strip down a vehicle loan on a car purchased for personal use within 910 days of the filing, and that the creditor was entitled to a secured claim for the total amount of its claim, regardless of the value of the vehicle. He rejected, however, the creditor's argument that 1325(a)(*) precluded the debtor from altering the term or interest rate of the loan.

In reaching this conclusion, Judge Federman noted that the Supreme Court recently confirmed in Till v. SCS Credit Corp., 541 U.S. 465 (2004) that debtors can modify the interest rates that secured creditors are to receive in a Chapter 13 case under 11 U.S.C. 1322(b)(2). While the creditor contended that Till was no longer good law in light of the amendment, Judge Federman disagreed. Rather, he found that if Congress had intended to modify Till's application to auto loans, it could have clearly done so by specifically modifying 1322(b)(2) or referring to "discount rate" or "interest." Indeed, Congress had previously done so with respect to home mortgages, and the Till decision had extended an express invitation to Congress to enact remedial legislation if the Supreme Court had gotten it wrong. As a result, while the BAPCPA amendments require the debtor to pay the full amount of the vehicle loan creditor's claim over the course of the Chapter 13 plan, they do not overrule Till or prevent the debtor from modifying the interest rate to be paid on the claim.

Not all loans secured by vehicles will fall within the ambit of 1325(a)(*), though, as was noted in In re Horn, __ B.R. __, 2006 WL 416314 (Bankr. M.D. Ala. 2/23/06). In Horn, the lender made a loan to the debtor which was used to purchase the car in 1997, and then between 2001 and 2003 refinanced the loan four more times, each time advancing additional funds to the debtor. Judge Williams found that under state law, the loan did not qualify as a "purchase-money obligation" because the debtor did not incur the entire debt as all or part of the purchase price of the vehicle. As a result of the multiple refinancings and additional advances, the security interest in the vehicle lost its purchase-money character. Thus, 506 still applied in determining the secured claim of the lender, which could be bifurcated and stripped down.

So there's still some stripping under BAPCPA after all.