Monday, August 25, 2008

New 9th Circuit BAP Opinion Weighs in Where Oregon Court Have Recently Been: BAPCPA's "hanging paragraph" & Trade-in Negative Equity in Vehicle Loans

by Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys:

Please read this Bulletin together with the one dated 8/29/08 entitled: Negative Equity in Vehicle Loans under Chapter 13: Harmonizing New 9th Circuit BAP Opinion With Recent Oregon Bankruptcy Court Opinions

June 28, 2008
In re Penrod
9th Circuit BAP, BAP Nos. NC-07-1360-MkKJu & NC-07-1368-MkKJu

So many bankruptcy debtors' vehicle loans are undersecured, and so often they are undersecured at least in part from the lenders having paid off prior undersecured loans on traded-in vehicles as part of the financing package. Therefore, how the trade-in portion of vehicle loans are treated affects many Chapter 13 cases, and because there are often many thousands of dollars at stake, whether that amount is treated as a secured or unsecured claim under BAPCPA will often greatly effect the monthly Plan payment amount as well as the total amount to be paid into the Plan. So the feasibility and eventual success of many cases turns on this issue.

In a published opinion dated 7/28/08 but released for publication only last week, In re Marlene Penrod, the 9th Circuit Bankruptcy Appellate Panel held that under BAPCPA that portion of a 910-day or less vehicle loan which was used to pay off a prior trade-in loan is secured by a Purchase Money Security Interest, and so must be subtracted from the loan balance to determine the amount of the secured claim. In that case the total loan balance was $25,675, the amount paid by the lender to pay off the undersecured loan on the traded-in vehicle was $7,137, and the value of the vehicle at the time of the Chapter 13 case was $15,615. The creditor argued that under amended Section 1325(a) its entire balance of $25,675 should be protected under that section and paid in full in the Chapter 13 plan. (The amended Section 1325(a) contains the infamous "hanging paragraph," so-called because Congress did not make clear in BAPCPA where in the Code it belonged!) Debtor argued that the paid secured claim should be limited to the value of the vehicle, $15,615, in that the hanging paragraph's creditor protections did not apply to this debt. After detailing its argument in a lengthy opinion, the BAP upheld the ruling of the underlying bankruptcy court in subtracting from the $25,675 balance the $7,137 which had been used to pay off the trade-in's loan, to arrive at a secured claim of $18,538.

The BAP noted that no Circuit Courts of Appeal or Bankruptcy Appellate Panels had addressed this issue. (And it did not refer to any specific bankruptcy court decisions on point, including two recent Oregon opinions--please see my 8/29/08 Bulletin on those.) So it made a very detailed analysis of Purchase Money Security Interests (PMSI) under the California version of the Uniform Commercial Code (UCC), determining that 1) the negative equity from the payoff of the trade-in loan was not part of the "price" of the purchase of the vehicle under Section 9-103(a)(2) of the UCC, and 2) negative equity was not part of the "value given to enable the debtor to acquire rights in" the car. Thus negative equity is not part of the PMSI.

This left the question of the effect of the Bankruptcy Code's new Section 1325(a) on the creditor's claim if a part of it was PMSI and part was not. The BAP discussed two possibilities: 1) the "transformation rule," positing that when a transaction contains both purchase money and non-purchase money obligations, the whole transaction is "transformed" into a non-purchase money one; and 2) the "dual status rule," positing instead that part of the transaction be treated as secured by a PMSI while the other part is not . Under the "transformation rule," the creditor would lose the entire benefit of the new Section 1325(a), that is, the entire claim would be subject to cramdown, as the debtor argued, whereas under the "dual status rule," the PSMI portion would not be subject to cramdown whereas the non-PMSI portion would. The BAP chose the latter rule because it "essentially captures both the lender's reasonable expectations and the debtor's economic situation, and is consistent with the apparent purpose of the hanging paragraph [Section 1325(a)]."


The portion of the vehicle loan used to pay off the prior traded-in vehicle loan is not PMSI according to the California UCC. But the entire claim is then bifurcated into a PMSI secured portion and the non-PMSI secured portion; the PMSI portion (the total claim minus the non-PMSI amount used to pay off the trade-in loan) is the amount which is protected by the amended Section 1325(a) and must be paid by the debtor.

IF this opinion stands, its impact may be significant, although the Oregon Bankruptcy Court has already ruled twice on this same issue, in December 2007 and February 2008, reaching the same conclusions on the basic issues of the PMSI and the "dual status rule," but with a couple of potentially important difference. Please refer to my Bulletin of 8/29/08 about this.

Furthermore, according to the Clerk of the BAP, Harold Marenus, the creditor in this case has filed a notice of appeal to the 9th Circuit (Appeal # 08-60037). As of this writing there has been no motion filed with either the BAP or the 9th Circuit to stay the BAP's ruling pending appeal, So the opinion appears for the moment to be good law. The practical question is whether this makes any difference in Oregon in light of the two local opinions. (Again, see my 8/29/08 Bulletin.) IF this BAP opinion IS overturned by the 9th Circuit, such a decision would also effectively overturn the Oregon opinions . . . so stay tuned.

by Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys,

© 2008 Bankruptcy Litigation Support for Attorneys