Friday, August 29, 2008

Negative Equity in Vehicle Loans under Chapter 13: Harmonizing New 9th Circuit BAP Opinion With Recent Oregon Bankruptcy Court Opinions

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

In re Penrod

9th Circuit BAP (arising out of Northern District of California)

BAP Nos. NC-07-1360-MkKJu & NC-07-1368-MkKJu

July 28, 2008

Consider how many Chapter 13 cases involve vehicle loans, how many of those loans are undersecured, and of these how many are undersecured because they include negative equity from a prior vehicle trade-in. BAPCPA created confusion about how to treat such negative equity in vehicle loans 910 days old or less with its notorious "Hanging Paragraph" of Section 1325(a). . In just the last few months the Oregon bankruptcy bar has been "blessed" with three separate opinions interpreting, to use Judge Randall Dunn's apt language, "the semantic briarpatch generally referred to as the Hanging Paragraph."

All three opinions--one last December by Judge Dunn, In re Johnson, and another in February by Judge Albert Radcliffe, In re Riach (unpublished letter opinion so link not readily available), both of the bankruptcy court for the District of Oregon, and the third just a few weeks old from the 9th Circuit BAP (Northern District of California), In re Penrod--deal with the same issue: "whether a creditor holds a purchase money security interest (“PMSI”) for purposes of the Hanging Paragraph, where a portion of its debt represents financing of negative equity in a vehicle traded in by the debtors at the time the debtors purchased their new car" (quoting Judge Dunn's opinion again). Luckily for practitioners, these three opinions all arrived at virtually the same conclusion, on largely (but not totally) the same rationales, with two differences worth noting, one in rationale and the other in practical effect.

First, the uniform conclusion was 1) that the negative equity which derived from the payoff of the traded-in balance was not part of the PMSI and so was NOT subject to the Hanging Paragraph's protection against cramdown; but 2) that, under the "dual status rule," this mixing of PMSI and non-PMSI status in one vehicle loan did not "transform the entire loan into a non-PMSI one but rather allowed the PMSI portion to be protected under the Hanging Paragraph while the non-PMSI one was not.

Second, as to the differences in rationale, the two Oregon opinions referred very specifically to the Oregon version of the UCC, with Judge Dunn expressly rejecting another bankruptcy court's suggestion that a uniform federal definition of PMSI be developed, instead stating: "I can appreciate the irony in developing federal common law to interpret a state law code term to aid in the interpretation of a federal law code provision. However, I find it inappropriate to do so. I join
with most other courts that have considered the issue and look to state law to determine whether [the vehicle creditor] holds a PMSI." The BAP opinion in contrast makes a point of NOT looking to the California version of the UCC in defining PMSI, instead looking to the current version of the general UCC as "a unifying code governing commercial transactions across and among the states that have adopted it." So the BAP extensively quotes from and refers only to the
UCC as promulgated by the National Conference of Commissioners on Uniform State Laws and its Official Comments (except for a passing mention of the California UCC on the limited issue of its interplay with California vehicle financing laws and disclosures). However, this difference in approach still yields the same result, probably because both the Oregon and California UCC's follow the uniform version closely as to the sections pertinent to this analysis.

A practical difference among these three cases was whether they addressed how to allocate debtors' prepetition payments between the PMSI and non-PMSI components of the debt. Without guidance on this, attorneys would be left up in the air about the exact amount that must be paid in a Chapter 13 plan. Judge Dunn chose not to reach that issue in In re Johnson, simply denying confirmation of a Plan that proposed to cram down the entire vehicle debt, with a 28-day order to file a modified plan. Judge Radcliffe, who in In re Riach quoted and followed In re Johnson closely in rationale and result, also denied confirmation with leave to amend, but he stated clearly (making the calculations down to the penny!) how to allocate those prepetition payments. According to debtor's counsel, Karen Oakes of Klamath Falls, Oregon, his opinion resolved this practical question because she briefed the issue and asked for a ruling. His answer: if, as here, there is no contractual provision allocating payments, prorate the combined amount of prepetition payments between the PMSI and non-PMSI components based on the ratio between the amount financed just for the new purchase and the amount used for the trade-in negative equity. Here, the contract did provide that payments on the account would go first to interest and late charges, and then to principal, so the amount to allocate was the amount credited to principal, $2,120. The ratio between the portion financed on the new purchase, $19,471, and the amount used to pay off the trade-in's loan, $3,768, is 83.79% to 16.21%; and multiplying the current balance on the account of $20,709 by the PMSI side of that ratio, 83.79%, equals $17,351, which is the PMSI component of that balance, the amount protected by the Hanging Paragraph. Since the vehicle was worth somewhat less than that, the remaining amount of the balance would be treated as a general unsecured claim. (Had the vehicle been worth more than $17,351 , the plan would have to provide for payment of that amount: "collateral's value is a floor below which the secured claim cannot be decreased".)

As for the BAP Penrod opinion, it did not need to address the payment allocation issue because the creditor surprisingly did not raise the issue on appeal, even though the bankruptcy court had allocated ALL of the prepetition payments to the PMSI side of the debt, thereby reducing the amount protected by the Hanging Paragraph.. But note that according to the Clerk of the BAP, Harold Marenus, about 2 weeks ago the creditor in this case 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 this BAP opinion appears for the moment to be good law, further buttressing the two Oregon opinions which preceded it. BUT IF this BAP opinion IS overturned by the 9th Circuit, such a decision would also effectively overturn the Oregon opinions. According to Mr. Marenus, the 9th Circuit will likely take about two years to rule on the Penrod appeal.

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

© 2008 Bankruptcy Litigation Support for Attorneys