The Hanging Paragraph and Secured Claims: The Impact of the Unnumbered Paragraph after Section 1325(a)(9) on the Treatment of Certain Claims in the Chapter 13 Context Southeastern Bankruptcy Law Institute Atlanta, Georgia April 12-14, 2007 Barry Schermer United States Bankruptcy Judge Eastern District of Missouri Susan M. Spraul Law Clerk to the Honorable Barry S. Schermer
The Hanging Paragraph and Secured Claims: The Impact of the Unnumbered Paragraph after Section 1325(a)(9) on the Treatment of Certain Claims in the Chapter 13 Context By Barry Schermer, United States Bankruptcy Judge for the Eastern District of Missouri, and Susan M. Spraul, Law Clerk to the Honorable Barry S. Schermer Introduction 1 BAPCPA created two new types of claims in the Chapter 13 context: a claim secured by a purchase money security interest in a vehicle purchased for the debtor s personal use within 910 days prior to the bankruptcy filing and a claim secured by a purchase money security interest in any other thing of value purchased within one year prior to the bankruptcy filing. At least that is one interpretation of what Congress did when it added certain language to the Bankruptcy Code after Section 1325(a)(9). Unfortunately the new language is not Congress finest work and has inspired divergent interpretations of its meaning. What do we call this new language? The first and most obvious problem with the new language is its orphan status. The language lacks a unique numeric or letter designation. Instead, it was inserted at the end of Section 1325(a)(9), which discusses the debtor s obligation to file tax returns and appears to have no substantive relation to the new language. As a result, the new language lacks a clear identifier and has therefore gained notoriety through various nicknames including the Hanging Paragraph, the 910 Language, the Unnumbered Paragraph, and the Flush Language. The language relates to more than 910 car claims purchase money claims secured by vehicles purchased within 910 days prior to the bankruptcy filing. It also includes purchase money claims relating to anything of value purchased within one year prior to the bankruptcy filing. Therefore, the new provision will be referred to as the Hanging Paragraph in these materials because this broader term does not inadvertently exclude claims secured by a purchase money security interest in anything of value acquired within the year preceding the bankruptcy filing. What does the new language say? The exact wording of the new language follows: For purposes of paragraph (5), section 506 shall not apply to a claim described in that paragraph if the creditor has a purchase money security 1 Please be advised that these materials were prepared on January 16, 2007. This area of the law is changing on a daily basis. Therefore, the law will have undoubtedly changed by the date of this seminar. Every effort will be made to include additional developments in this area during the oral presentation. 1
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 (as defined in section 30102 of title 49) 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 that filing. 11 U.S.C. 1325(a) Hanging Paragraph. What does the new language mean? The courts must answer this question. An obvious problem with the provision is the grammatical mistake within the 910 day preceding the date of the filing.... Does this mean the provision only applies to vehicles purchased on the 910 th day preceding the bankruptcy filing? No, we can safely assume this is merely a typographical error. Otherwise, Congress went to a lot of trouble to create a special class of claims secured by purchase money security interests in vehicles purchased exactly 910 days before a bankruptcy filing. Debtors could easily avoid this section by filing bankruptcy on any day other than the 910 th day after purchasing a car. Furthermore, while Congress is certainly free to discriminate among creditors in the Bankruptcy Code and in fact does so in the Hanging Paragraph discrimination in this context would be absurd. Therefore, the missing word period is generally read into the language, resulting in the language applying to debts incurred within the 910-day period preceding the date of the filing of the bankruptcy petition. This is consistent with the language concerning claims secured by a purchase money security interests in any thing of value if the debt was incurred during the 1-year period preceding that filing. What type of claims fall within the Hanging Paragraph? With respect to vehicles, the creditor must have a purchase money security interest for its claim to fall within the parameters of the Hanging Paragraph. Second, the debt must have been incurred within the 910 days preceding the filing of the bankruptcy petition. Third, the collateral must consist of a motor vehicle. Fourth, the motor vehicle must have been acquired for the personal use of the debtor. Each of these elements is necessary for a claim to fall within the ambit of the Hanging Paragraph. What is a purchase money security interest? This term is defined by state law. The Uniform Commercial Code defines a purchase money security interest in goods as follows: A security interest in goods is a purchase-money security interest to the extent that the goods are purchase-money collateral with respect to that security interest. 2
U.C.C. 9-103(b)(1). The term purchase-money collateral means goods that secure a purchase-money obligation incurred with respect to that collateral. U.C.C. 9-103(a)(1). A purchase-money obligation is an obligation incurred as all or part of the price of the collateral or for value given to enable the debtor to acquire rights in or the use of the collateral if the value is in fact so used. U.C.C. 9-103(a)(2). It is generally accepted that a creditor who finances the purchase of a car and retains a lien on the vehicle is a purchase money secured creditor with respect to the vehicle. But what if the amount financed does not equal the purchase price? For example, what if the amount financed includes the purchase of a service contract or an extended warranty, or document and title fees? So far, courts have generally held that a lender s claim is a purchase money security interest even if the amount financed included funds attributable to title and document fees and service contracts which are commonly financed in conjunction with vehicle acquisitions. In re Johnson, 337 B.R. 269 (Bankr. M.D.N.C. 2006); In re Murray, 346 B.R. 237 (Bankr. M.D. Ga. 2006). Another court has acknowledged that the purchase price; sales tax; notary documentation; and license, title, registration, and recordation fees are included in a purchase money obligation. However, that court concluded that costs associated with extended warranties and insurance deficiency coverage are not purchase money obligations. In re White, 352 B.R. 633 (Bankr. E.D. La. 2006). A refinance with the extension of additional credit may eradicate purchase money security interest status. For example, where a lender finances the purchase of a vehicle and subsequently extends additional credit which is included in the refinance of the vehicle, all of which is secured by the vehicle, the lender no longer has a purchase money security interest in the vehicle and its claim does not fall within the ambit of the Hanging Paragraph. In re Horn, 338 B.R. 110 (Bankr. M.D. Ala. 2006). The Horn court relied on 11th Circuit precedent for the proposition that if an item of collateral secures some type of debt other than purchase money debt, such as antecedent debt, the security interest is not a purchase money security interest. See Snap-On Tools, Inc. v. Freeman, 956 F.2d 252 (11th Cir. 1992). What about other elements included in the original financing? For example, what if the debtor trades in a vehicle and receives less than the amount owed on the vehicle in connection with the trade-in? And what if the lender finances the balance due on the old vehicle in addition to the purchase price of the new vehicle, essentially rolling the old balance into the new loan? One court faced with this issue determined that if the amount financed in connection with the acquisition of the vehicle included funds to pay off a prior loan, such as a balance due on a trade-in vehicle, only that portion of the debt attributable to the acquisition of the new vehicle is a debt secured by a purchase money security interest falling within the ambit of the Hanging Paragraph. The excess debt covering the balance due on the prior vehicle is not entitled to purchase money treatment under the Hanging Paragraph. In re Vega, 344 B.R. 616 (Bankr. D. Kansas 2006). Other courts have refused to break down the debt into purchase money and non-purchase money components. One view classifies the entire debt, including the refinanced trade-in balance, as the cost of acquiring the new vehicle and, therefore, considers the entire debt secured by a purchase money security interest. In re 3
Graupner, 2006 WL 3759457 (Bankr. M.D. Ga. 2006). Another view concludes that when the balance due on a trade-in is rolled into the loan for the new vehicle the entire debt is transformed into a non-purchase money debt. Under this view, the claim does not fall within the ambit of the Hanging Paragraph. In re Peaslee, 2006 WL 3759476 (Bankr. W.D. N.Y.). See also In re Jackson, 2007 WL 63582 (Bankr. W.D. N.Y.)(followup to Peaslee discussing the respective burdens of proof where a balance due on a trade-in is rolled into the amount financed for the new vehicle). When in doubt as to what constitutes a purchase money security interest, attorneys should look to applicable state law because the Bankruptcy Code does not provide the answer to this question. The 910 day requirement is the simplest element, assuming we insert the word period so that we include the entire 910 days preceding the bankruptcy filing and not just the 910th day. This is a matter of counting and has not yet created a problem among the bankruptcy bar. The requirement that the collateral consist of a motor vehicle has not been problematic to date. The term motor vehicle is defined in Title 49 of the United States Code as a vehicle driven or drawn by mechanical power and manufactured primarily for use on public streets, roads, and highways, but does not include a vehicle operated only on a rail line. 49 U.S.C. 30102(a)(6). This definition was expressly incorporated into the Hanging Paragraph by BAPCPA. However, the phrase the collateral for that debt consists of a motor vehicle does raise the question of whether the Hanging Paragraph applies to a debt with other collateral in addition to a vehicle. Congress did not say the only collateral for that debt consists of a motor vehicle. In contrast, Congress singled out home mortgage claims which are secured only by a security interest in real property that is the debtor s principal residence as unmodifiable in the Chapter 13 plan context. See 11 U.S.C. 1322(b)((2). Presumably Congress was not limiting the Hanging Paragraph treatment to claims only secured by a motor vehicle. This is consistent with the opinions considering what constitutes a purchase money security interest discussed above. See In re Johnson, 337 B.R. 269 (Bankr. M.D.N.C. 2006); In re Murray, 346 B.R. 237 (Bankr. M.D. Ga. 2006); In re Vega, 344 B.R. 616 (Bankr. D. Kansas 2006). However, the language is subject to interpretation. Finally, the motor vehicle must have been acquired for the personal use of the debtor. What is personal use? Personal use is non-business use and generally includes travel to and from work. In re Solis, 2006 WL 3298351 (Bankr. S.D. Tex.); In re White, 352 B.R. 633 (Bankr. E.D. La. 2006). Use is personal if it satisfies personal wants, personal needs, and family and other personal obligations. In re Solis, 2006 WL 3298351 (Bankr. S.D. Tex.). The debtor need not be the driver of the vehicle in order for the use to be for his or her benefit. Id. The personal use must be significant and material; however personal use of the debtor need not be the exclusive use of the vehicle. Id. See also In re Wilson, 2006 WL 3512921 (Bankr. D. Kan.). Who is the debtor for whom the use of the vehicle must be personal? Is it the debtor who signed the contract or the debtor who filed bankruptcy? Courts are split on this issue. Compare, e.g., In re Solis, 2006 WL 3298351 (Bankr. S.D. Tex.)(debtor in 4
this context refers to the bankrupt), and In re Press, 2006 WL 2734335 (Bankr. S.D. Fla.)(debtor refers to obligor on the loan). What if the vehicle was acquired for the use of a non-debtor family member? In such a situation the Hanging Paragraph does not apply. For example, a car purchased for use by a non-filing spouse does not fall within the Hanging Paragraph. In re Jackson, 338 B.R. 923 (Bankr. M.D. Ga. 2006); In re Davis, 2006 WL 3613319 (Bankr. M.D. Ala. 2006). Likewise, a vehicle purchased for a non-debtor adult child does not fall within the Hanging Paragraph. In re Lewis, 347 B.R. 769 (Bankr. D. Kan. 2006). However, a vehicle purchased by one debtor for the personal use of a co-debtor spouse does fall within the Hanging Paragraph. In re Vagi, 351 B.R. 881 (Bankr. N.D. Ohio 2006). Where spouses file a joint bankruptcy case, the vehicle need not be purchased for the personal use of the acquiring debtor. It need only be acquired for the personal use of one of the co-debtors, regardless of which debtor obtained the financing. Id. What if the vehicle was purchased for use by a non-filing family member but the debtor is using the vehicle as of the petition date? Does the timing of usage matter under the Hanging Paragraph? The Jackson court acknowledged the question of timing as a potential issue in the context of use of the vehicle. In re Jackson, 338 B.R. at 926 n.1. On its face the language applies to a vehicle acquired for the personal use of the debtor. Therefore the relevant time for assessing usage is the time of acquisition. In re Solis, 2006 WL 3298351 (Bankr. S.D. Tex.). Therefore, if a vehicle was acquired for use by the debtor but is not used by the debtor as of the petition date, the associated claim appears to fall within the Hanging Paragraph. In the alternative, if a vehicle was acquired for use by a non-debtor but is used by the debtor as of the petition date, the vehicle does not fall within the express language of the Hanging Paragraph. With respect to claims secured by non-vehicles, the creditor must have a purchase money security interest, but the collateral can be anything of value and the debt must have been incurred during the one-year period preceding the bankruptcy filing. If the claim fits within these criteria, it too is entitled to treatment under the Hanging Paragraph. Is a claim which falls within the Hanging Paragraph a secured claim? Most courts have concluded that a claim which falls within the Hanging Paragraph is a secured claim. In re Robinson, 338 B.R. 70 (Bankr. W.D. Mo. 2006); In re Wright, 338 B.R. 917 (Bankr. M.D. Ala. 2006); In re Parish, 2006 WL 1679710 (Bankr. M.D. Fla.); In re Brown, 339 B.R. 818 (Bankr. S.D. Ga. 2006); In re Turner, 349 B.R. 437 (Bankr. D. S.C. 2006); In re Shaw, 341 B.R. 543 (Bankr. M.D. N.C. 2006); In re Brooks, 344 B.R. 417 (Bankr. E.D. N.C. 2006); In re Brown, 346 B.R. 246 (Bankr. M.D. Ga. 2006); In re Murray, 346 B.R. 237 (Bankr. M.D. Ga. 2006), reaffirmed on reh g, 352 B.R. 340; In re Henry, 353 BR. 261 (Bankr. D. Or. 2006); In re White, 352 B.R. 633 (Bankr. E.D. La. 2006); In re McCormick, 2006 WL 3499226 (Bankr. E.D. Wis.). Other courts have held that a claim which falls within the Hanging Paragraph is not a secured claim. In re Carver, 338 B.R. 521 (Bankr. S.D. Ga. 2006)(Walker, Jr., J.); 5
In re Green, 348 B.R. 601 (Bankr. M.D. Ga. 2006)(Walker, Jr., J.); In re Robinson, 2006 WL 3479301 (Bankr. M.D. Ga.)(Walker, Jr., J.); In re Wampler, 345 B.R. 730 (Bankr. D. Kan. 2006); In re Taranto, 344 B.R. 857 (Bankr. N.D. Ohio 2006). Instead, it is a unique type of claim entitled to special treatment. To what treatment is a Hanging Paragraph claim entitled? The majority view is that a Hanging Paragraph claim is a secured claim which may not be stripped down. The value of the vehicle (or other purchase money collateral) is irrelevant. The holder of a Hanging Paragraph claim must receive the present value of the entire debt. Accordingly, the Hanging Paragraph claim must be repaid in full with interest at the rate set forth in Till v. SCS Credit Corp., 541 U.S. 465 (2004). In re Robinson, 338 B.R. 70 (Bankr. W.D. Mo. 2006); In re Wright, 338 B.R. 917 (Bankr. M.D. Ala. 2006); In re Fleming, 339 B.R. 716 (Bankr. E.D. Mo. 2006); In re Parish, 2006 WL 1679710 (Bankr. M.D. Fla.); In re Brown. 339 B.R. 818 (Bankr. S.D. Ga. 2006); In re Turner, 349 B.R. 437 (Bankr. D. S.C. 2006); In re Shaw. 341 B.R. 543 (Bankr. M.D. N.C. 2006); In re Brooks, 344 B.R. 417 (Bankr. E.D. N.C. 2006); In re Brown, 346 B.R. 246 (Bankr. M.D. Ga. 2006); In re Murray, 346 B.R. 237 (Bankr. M.D. Ga. 2006), reaffirmed on reh g, 2006 WL 2457851; In re Henry, 353 B.R. 261 (Bankr. D. Or. 2006); In re White, 352 B.R. 633 (Bankr. E.D. La. 2006); In re McCormick, 2006 WL 3499226 (Bankr. E.D. Wis.)(applying Till, court found that no adjustment to prime rate of interest was necessary). Under the minority view, Hanging Paragraph claims are not allowed as secured claims. Courts that have reached this conclusion have differed on the treatment to which these claims are entitled. One judge has concluded that Hanging Paragraph claims are a new type of claim entitled to the greater of the full amount of the debt without interest, or the amount the creditor would receive if the claim was bifurcated and crammed down. In re Carver, 338 B.R. 521 (Bankr. S.D. Ga. 2006)(Walker, Jr., J.); In re Green, 348 B.R. 601 (Bankr. M.D. Ga. 2006)(Walker, Jr., J.); In re Robinson, 2006 WL 3479301 (Bankr. M.D. Ga.)(Walker, Jr., J.). Another judge has concluded that the claim must be paid in full without interest over the life of the plan. In re Wampler, 345 B.R. 730 (Bankr. D. Kan. 2006). A third judge has decided that a Hanging Paragraph claim is entitled to fair treatment. In re Taranto, 344 B.R. 857 (Bankr. N.D. Ohio 2006). Where the original contract provided for no interest and the plan proposes payment in full without interest sooner than the claim would have been paid under the original contract, such treatment is fair under the Hanging Paragraph. Id. What if the debtor does not retain the collateral securing the Hanging Paragraph claim? Initially most courts determined that a debtor can surrender the collateral securing a Hanging Paragraph claim in full satisfaction of the debt. The value of the collateral is irrelevant and the creditor is not entitled to a deficiency claim. In re Ezell, 338 B.R. 330 (Bankr. E.D. Tenn. 2006); In re Long, 2006 WL 2090246 (Bankr. E.D. Tenn. 2006); In re Brown, 346 B.R. 868 (Bankr. N.D. Fla. 2006); In re Pool, 351 B.R. 6
747 (Bankr. D. Or. 2006); In re Feddersen, 2006 WL 3347919 (Bankr. S.D. Ill.); In re Turkowitch, 2006 WL 3346156 (Bankr. E.D. Wis.). This result follows even when the plan proposes full payment of all unsecured claims. In re Bayless, 2006 WL 2982101 (Bankr. E.D. Tenn.). However, a minority have found no anti-deficiency language in the Hanging Paragraph. These courts concluded that the surrender of the vehicle does not result in the full satisfaction of the claim, leaving the creditor whatever rights are available under state law including the pursuit of a deficiency as an unsecured claim in the Chapter 13 case. Dupaco Cmty. Credit Union v. Zehrung (In re Zehrung), 315 B.R. 675 (W.D. Wis. 2006); In re Duke, 345 B.R. 806 (Bankr. W.D. Ky. 2006); In re Particka, 2006 WL 3350198 (Bankr. E.D. Mich.); In re Hoffman, 2006 WL 3813775 (Bankr. E.D. Mich.). What impact does the Hanging Paragraph have on non-hanging Paragraph claims which are cross-collateralized with Hanging Paragraph claims? A lender extends funds to purchase a vehicle within the parameters of the Hanging Paragraph and later extends additional funds which are secured by other existing collateral as well as the vehicle purchased with the original funds. The first funds loaned form the basis of a Hanging Paragraph claim and the later funds loaned form the basis of a non-hanging Paragraph secured claim. The non-hanging Paragraph secured claim is not subject to the restrictions imposed by the Hanging Paragraph. Accordingly, it is subject to bifurcation. Does the Hanging Paragraph have any impact on the valuation of the collateral securing the non-hanging Paragraph claim? No. The value of the vehicle is determined and compared to the amount of the Hanging Paragraph claim. If any excess collateral value exists, it is added to the value of the other collateral securing the non-hanging Paragraph claim to determine how much of the non-hanging Paragraph claim is secured and how much, if any, is unsecured. In re Sanders, 2006 WL 3386739 (Bankr. C.D. Ill.); see also In re White, 352 B.R. 633 (Bankr. E.D. La. 2006). The Sanders court rejected the argument that the Hanging Paragraph deemed the Hanging Paragraph claim fully secured and therefore no excess collateral value existed with respect to the vehicle to secure the non-hanging Paragraph claim. Conclusion The majority of courts have concluded that claims that fall within the ambit of the Hanging Paragraph are secured claims entitled to payment in full plus interest so that the creditor receives the present value of the full claim. Hanging Paragraph claims cannot be stripped down. Conversely, the collateral securing a Hanging Paragraph claim can be returned in full satisfaction of the debt. Deficiency claims no longer exist with respect to Hanging Paragraph claims. A minority of courts have concluded otherwise. Those attorneys who practice in the area of consumer bankruptcy law are advised to familiarize themselves with the views of the judges before whom they practice. All attorneys are also urged to look 7
closely at the facts and circumstances surrounding the transaction to determine if they create a claim which falls within the ambit of the Hanging Paragraph. If not, one must look beyond the Hanging Paragraph to determine what type of treatment the claim is entitled to receive in a Chapter 13 plan. That issue is beyond the scope of this article and shall be left for another day. 8