In a case that was a direct appeal to the Seventh Circuit Court of Appeals, pursuant to 28 U.S.C. §158(d)(2)(A), the Court held that the “hanging paragraph” of 11 U.S.C. §1325 left lenders with a deficiency claim after surrender of the “910 vehicle.” The Court rejects the majority (?) view that Congress “accidentally gave debtors a break” in §1325 (see the bottom of the post for the audio of the oral argument).
In In re Wright, (click for .pdf), Case No. 07-1483, 2007 U.S. App. LEXIS 15843 (7th Cir. July 5, 2007), the Chapter 13 debtors proposed a plan that would result in surrendering their “910 vehicle,” but making no provision for paying the difference in the value of the vehicle and the amount of their debt.
The question we must decide is what happens when, as a result of the hanging paragraph, §506 vanishes from the picture. The majority view among bankruptcy judges is that, with §506(a) gone, creditors cannot divide their loans into secured and unsecured components. Because §1325(a)(5)(C) allows a debtor to surrender the collateral to the lender, it follows (on this view) that surrender fully satisfies the borrower’s obligations. If this is so, then many secured loans have been rendered nonrecourse, no matter what the contract provides. See, e.g., In re Payne, 347 B.R. 278 (Bankr. S.D. Ohio 2006); In re Ezell, 338 B.R. 330 (Bankr. E.D. Tenn. 2006); In re Kenney, 2007 Bankr. LEXIS 1646 at *16-17 (Bankr. E.D. Va. May 11, 2007) (collecting cases). The minority view is that Article 9 of the Uniform Commercial Code plus the law of contracts entitle the creditor to an unsecured deficiency judgment after surrender of the collateral, unless the contract itself provides that the loan is without recourse against the borrower. See, e.g., In re Particka, 355 B.R. 616 (Bankr. E.D. Mich. 2006); In re Zehrung, 351 B.R. 675 (W.D. Wis. 2006). That unsecured balance must be treated the same as other unsecured debts under the Chapter 13 plan.
Like the bankruptcy court, we think that, by knocking out §506, the hanging paragraph leaves the parties to their contractual entitlements. True enough, §506(a) divides claims into secured and unsecured components…Yet it is a mistake to assume, as the majority of bankruptcy courts have done, that §506 is the only source of authority for a deficiency judgment when the collateral is insufficient. The Supreme Court held in Butner v. United States, 440 U.S. 48 (1979), that state law determines rights and obligations when the Code does not supply a federal rule. See also, e.g., Travelers Casualty & Surety Co. v. Pacific Gas & Electric Co., 127 S. Ct. 1199 (2007); Raleigh v. Illinois Dep’t of Revenue, 530 U.S. 15 (2000). …
By surrendering the car, debtors gave their creditor the full market value of the collateral. Any shortfall must be treated as an unsecured debt. It need not be paid in full, any more than the Wrights’ other unsecured debts, but it can’t be written off in toto while other unsecured creditors are paid some fraction of their entitlements.
(emphasis added)
The National Association of Consumer Bankruptcy Attorneys submitted an amicus curiae brief supporting the debtors, but the Court did not find it pursuasive –
Appearing as amicus curiae, the National Association of Consumer Bankruptcy Attorneys makes the bold argument that loans covered by the hanging paragraph cannot be treated as secured in any respect. Only §506 provides for an “allowed secured claim,” amicus insists, so the entire debt must be unsecured. This also would imply that a lender is not entitled to any post-petition interest. Amicus recognizes that §502 rather than §506 determines whether a claim should be “allowed” but insists that only §506 permits an “allowed” claim to be a “secured” one.
This line of argument makes the same basic mistake as the debtors’ position: it supposes that contracts and state law are irrelevant unless specifically implemented by the Bankruptcy Code. Butner holds that the presumption runs the other way: rights under state law count in bankruptcy unless the Code says otherwise. Creditors don’t need §506 to create, allow, or recognize security interests, which rest on contracts (and the UCC) rather than federal law. Section 502 tells bankruptcy courts to allow claims that stem from contractual debts; nothing in §502 disfavors or curtails secured claims. Limitations, if any, depend on §506, which the hanging paragraph makes inapplicable to purchase-money interests in personal motor vehicles granted during the 910 days preceding bankruptcy (and in other assets during the year before bankruptcy).
See also my earlier posts on Judge Massey’s opinion and Judge Bonapfel’s and Judge Diehl’s opinions, in the Northern District of Georgia, which hold the same as the Seventh Circuit.
Click here for the audio of the oral argument in the Wright case. I only listened to the first 2-3 minutes as I was typing the link, but that was enough to tell you where it was going.