The 7th Circuit "Hangs" with the Minority - Or Does It?

In the previous post, I covered In re Trejos, 2007 WL 2391184 (Bankr. App. 9th Cir. July 30, 2007), in which the Ninth Circuit BAP first considered BAPCPA’s infamous “hanging paragraph.” The language in issue is found in Bankruptcy Code section 1325(a):

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 interest securing the debt that is the subject of the claim, the debt was incurred within the 910-day [period] 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.

In Trejos, the BAP rejected the Debtors’ argument that if section 506 does not apply to a “910 loan” then the auto lender cannot have an allowed secured claim in the chapter 13 case. In its ruling, the BAP stated that it is not section 506 that is the basis for a creditor’s security interest.

Trejos did not cite In re Wright, 492 F.3d 829 (7th Cir. 2007), published less than a month before. Wright was the first circuit decision on the “hanging paragraph.” Incidentally, the appeal reached the Seventh Circuit under BAPCPA’s new direct appeal provision, 28 U.S.C. § 158(d)(2)(A).

Unlike the Debtors in Trejos, the Wrights did not want to keep their car, but instead opted to return it. They claimed that the effect of the hanging paragraph was to disallow the lender’s unsecured claim for a deficiency. The Seventh Circuit adopted what it characterized as the “minority view” among bankruptcy courts, holding that the deficiency claim must be allowed. The opinion goes out of its way to debunk the argument (made by the National Association of Consumer Bankruptcy Attorneys in an amicus brief) that the hanging paragraph deprives the lender of even an allowed secured claim. The Court stated:

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).

Interestingly, the BAP in Trejos claimed to be siding with the substantial majority of published bankruptcy opinions in upholding the lender’s allowed secured claim against the hanging paragraph. In upholding the lender’s deficiency claim, the Seventh Circuit stated that it was adopting a minority view. That there should be a difference in result depending on the context is not surprising. In the Trejos situation, where the debtor wants to keep the car, the notion that the hanging paragraph was intended to deprive consumer lenders of a secured claim is absurd. However, it is less absurd (although implausible given the general tenor of BAPCPA) that Congress intended to relieve the Debtor of the burden of a deficiency claim in cases where the collateral is surrendered. It may also be argued that while section 506 may not be the origin of a secured claim, it may be the only basis for the creditor’s ability to bifurcate its claim.

Nevertheless, both Trejos and Wright are based on exactly the same, persuasive reasoning. Perhaps some future opinion will better explain why that reasoning should apply in one situation and not the other.

How's It Hanging?

The Ninth Circuit BAP has spoken on the “hanging paragraph” issue, siding with consumer lenders. Ever since the enactment of BAPCPA, some have claimed that poor legislative drafting must be read as substantially liberalizing the treatment of certain consumer loans in chapter 13.

In re Trejos, 2007 WL 2391184 (Bankr. App. 9th Cir. July 30, 2007) interprets the following language which was added to Bankruptcy Code section 1325(a) but left “hanging” without inclusion in any of its subparagraphs:

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 interest securing the debt that is the subject of the claim, the debt was incurred within the 910-day [period] 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.

The Debtors first asserted that because their vehicle finance contract was assigned by the dealer to VW Credit, the assignee did not have a “purchase money security interest.” The BAP disposed of this argument, holding that “under the assignment, VW Credit simply stepped into the Dealer's shoes.”

The Debtors next argued that because under the language of the hanging paragraph, section 506 did not apply , VW credit could not have an allowed secured claim. In support of this position they cited the following passage in Colliers:

It is possible that [the “Hanging Paragraph”] was intended to prohibit the use of section 506(a) to bifurcate a secured claim into an allowed secured claim and an allowed unsecured claim as part of the cramdown permitted by section 1325(a)(5)(B) and, therefore, that such claims should be treated as fully secured claims regardless of the value of the collateral. But, even if that was the intent, because [the “Hanging Paragraph”] renders entirely inapplicable for some creditors the only section, section 506(a), that gives those creditors allowed secured claims, it does not to [sic] carry out such intent.

The assumption made by Colliers is that it is section 506 that “gives” creditors an allowed secured claim. In holding otherwise, the BAP quoted In re Brown, 346 B.R. 868, 873 (Bankr.N.D.Fla.2006): “Just because § 506 does not apply does not mean that there is no secured claim. Section 506(a) simply provides for bifurcation of claims into secured and unsecured portions in accordance with the value of the collateral; it does not form the basis for a secured claim.”

Trejos was not one of those cases in which the Court was invited to interpret the “plain language” of BAPCPA to reach an absurd result. In order to sustain the Debtors’ position, one was required to make basic assumptions about bankruptcy law that go far beyond the tinkering of BAPCPA. A creditors’ lien is not a privilege created by the Bankruptcy Code. It is a constitutionally protected property interest that the Bankruptcy Code can affect within limits. This opinion may be quoted for that much broader and significant holding long after the “hanging paragraph” issue has been finally resolved.