Trade-in Value and Automobile Loans After Bankruptcy Reform

In the 106th Congress, the House and Senate passed legislation that was presented to President Clinton, but was then pocket-vetoed. See H.R. 2415, 106th Cong. (2000). This legislation was identical to H.R. 3150 in many respects. However, the final version of legislation presented to President Clinton had been modified to contain a compromise; this version prohibited bifurcation for automobiles purchased within five years if there was a purchase money secured interest, with a shorter, one year look-back period for other types of collateral. See S. 3186, 106th Cong. ' 306(b).

The procedural history of H.R. 2415 is complex. H.R. 2415 as originally passed by both the House and Senate related to security at State Department facilities overseas. However, the substance of both versions of H.R. 2415 was stricken and replaced by the text of S. 3186. The text of S. 3186, in turn, represented a bi-cameral compromise between competing versions of bankruptcy reform-H.R. 833 and S. 625. S. 3186, therefore, contained the operative text that was vetoed by President Clinton; its provisions closely resembled the final version of the hanging paragraph.

During the 106th Congress, when the House of Representatives held a hearing to consider HR 833, its version of bankruptcy reform that contained text identical to H.R. 3150, the Acting Assistant Attorney General for Legislative Affairs of the Department of Justice (DOJ) submitted a views letter dated March 24, 1999. This letter criticizes the five-year look back as too long, and suggested instead a 180-day look back. See Letter to the Honorable George Gekas, March 24, 1999, page 11.

When the Senate considered the conference report for H.R. 2415, Senator Grassley inserted into the Congressional Record a detailed history and explanation of the bill in lieu of a formal legislative history. In relevant part, this history reads as follows:

Section 306. Giving Secured Creditors Fair Treatment in Chapter 13.

Second, the extent to which claims secured by purchase money security interests in personal property are subject to cramdown to fair market value is limited. It is intended that cramdown not apply to any collateral described in this provision during the periods of time specified, and that the amount of the claim which must be paid under the plan be the full amount of the claim allowed under section 502 without application of section 506. Thus, if the debt was incurred within 5 years prior to filing and the collateral consists of a motor vehicle acquired for the personal use of the debtor, the value of the collateral cannot be reduced to the current fair market value and therefore the amount the plan must pay under section 1325(5)(B)(ii) over the duration of the plan must be the amount of the allowed secured claim under section 506. A similar result applies for any other personal property if the debt was incurred during the one year period preceding the filing.

See 1216 Cong. Rec. S11709 (daily ed. Dec. 7, 2000) (emphasis added).

From this record, it is clear that as of 2000, the anti-bifurcation amendment expanded its protection of secured creditors. This penultimate version of the hanging paragraph extended its reach to cover all charges encompassed within a purchase-money security interest and removed the limitations associated with the “to the extent” and “in whole or in part” language.

Claims Made by Opponents in 2000

The claims made by opponents of the legislation in 2000 are also instructive. The Committee Report that accompanied the legislation that ultimately became S. 3186 contains the dissenting views of Sen. Herb Kohl (D-WI) of the Senate Judiciary Committee, who based his opposition on the fact that, under the bill, debtors in Chapter 13 cases would be required to pay the full value of the loan in automobile finance transactions. See S. Rep. No. 106-49 at 7 (1999).

One of the most telling and incisive descriptions of this near-final version of the hanging paragraph, which clearly demonstrates the breadth of the anti-bifurcation provision, comes from Sen. Dianne Feinstein, D-CA:

Here is another sort of Orwellian title. Section 306 is called “Giving Secured Creditors Fair Treatment Under Chapter 13.” It ought to be called “Giving Certain Secured Creditors Preferred Treatment Under Chapter 13″ because it favors those who make car loans over other secured creditors and over unsecured creditors.

Here is how it works. There is, of course, a concept in bankruptcy law currently called cramdown or strip down. It recognizes the fact that the collateral for some kinds of loans can lose value over time so it may be worth significantly less than the debt owed. Remember that in a bankruptcy proceeding, secured creditors get paid first, but the cramdown concept says to those creditors that they only get paid first up to the amount of the value of the collateral for the loan. After that, if they are still owed money, they have to get in line with the other unsecured creditors.

To give a more tangible example, if someone owes $10,000 on a car loan, but the car which is collateral for that loan is worth only $7,000 now, then only $7,000 of that loan is considered secured in a bankruptcy. That makes perfect sense since the maker of that loan has the right to repossess the car, but if it does that, it can only get $7,000 when it sells the car.

What the bill does is eliminate the cramdown for any car that is purchased within five years of bankruptcy. That means that even though the vehicle that secures the loan has lost much of its value, the entire amount of the debt must be repaid in a Chapter 13 plan. This gives special treatment to the lender and, more importantly, it will make it much more difficult for a Chapter 13 plan to work, and that will hurt people who want to pay off their debts in an organized fashion under Chapter 13.

See 146 Cong. Rec. S11636 (daily ed. Dec. 6. 2000). (Emphasis added.)

While Congress would later reduce the five-year period to 910 days, the wording of the hanging paragraph would remain otherwise identical.

Based on this review of the legislative history, the only reasonable conclusion is that Congress intended the hanging paragraph to protect far more than mere purchase price and associated interest from bifurcation. In fact, some Congressional opponents of the legislation citied the breadth of the protection afforded by the hanging paragraph as a basis for their opposition. See Rep. No. 107-617, at 58.

107th Congress

In the 107th Congress, the House version of bankruptcy reform continued the five-year look back, while the Senate version contained a three-year look back. Compare H.R. 333, 107th Cong. (2001). (Introduced) with H.R. 333, 107th Cong. (2001). (Engrossed Senate Amendment); see also S. 220, 107th Cong. (2001). When the House and Senate reconciled these competing legislative proposals, the bodies agreed to the 910-day limitation in the current hanging paragraph but otherwise left the text of the hanging paragraph as it was when pocket vetoed.

The evolution of the hanging paragraph was now complete. Significantly, when settling on the final version of the hanging paragraph, Congress had changed its focus away from the nature of the debt to the type of transaction that gave rise to the protection against bifurcation: it must be a purchase-money transaction, and not merely principal and interest.

109th Congress

In the 109th Congress, President Bush signed PL 109-8 into law, creating the text of 11 USC ' 1325 (b)(*) as it currently exists. See S. 256, 109th Cong. (2005). The text of the hanging paragraph was not modified from the 107th Congress. While the Senate passed its version of the legislation that would become PL 109-8 without filing a report to detail legislative history, the House of Representatives filed a committee report that further supports and reinforces the conclusion that Congress intended the hanging paragraph. Once again, much can be gleaned from the criticisms of the opponents of PL 109-8. In Dissenting Views filed with the report, a number of Congressmen who voted against PL 109-9 specifically cited as a reason for opposition that the 910-day provision would “eliminate” the possibility of bifurcation for “any loan” incurred to purchase an automobile. Thus, it is once again clear that, on the eve of enactment, even the critics of the hanging paragraph understood the breadth of the protection it would afforded the automobile finance industry. See Rep. No.109-31, at 72.

Conclusion

A careful review of the various proposals to limit or prohibit claim bifurcation in Chapter 13 reveals that Congress specifically intended to prohibit claims bifurcation for all debt incurred to acquire a new automobile. Congress initially considered a more limited anti-modification proposal that did not differentiate among types of collateral. Eventually, by the early part of this decade, Congress settled on a two-tiered approach: two and one-half years of protection for automobile financings, and one year of protection for other forms of collateral. The evidence is clear, from both proponents and opponents, that the scope of the anti-modification proposal was broad and covered all portions of debt acquired for the purpose of purchasing an automobile.

The policy purpose of the 910-day provision was to provide certainty to auto lenders, which would otherwise face losses in Chapter 13. The literature available at this time indicates that this policy has been successful as interest rates have declined in states with high bankruptcy exemptions. In this regard, court decisions that limit the protection against bifurcation where negative equity is rolled into a vehicle loan are troubling. To the extent these decisions substantially erode the protections Congress clearly intended to provide auto finance companies, it is reasonable to assume that market acts will respond by increasing borrowing costs as a hedge against increased risk. As the interpretive issues under litigation become more settled, it is reasonable to assume that borrowing costs will be effected by scope of protection afforded by the hanging paragraph.

John D. McMickle is a partner in Winston & Strawn LLP's federal governmental relations and regulatory affairs practice group, practicing in the firm's Washington, DC, office. McMickle represents clients before Congress and administrative agencies. He may be reached at [email protected]. The author gratefully acknowledges Financial Services Roundtable's Anthony T. Cluff Research Fund for support in writing this article.

Last month, we discussed that when, in 2005, Congress enacted PL 109-8, significant changes were in store for the automobile finance industry. Four years after the enactment of PL 109-8, there is as yet little literature on the real-world financial consequences of the 910 provision. Based on a comprehensive review of the legislative history of 11 USC ' 1325(a)(*), there can be little doubt that the 910 day provision covers all portions of a debt incurred for the purpose of financing an automobile, including negative equity and insurance charges. But there is heavy debate in Congress; we presented an overview of selected legal issues to prove our point. The conclusion herein continues the discussion.

Overview of Selected Legal Issues

106th Congress

In the 106th Congress, the House and Senate passed legislation that was presented to President Clinton, but was then pocket-vetoed. See H.R. 2415, 106th Cong. (2000). This legislation was identical to H.R. 3150 in many respects. However, the final version of legislation presented to President Clinton had been modified to contain a compromise; this version prohibited bifurcation for automobiles purchased within five years if there was a purchase money secured interest, with a shorter, one year look-back period for other types of collateral. See S. 3186, 106th Cong. ' 306(b).

The procedural history of H.R. 2415 is complex. H.R. 2415 as originally passed by both the House and Senate related to security at State Department facilities overseas. However, the substance of both versions of H.R. 2415 was stricken and replaced by the text of S. 3186. The text of S. 3186, in turn, represented a bi-cameral compromise between competing versions of bankruptcy reform-H.R. 833 and S. 625. S. 3186, therefore, contained the operative text that was vetoed by President Clinton; its provisions closely resembled the final version of the hanging paragraph.

During the 106th Congress, when the House of Representatives held a hearing to consider HR 833, its version of bankruptcy reform that contained text identical to H.R. 3150, the Acting Assistant Attorney General for Legislative Affairs of the Department of Justice (DOJ) submitted a views letter dated March 24, 1999. This letter criticizes the five-year look back as too long, and suggested instead a 180-day look back. See Letter to the Honorable George Gekas, March 24, 1999, page 11.

When the Senate considered the conference report for H.R. 2415, Senator Grassley inserted into the Congressional Record a detailed history and explanation of the bill in lieu of a formal legislative history. In relevant part, this history reads as follows:

Section 306. Giving Secured Creditors Fair Treatment in Chapter 13.

Second, the extent to which claims secured by purchase money security interests in personal property are subject to cramdown to fair market value is limited. It is intended that cramdown not apply to any collateral described in this provision during the periods of time specified, and that the amount of the claim which must be paid under the plan be the full amount of the claim allowed under section 502 without application of section 506. Thus, if the debt was incurred within 5 years prior to filing and the collateral consists of a motor vehicle acquired for the personal use of the debtor, the value of the collateral cannot be reduced to the current fair market value and therefore the amount the plan must pay under section 1325(5)(B)(ii) over the duration of the plan must be the amount of the allowed secured claim under section 506. A similar result applies for any other personal property if the debt was incurred during the one year period preceding the filing.

See 1216 Cong. Rec. S11709 (daily ed. Dec. 7, 2000) (emphasis added).

From this record, it is clear that as of 2000, the anti-bifurcation amendment expanded its protection of secured creditors. This penultimate version of the hanging paragraph extended its reach to cover all charges encompassed within a purchase-money security interest and removed the limitations associated with the “to the extent” and “in whole or in part” language.

Claims Made by Opponents in 2000

The claims made by opponents of the legislation in 2000 are also instructive. The Committee Report that accompanied the legislation that ultimately became S. 3186 contains the dissenting views of Sen. Herb Kohl (D-WI) of the Senate Judiciary Committee, who based his opposition on the fact that, under the bill, debtors in Chapter 13 cases would be required to pay the full value of the loan in automobile finance transactions. See S. Rep. No. 106-49 at 7 (1999).

One of the most telling and incisive descriptions of this near-final version of the hanging paragraph, which clearly demonstrates the breadth of the anti-bifurcation provision, comes from Sen. Dianne Feinstein, D-CA:

Here is another sort of Orwellian title. Section 306 is called “Giving Secured Creditors Fair Treatment Under Chapter 13.” It ought to be called “Giving Certain Secured Creditors Preferred Treatment Under Chapter 13″ because it favors those who make car loans over other secured creditors and over unsecured creditors.

Here is how it works. There is, of course, a concept in bankruptcy law currently called cramdown or strip down. It recognizes the fact that the collateral for some kinds of loans can lose value over time so it may be worth significantly less than the debt owed. Remember that in a bankruptcy proceeding, secured creditors get paid first, but the cramdown concept says to those creditors that they only get paid first up to the amount of the value of the collateral for the loan. After that, if they are still owed money, they have to get in line with the other unsecured creditors.

To give a more tangible example, if someone owes $10,000 on a car loan, but the car which is collateral for that loan is worth only $7,000 now, then only $7,000 of that loan is considered secured in a bankruptcy. That makes perfect sense since the maker of that loan has the right to repossess the car, but if it does that, it can only get $7,000 when it sells the car.

What the bill does is eliminate the cramdown for any car that is purchased within five years of bankruptcy. That means that even though the vehicle that secures the loan has lost much of its value, the entire amount of the debt must be repaid in a Chapter 13 plan. This gives special treatment to the lender and, more importantly, it will make it much more difficult for a Chapter 13 plan to work, and that will hurt people who want to pay off their debts in an organized fashion under Chapter 13.

See 146 Cong. Rec. S11636 (daily ed. Dec. 6. 2000). (Emphasis added.)

While Congress would later reduce the five-year period to 910 days, the wording of the hanging paragraph would remain otherwise identical.

Based on this review of the legislative history, the only reasonable conclusion is that Congress intended the hanging paragraph to protect far more than mere purchase price and associated interest from bifurcation. In fact, some Congressional opponents of the legislation citied the breadth of the protection afforded by the hanging paragraph as a basis for their opposition. See Rep. No. 107-617, at 58.

107th Congress

In the 107th Congress, the House version of bankruptcy reform continued the five-year look back, while the Senate version contained a three-year look back. Compare H.R. 333, 107th Cong. (2001). (Introduced) with H.R. 333, 107th Cong. (2001). (Engrossed Senate Amendment); see also S. 220, 107th Cong. (2001). When the House and Senate reconciled these competing legislative proposals, the bodies agreed to the 910-day limitation in the current hanging paragraph but otherwise left the text of the hanging paragraph as it was when pocket vetoed.

The evolution of the hanging paragraph was now complete. Significantly, when settling on the final version of the hanging paragraph, Congress had changed its focus away from the nature of the debt to the type of transaction that gave rise to the protection against bifurcation: it must be a purchase-money transaction, and not merely principal and interest.

109th Congress

In the 109th Congress, President Bush signed PL 109-8 into law, creating the text of 11 USC ' 1325 (b)(*) as it currently exists. See S. 256, 109th Cong. (2005). The text of the hanging paragraph was not modified from the 107th Congress. While the Senate passed its version of the legislation that would become PL 109-8 without filing a report to detail legislative history, the House of Representatives filed a committee report that further supports and reinforces the conclusion that Congress intended the hanging paragraph. Once again, much can be gleaned from the criticisms of the opponents of PL 109-8. In Dissenting Views filed with the report, a number of Congressmen who voted against PL 109-9 specifically cited as a reason for opposition that the 910-day provision would “eliminate” the possibility of bifurcation for “any loan” incurred to purchase an automobile. Thus, it is once again clear that, on the eve of enactment, even the critics of the hanging paragraph understood the breadth of the protection it would afforded the automobile finance industry. See Rep. No.109-31, at 72.

Conclusion

A careful review of the various proposals to limit or prohibit claim bifurcation in Chapter 13 reveals that Congress specifically intended to prohibit claims bifurcation for all debt incurred to acquire a new automobile. Congress initially considered a more limited anti-modification proposal that did not differentiate among types of collateral. Eventually, by the early part of this decade, Congress settled on a two-tiered approach: two and one-half years of protection for automobile financings, and one year of protection for other forms of collateral. The evidence is clear, from both proponents and opponents, that the scope of the anti-modification proposal was broad and covered all portions of debt acquired for the purpose of purchasing an automobile.

The policy purpose of the 910-day provision was to provide certainty to auto lenders, which would otherwise face losses in Chapter 13. The literature available at this time indicates that this policy has been successful as interest rates have declined in states with high bankruptcy exemptions. In this regard, court decisions that limit the protection against bifurcation where negative equity is rolled into a vehicle loan are troubling. To the extent these decisions substantially erode the protections Congress clearly intended to provide auto finance companies, it is reasonable to assume that market acts will respond by increasing borrowing costs as a hedge against increased risk. As the interpretive issues under litigation become more settled, it is reasonable to assume that borrowing costs will be effected by scope of protection afforded by the hanging paragraph.

John D. McMickle is a partner in Winston & Strawn LLP's federal governmental relations and regulatory affairs practice group, practicing in the firm's Washington, DC, office. McMickle represents clients before Congress and administrative agencies. He may be reached at [email protected]. The author gratefully acknowledges Financial Services Roundtable's Anthony T. Cluff Research Fund for support in writing this article.