FYI: 9th Cir Says No PMSI in Negative Equity for "910 Vehicle," Split with Other Circuits

Tuesday, July 20, 2010

The U.S. Court of Appeals for the Ninth Circuit recently affirmed the decision of the Bankruptcy Appellate Panel that a creditor does not have a purchase money security interest in the negative equity of a vehicle traded in at the time of a new vehicle purchase.  

The debtor in a Chapter 13 bankruptcy case brought in California bought a car within 910 days of her bankruptcy filing.  As part of the transaction, the debtor traded in her old car, in which she had approximately $7,000 of negative equity (meaning that she owed more on the old car then what it was worth).  The car dealership paid off the balance on the trade-in car and added the negative equity to the total amount financed.  When the debtor filed for bankruptcy protection under Chapter 13, she still owed on the car loan, which included the negative equity from the trade-in car.  The debtor proposed bifurcating the claim into secured and unsecured portions.  The holder of the debt objected, claiming that it had a purchase money security interest (“PMSI”) in the entire amount of the claim, including the negative equity.  The bankruptcy court held that the debt holder did not have a PMSI in the portion of the loan related to the negative equity charges, allowing part of the loan to have a non-purchase money status, with the remainder covered by a PMSI.  The Bankruptcy Appellate Court affirmed the bankruptcy court decision and this appeal followed.

In a decision that creates a circuit split with eight other circuits, the Ninth Circuit affirmed the ruling of the Bankruptcy Appellate Court, declining to adopt the reasoning of its sister circuits.  In doing so, the Ninth Circuit looked to the “hanging paragraph” provision of the Bankruptcy Code.  By way of background, and as you may recall, in 2005, Congress amended Chapter 13 of the Bankruptcy Code by adding the "hanging paragraph" (so called because the paragraph is unnumbered), which prevents the bifurcation of a secured claim potentially into secured and unsecured portions when the creditor has a "purchase money security interest" in a motor vehicle acquired for the debtor’s personal use within 910 days of the debtor’s bank­ruptcy filing.  At issue in this case is whether there was a PMSI in the negative equity in the trade-in vehicle. 

The Court noted that the key issue of the appeal is the meaning of “price” for the purposes of a PMSI, given that a purchase money obligation, as defined in the Uniform Commercial Code, is an “obligation of an obligor 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” and the Official Comment of the UCC defines “price” to include “obligations for expenses incurred in connection with acquiring rights in the collateral, sales taxes, duties, finance charges, interest … and other similar obligations.”

The Court disagreed with the debt owner’s claim that the negative equity is an “expense,” rather, the Court noted that it is the payment of an antecedent debt, not “an expense incurred in buying the new vehicle.”  Further, the Court found that the transactions of (1) combining a new vehicle purchase with (2) negative equity from an old vehicle as a “package deal” are not closely connected so as to satisfy the requirements of the UCC Official Comment and negative equity cannot call under the other similar obligations category of “price” as noted in the Official Comment.

The Court also disagreed with the debt owner’s claim that its position was in harmony with federal bankruptcy law, finding that the debt owner’s position is not consistent with the Bankruptcy Code, as under the Code, “security interests are given preferential treatment to the extent that the obligation relates to the receipt of truly new value, not just old obligations that have been repackaged.” Finally, the Court disagreed with the debt owner’s argument that the California Automobile Sales Finance Act should be used in determining the “price of the collateral” and found that any conclusion in favor of the debt owner based on the phrase “value given to enable the debtor…” would be erroneous.    

Eric Tsai
McGinnis Wutscher Beiramee LLP 
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