April 29, 2009
4th Circuit Rules that Auto Lender has Purchase Money Security Interest Even in Negative Equity Portion of Loan
Brief by Roksana Moradi, third year student at University of West Los Angeles School of Law.
Wells Fargo Fin. Acceptance v. Price, --- F.3d ---, 2009 WL 975796 (4th Cir. 2009)
ISSUE: Does a creditor have a “purchase money security interest” for the portion of its claim relating to negative equity?
Circuit Judge Wilkinson,
Debtors Telephius and Shawana Price bought a 2001 Lincoln from Capital Mazda in North Carolina. Debtors purchased the Lincoln on secured credit financed by Capital Mazda who subsequently assigned the contract to Wells Fargo. They put down $1,400 and traded in their 1997 Nissan Maxima. Debtors had purchased the Nissan on credit, and still owed $5,500.00 to their previous lender. The contract for the Lincoln therefore included financing for "negative equity.”
Almost one year later the Prices filed a Chapter 13. Their Chapter 13 plan proposed to bifurcate Wells Fargo’s claim under Section 506(a): a secured claim for the present value of the Lincoln and an unsecured claim for the remainder. Wells Fargo objected arguing that the "hanging paragraph" protected its claim from bifurcation because that claim was secured by a "purchase money security interest."
The bankruptcy court ruled that the meaning of "purchase money security interest" in the hanging paragraph depended on state law and therefore, under North Carolina law, the negative equity and gap insurance components of the contract did not give rise to a purchase money security interest.
On appeal, the district court agreed but applied the "dual status rule" and held that Wells Fargo did have a purchase money security interest for the part of its claim that did not relate to negative equity and gap insurance.
The Fourth Circuit reversed both the bankruptcy court and the district court. In Chapter 13, the debtor has the option of retaining his property over the objection of a secured creditor. In return, the secured creditor retains its lien on the collateral, and the debtor must pay the present value of the creditor’s "allowed secured claim" over time. Section 506(a)(1) provides that the value of the allowed secured claim is equal to the value of the collateral. Thus, if the secured creditor’s claim is for more than the collateral’s value, Section 506(a)(1) requires the bifurcation of the claim into two components: a secured claim for the value of the collateral, and an unsecured claim for the balance. Bifurcation of the secured creditor’s claim is sometimes characterized as "stripping down" the secured claim to the collateral’s value.
In 2005, Congress amended Chapter 13 by adding the "hanging paragraph" (so called because the paragraph is unnumbered) to Section 1325(a). The effect of the hanging paragraph is to prevent the bifurcation of certain secured claims when confirming a debtor’s plan under Section 1325(a)(5). The text of the hanging paragraph provides: 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 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 hanging paragraph does not define the term "purchase money security interest." The Court of Appeals looked to state law to define those terms. In North Carolina, a "purchase-money security interest" in goods is defined as a security interest in goods that are "purchase-money collateral," which is in turn defined as goods that secure a "purchase-money obligation." So the important question for the court’s purposes was the definition of a "purchase-money obligation." To constitute a purchase-money obligation, the debt must be "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."
Wells Fargo claimed that the Prices incurred the portion of the debt relating to negative equity "for value given to enable the [Prices] to acquire rights in or the use of the [new car]," and that the value was "in fact so used." The Court of Appeals agreed in that the value from Capital Mazda used to pay off the Prices’ negative equity "enabled" the Prices to acquire the new vehicle and held that the entire debt was secured by a purchase money security interest that Wells Fargo’s claim was therefore protected from bifurcation by the hanging paragraph. The negative equity financing was integral to the whole transaction in which the new vehicle was purchased. All of the Prices’ debt to Wells Fargo was incurred at the same time, in the same contract, and for the same purpose: acquiring the new car. Therefore, Wells Fargo’s claim was entirely a “purchase money obligation.”
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Posted by: Amit Cohen | Jul 8, 2009 2:21:33 AM