§ 1325(a)(5)(C) and (a)(9) Hanging Paragraph -

Surrender of Collateral in Full Satisfaction of Secured Claim

In re Doddroe, Case No. 06-61947 (Bankr. N.D. Ohio May 3, 2007) (J. Kendig). In a Chapter 13 proceeding, the debtors proposed to surrender 910-day collateral to the bank in full satisfaction of the bank’s secured claim under 11 U.S.C. § 1325(a)(5)(C) and the “hanging paragraph” of 11 U.S.C. § 1325(a)(9). The bank objected.

The Court determined that the hanging paragraph of § 1325(a)(9) alters how an allowed secured claim is valued, and thus treated, in a Chapter 13 case. The Court found that post-BAPCPA a secured claim cannot be valued based upon the present value of the collateral, which would generally result in a “remainder” portion of the claim. Thus, a claim must be treated as fully secured. The Court recognized that this understanding requires the imposition of a fiction, that the collateral is worth the amount of the claim, however, the Court stated that the fiction is necessary to achieve the end result that the claim is fully secured. Further, the Court determined that §§ 1325(a)(5)(B) and 1325(a)(5)(C) are both subject to the hanging paragraph. Therefore, the Court ruled that if a debtor intends to retain collateral, then the claim must be paid in full because if the collateral is valued at the amount of the claim, then no unsecured claim results. Likewise, if the collateral is surrendered, then there is no unsecured claim. The bank’s objection to confirmation was overruled.

§ 707(b)(3)(B) - Analyzing Abuse

In re Zayas, 2007 WL 987240 (Bankr. N.D. Ohio 2007) (unpublished) (J. Harris). The debtors filed a Chapter 7 petition with amended schedules showing assets in the amount of $354,679.63 and debt in the amount of $448,917.15. Of that debt, $372,507.99 was secured debt, $3,782.13 was unsecured priority debt, and $72,681.03 was general unsecured debt. The bulk of the debtors’ secured debt was owed on their residence in the amount of $360,000.00. The debtors’ amended schedules showed a combined average monthly net income of $7,867.11 and average monthly expenses of $7,850.60. Their most recent tax return showed an adjusted gross income of $143,309.00. In addition, husband was owed over $7,000.00 in commissions from a previous employer.

The United States Trustee moved to dismiss the debtors’ case for abuse under 11 U.S.C. § 707(b)(3)(B). In determining the appropriate standard to be utilized under § 707(b), the Court reviewed former § 707(b), which called for dismissal in cases of “substantial abuse.” The Court noted that while the Bankruptcy Code did not define “substantial abuse,” the Sixth Circuit Court of Appeals had held that “in seeking to curb ‘substantial abuse,’ Congress meant to deny Chapter 7 relief to the dishonest or non-needy debtor.” In re Behlke, 358 F.3d 429, 434 (6th Cir. 2004) (internal citation omitted). Whether the granting of Chapter 7 relief was a “substantial abuse” was determined from the totality of the circumstances. In making this analysis, the Court found that new § 707(b)(3)(B) closely tracks the Sixth Circuit’s prior precedent by “directing the Bankruptcy Court to consider the ‘totality of the circumstances of the debtor’s financial condition.’” Therefore, the Court found that the prior Sixth Circuit precedent remained good law to the extent that facts constituting “substantial abuse” under those cases based on a debtor’s “want of need” would also be considered “abuse” under the “totality of the circumstances” pursuant to § 707(b)(3)(B).

Thus, the Court utilized the same factors established by the Sixth Circuit for analyzing the “totality of the circumstances” to determine whether “substantial abuse” existed. These factors included: (1) the debtors’ ability to repay their debts out of future earnings, (2) whether the debtors enjoyed a stable source of income, (3) whether the debtors were eligible for adjustment of their debts through Chapter 13, (4) whether there were state remedies with the potential to ease the debtors’ financial predicament, (5) the degree of relief obtainable through private negotiations, (6) whether the debtors’ expenses could be reduced significantly without depriving them of adequate food, clothing, shelter, and other necessities, and (7) whether the debtors’ financial situation was a result of an unforeseen catastrophic event. Further, the Court determined that although the threshold for “abuse” under new § 707(b) is now lower than the threshold for “substantial abuse” under former § 707(b), the Court presumed that financial circumstances establishing “substantial abuse” under former § 707(b) would establish “abuse” under new § 707(b). The Court went on to find that the United States Trustee had proven, by a preponderance of the evidence, that it would be an “abuse” of the Chapter 7 process to allow the debtors’ Chapter 7 case to proceed, and the Court found that the United States Trustee had established circumstances that would “surpass even the higher threshold for ‘substantial abuse’” under former § 707(b), therefore negating the Court’s need to determine by how much the threshold had been lowered as a result of the new § 707(b).

COMMENT: Judge Harris' approach makes logical sense and its application works fine for this case. However, at some point, a line will have to be drawn as creditors should not be confined to using the "substantial abuse" standard of former § 707. The new Bankruptcy Code lowered the threshold from substantial abuse to plain old abuse without giving much in the way of guidance. Nevertheless, judges will be forced to flesh out this new standard more precisely in the future.

§ 1325(a)(9) Hanging Paragraph - Purchase Money Security Interest

In re Westfall, --- B.R. ----, 2007 WL 981730 (Bankr. N.D. 2007) (J. Kendig). In their Chapter 13 Plans, debtors proposed to cram down the secured liens on two vehicles, notwithstanding the hanging paragraph of 11 U.S.C. § 1325(a)(9), where a portion of the loan proceeds was used to pay off negative equity. The affected creditors objected.

The issue presented to the Court was what constitutes a purchase money security interest and whether payment of negative equity from a trade-in is part of the purchase money security interest. To determine the definition of “purchase money security interest,” the Court turned to § 1309.103 in the Ohio Revised Code because the term is not defined in the Bankruptcy Code. The Court concluded that to determine whether a “purchase money security interest” exists, one must first define a purchase money obligation to define purchase money collateral, providing a definition and understanding of a purchase money interest.

The Court found that purchase money obligations existed, and that the new vehicles purchased qualified as purchase money collateral to the extent of the purchase money obligations. However, the Court concluded that the obligations were “mixed” transactions, divisible into purchase money and non-purchase money elements.

After concluding that the transactions had elements of both purchase money and non-purchase money interests, the Court then pondered the impact that this conclusion had on the application of § 1325(a)(9). In doing so, the Court considered the transformation rule, where a mixed transaction results in the loss of the purchase money security protection, thus, the hanging paragraph does not apply and the lien may be stripped. Although the Court was inclined to adopt this approach, paving the way for the liens to be crammed down, the Court provided the parties an opportunity to brief the issue as to whether there should be a definition of “purchase money security interest” developed strictly for application under § 1325(a)(9) to capture the spirit of the amendments and to be logically applied in the Chapter 13 context.

COMMENT: The authors agree with Judge Kendig's analysis of how Ohio law deals with the dual nature of the purchase money security interest in this case and with the Judge's application of the hanging paragraph with respect to these types of loans.

Judge Kendig raises, but does not resolve, the issue of whether a federal court can create a federal definition of "purchase money security interest" or whether state law must be considered. The author notes that the Bankruptcy Code contains many definitions, including the definition of "security agreement" and "security interest" but not "purchase money security interest." If Congress had desired to create a federal definition of purchase money security interest, it seems that it would have done so along with the other related concepts in § 101 of the Bankruptcy Code.