CRAMDOWN: How you may be able to save thousands of dollars on your vehicle in a Chapter 13 Bankruptcy
Under Chapter 13 bankruptcy, individuals with regular income are granted the opportunity to develop a repayment plan in order to satisfy all or part of the debts for which Creditors hold claims. A Chapter 13 repayment plan will allow a Debtor to make installments to Creditors over a period of three to five years to satisfy their debts. Some debts under this plan must be paid in full, while others may be paid only in part. A Creditor’s claim will be one of these four types: a priority claim, an administrative claim, a secured claim, or an unsecured claim. For purposes of Chapter 13 Cramdown, the focus will be on secured claims. A Creditor holds a secured claim when the Debtor pledges an asset as collateral to incur a debt, and, if the Debtor fails to pay the underlying debt, the Creditor will have the right to repossess or foreclose on the collateral. Examples of common secured debt incurred by Debtors include home mortgages, auto loans, and tax liens.
What is Cramdown?
Although it is not a word used directly in the Bankruptcy Code, the Chapter 13 Cramdown provision can be found in §1325(a)(5)(B) of the Bankruptcy Code. The United States Supreme Court in Associates Commercial Corp. v. Rash, 520 U.S. 953 (1977) describes §1325(a)(5)(B) as follows:
“Under the cram down option, the debtor is permitted to keep the property over the objection of the creditor, the creditor retains the lien securing the claim…and the debtor is required to provide the creditor with payments, over the life of the plan, that will total the present value of the allowed secured claim, i.e., the present value of the collateral.”
In other words, Cramdown allows a Debtor to propose a reduction of the principal amount of the secured claim to the fair market value of the collateral. This is usually available where the value of the collateral is worth less than the amount on the loan. Moreover, Cramdown separates the debt into a secured portion, the market value of the collateral, and an unsecured portion, that is the excess debt remaining over the collateral’s market value.
EXAMPLE: Debtor’s vehicle is worth $7,500 at fair market value, but Debtor has a loan on the vehicle with a balance of $10,000. The Court has the power to Cramdown (or reduce) the amount of the loan to the $7,500 fair market value of the vehicle. In this instance, the $7,500 will be a secured claim, and the remaining $2,500 will be an unsecured claim.
Ultimately, the secured claim is paid in full, and the unsecured claim is paid a pro rata share of amounts allocated to unsecured creditors. Cramdown significantly reduces a Debtor’s underwater obligation.
Debtor’s Principal Residence – Section 1322(b)(2) of the Bankruptcy Code prohibits modification, or Cramdown, of the mortgage on an individual’s principal residence. In other words, Cramdown is not available for a single family home that is the Debtor’s residence. Despite the limitations set forth in §1322 of the Bankruptcy Code, a Debtor may, in limited situations, be able to Cramdown a mortgage secured solely by a Debtor’s principal residence. These situations include consent or lack of objection to the Cramdown by the Creditor, additional security being taken by the Creditor apart from the Debtor’s residence, purchase money first mortgages, accelerated mortgages, and the theory of equitable subordination which allows a court to strip a Secured Creditor of all validly perfected lien rights.
910 Rule on Vehicle Loans – As mentioned above, Cramdown is available on a vehicle loan, however, the Debtor must have purchased the vehicle more than 910 days before they filed bankruptcy. If a Debtor purchases a vehicle within 910 of filing bankruptcy, then Debtor will not be able to Cramdown the loan and will be responsible for the entire loan (even if the loan amount exceeds the fair market value).
One Year Rule on Personal Property – Similar to the 910 Rule mentioned above, the One Year rule does not allow a Debtor to Cramdown loans on personal property that were purchased within one year prior to the bankruptcy filing. To put it another way, you must have purchased the personal property at least one year prior to the bankruptcy filing. Most often this rule applies where the personal goods, such as furniture, is purchased with in-store financing.
Debtor’s should be aware of the advantages of Cramdown, because it can be an extremely useful mechanism to lower a Debtor’s obligation on a loan, particularly on loans that put the Debtor underwater.