Page 13 - John Hundley 2010

Sharp Thinking

No. 34 Perspectives on Developments in the Law from The Sharp Law Firm, P.C. June 2010
Posner Pens Primer on Auto ‘Cramdowns’

By Terry Sharp, 618-242-0246, law@lotsharp.com

Judge Richard Posner of the United States Court of Appeals for the Seventh Circuit is known for
clear and effective analysis, particularly on bankruptcy cases. A recent case, In re Howard, 597 F.3d
852 (7th Cir. 2010), is a primer on automobile financing and Chapter 13 “cramdowns”.

Judge Posner starts by defining “cramdown” as “forcing a secured creditor to take cash
in lieu of his collateral” after the market value of the collateral is determined. Under established
bankruptcy law, the creditor’s claim is treated as a secured claim to the extent of that value, but “[i]f
the value is less than the unpaid balance of the secured loan, the difference is demoted to being an
unsecured claim.” The effects of this process can be significant, as the debtor’s Chapter 13 plan
need only pay in full the “secured” portion of the claim, with the remainder receiving a fractional
payment, like the fractional payments given, on a proportional basis, to all other unsecured creditors.

Posner then applied the economic analysis, for which he is famous, to explain why car dealers
and finance companies lobbied Congress in 2005 for changes in 11 U.S.C. § 1325(a), specifically to
prohibit cramming down automobile purchase money security interests incurred within 910 days of
bankruptcy. Howard involved a car purchased within the 910-day
period, which at the time of purchase involved a trade-in of a car on
which the owner owed more than it was worth. Such situations are
known as the car being “under water” or having “negative equity”. In the
context of Howard’s trade-in, this required that the new vehicle seller (or
its finance company) pay to the financier of the trade-in vehicle an
amount greater than the actual trade-in value of the old car. The
“negative equity” payment which was made on the old vehicle resulted in
the new vehicle being “under water” – i.e., the amount financed being
greater than the value of the new car sold – from the outset.
Not A Vehicle Under Water
As Posner noted, the question in Howard was “whether the $8,000 paid to cover the negative
equity on the trade-in is subject to the bankruptcy judge’s cramdown power.” Put another way,
should the amount paid for negative equity in the old vehicle
be treated as part of the purchase money security interest
which the financier acquired in the new vehicle? Addressing
that issue, Posner noted that the Bankruptcy Code did not define
“purchase money security interest”, so the Court relied on the
Uniform Commercial Code approach (810 ILCS 5/9-103(b)) that
NotCrammed Down, Not Under Water a “PMSI” is a security interest in the item purchased.

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Sharp Thinking is an occasional newsletter of The Sharp Law Firm, P.C. addressing developments in the law which may be of interest. Nothing contained in Sharp
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