Page 14 - John Hundley 2010

Posner then dealt with the argument that the definition of “amount financed” in the Illinois Motor
Vehicle Retail Installment Sales Act (815 ILCS 375/2.8) meant that the finance
company’s negative equity was protected in a cramdown. He concluded that
that Act is “at least evidence that negative equity is indeed a common element
of a credit purchase of a car”.

Judge Posner concluded that “allowing the purchase money security
interest to include negative equity — a permission that does no violence to the
language of Article 9, though neither is it compelled by it — may be essential to
the flourishing of the important market that consists of the sale of cars on
credit.” Accordingly, the 7th Circuit “join[ed] the other courts in ruling that
negative equity can be part of a purchase money security interest and if
thus secured is not subject to the cramdown power of the bankruptcy
judge in a Chapter 13 bankruptcy.” Sharp

Several implications of the Howard decision may be noted.

First, Howard will create a significant incentive for debtors otherwise eligible for Chapter 13 relief
to “hold on” until their vehicle passes the 910-day (2½ year) mark. Howard seems to say that
negative-equity arrangements protected by it are so protected even after the 910-day period has
passed – and that the consumer thus is saddled with the vehicle (and with paying more than it is
worth) throughout the length of the plan (up to 5 years), so the incentive to delay Chapter 13 filing
until the 910-day period has passed can be significant.

Second, Howard does not address what happens if a Chapter 13 debtor wants to surrender his or
her under-water vehicle within the 910-day period. Should the deficiency be treated as secured in the
bankruptcy? Arguably, a positive answer to that question is equally “essential to the flourishing of the
important market that consists of the sale of cars on credit.”

Third, how far should the legislature and courts go in encouraging what is
fundamentally uneconomic behavior? Posner cites a Federal Deposit Insurance
Corp. article stating that “in almost 40 percent of all car sales the consideration
includes a trade-in with negative equity.” That implies that more than 40 percent
of all car sales may be under water on Day 1, because an auto sale involves
costs like taxes and registration which are not part of the new-car’s value and
must be added to the old-car’s negative value in coming to the amount
financed in the new transaction. Policy decision-makers who elect to encourage
that situation do so because it provides relief for the distressed auto sector and the
depressed economy. But how is that different from systematically encouraging
persons who couldn’t afford to buy a home to be able to do so with “no money down” mortgages
which, like the instant transactions, result in negative equity from Day 1? Will instruments which
provide capital to finance the auto markets be the source of our next meltdown?

John\SharpThinking\#34.doc.
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