In re Penrod, BAP No. NC-07-1360-MkKJu.

• Decision Date: 28 July 2008
• Docket Number: Bankruptcy No. 07-30252-TC.,BAP No. NC-07-1368-MKKJu.,BAP No. NC-07-1360-MkKJu.
• Citation: 392 B.R. 835
• Parties: In re Marlene A. PENROD, Debtor. Americredit Financial Services, Inc., Appellant, v. Marlene A. Penrod, Appellee.
• Court: U.S. Bankruptcy Appellate Panel, Ninth Circuit

392 B.R. 835

In re Marlene A. PENROD, Debtor Americredit Financial Services, Inc., Appellant, v. Marlene A. Penrod, Appellee.

BAP No. NC-07-1360-MkKJu.

BAP No. NC-07-1368-MKKJu.

Bankruptcy No. 07-30252-TC.

United States Bankruptcy Appellate Panel of the Ninth Circuit.

Argued and Submitted January 24, 2008.

Filed July 28, 2008.

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Randall P. Mroczynski, for Appellant.

Craig V. Winslow, for Appellee.

Before MARKELL, KLEIN and JURY, Bankruptcy Judges.

OPINION

MARKELL, Bankruptcy Judge.

I. Introduction

This appeal presents a pure question of law: When a debtor trades in a motor vehicle in connection with buying a new one, and the lender who is financing the purchase assumes the debtor's "negative equity" on the trade-in, how should the transaction be treated under the troublesome "hanging paragraph" of § 1325(a) of the Bankruptcy Code?

As an initial matter, we ask whether the lender's payoff of the deficiency on the trade-in is secured by a purchase money security interest in the new car, which would make it protected by the hanging paragraph. Borrowing and applying rules from the Uniform Commercial Code (UCC), we hold that it is not.

That leaves the question of what to do with that portion of the debt not entitled to purchase-money status. Courts that have looked at this question have followed two different lines of reasoning with two different outcomes. For the reasons discussed below, we believe one of them, the so-called "Dual Status Rule" fits federal law better than the other, the so-called "Transformation Rule." We thus hold that the hanging paragraph protects that portion of the lender's debt allocable to the car purchased, and does not protect that portion of the debt that is allocable to negative equity.

The bankruptcy court in this case reached the same conclusion, and we therefore AFFIRM.

II. Facts

On September 12, 2005, Marlene Penrod bought a 2005 Ford Taurus from Hansel Ford in Santa Rosa, California. The cash price of the car was approximately $23,500,¹ and with tax and license, the total amount that a cash buyer would have paid for the Taurus was $25,600. To finance the purchase, Penrod paid $1,000 down and traded in her 1999 Ford Explorer. The dealership gave her $6,000 in credit for the Explorer, on which she owed $13,137.42. The $7,137.42 difference is what is referred to as "negative equity" in the business of motor vehicle sales finance.

Hansel agreed to pay off the entire amount owed on the Explorer and add the negative equity to the amount Penrod financed.² As a result, the total amount financed appears to have been approximately $31,700. Shortly after the sale, Hansel assigned Penrod's contract to appellant Americredit Financial Services, Inc.³

Penrod filed a chapter 13 bankruptcy on March 2, 2007, which was 523 days after she bought the Taurus. As of the filing, the bankruptcy court found that the total amount of the debt secured by the car was $25,675, which included the negative equity.

Penrod initially proposed a chapter 13 plan that valued the Taurus at $15,615 (its then-Kelly Blue Book value). The plan reduced Americredit's secured claim to that amount, and it also reduced the rate of interest applicable to that secured debt to 9%.⁴ Americredit objected, claiming that the entire amount of its claim was protected by the so-called "hanging paragraph" of § 1325(a), and, thus, the debtor could not cram down its secured claim to the car's value.

After supplemental briefing, the bankruptcy court ruled that, to the extent that Americredit's security interest in the Taurus secured Penrod's negative equity, it was not a purchase money security interest.⁵ But the court also held that the remaining balance — some $18,540 — was secured by a purchase money security interest.⁶

In finding that a portion of Americredit's claim was still secured by a purchase money security interest, the bankruptcy court rejected Penrod's assertion that the "Transformation Rule" rendered the entire security interest nonpurchase money. It also rejected Americredit's assertion that the negative equity was irrelevant to the purchase money characterization.

The bankruptcy court adopted the "Dual Status Rule" from state law, holding that a security interest may be simultaneously characterized as purchase money and nonpurchase money depending on the nature of the debt it secures. Seven days after its ruling on the purchase money status of Americredit's security interest, the bankruptcy court confirmed Penrod's second amended chapter 13 plan.

Americredit has appealed both the order finding that its security interest was only partially purchase money and the order confirming Penrod's chapter 13 plan.

III. Jurisdiction

The bankruptcy court had jurisdiction under 28 U.S.C. § 1334(a), the general order of reference for the Northern District of California, and 28 U.S.C. § 157(b)(2)(A), (B) & (L). We have jurisdiction under 28 U.S.C. § 158.

IV. Standards of Review

"[I]ssues of statutory construction and conclusions of law, including interpretation of provisions of the Bankruptcy Code," are reviewed de novo. Mendez v. Salven (In re Mendez), 367 B.R. 109, 113 (9th Cir. BAP 2007) (citing Einstein/Noah Bagel Corp. v. Smith (In re BCE W., L.P.), 319 F.3d 1166, 1170 (9th Cir.2003)). See also Trejos v. VW Credit, Inc. (In re Trejos), 374 B.R. 210, 214 (9th Cir. BAP 2007) (interpretation of § 1325(a)'s "hanging paragraph" reviewed de novo).

V. Discussion

Although much has been written on the issues presented, most of the opinions have been in bankruptcy courts, with a few district court appellate decisions appearing occasionally. No circuit, including the Ninth, has addressed these issues squarely, and we are not aware of any other Bankruptcy Appellate Panel decision on point. Accordingly, we start our analysis with some basic propositions.

In bankruptcy, secured claims normally do not exceed the value of the collateral. 11 U.S.C. § 506(a)(1). Shortfalls between claim amount and collateral value are treated as unsecured claims. Id. Before 2005, this feature of the law allowed many chapter 13 debtors to "cram down" claims secured by cars, since cars typically are worth less than the financing against them. This treatment mirrored what the creditor could expect outside of bankruptcy: a secured claim equal to the car's value and an unsecured deficiency for the balance. The principal differences in bankruptcy were: (1) that while the secured claim had to be paid in full during the life of the plan, the debtor received a discharge at the end of the plan for any unpaid portion of the car lender's deficiency; and (2) that the debtor was able to readjust the interest rate to a market rate of interest.

For certain types of car loans, this treatment changed radically after the 2005 amendments to the Code. For those claims covered by the so-called "hanging paragraph," car lenders' secured claims were no longer limited by the car's value. The hanging paragraph essentially gives covered car lenders a secured claim for the entire amount of their claim, regardless of the car's value.

The application of these changes to this case is straightforward. Penrod's Taurus was worth approximately $15,615 at the start of the case; the amount owed to Americredit was $25,675. Penrod's initial plan assumed that the hanging paragraph did not apply and proposed to cram down Americredit's claim to $15,615 (the car's value), pay that amount over the life of the plan at 9% interest, and classify the remainder — some $10,080 — as an unsecured claim.

Americredit's response asserted that the hanging paragraph applied to its entire claim of $25,765. On this view, this higher amount would have to be paid over the plan's life.

The bankruptcy court found that the portion of the secured claim attributable to negative equity — some $7,100 — was not governed by the hanging paragraph but that the remainder of Americredit's claim was. Accordingly, it found that Americredit had a secured claim of $18,625 and an unsecured claim of $7,100. Based on those valuations, the bankruptcy court confirmed Penrod's plan.

A. The Hanging Paragraph

The "hanging paragraph" is found somewhere around § 1325(a).⁷ It 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 [sic] preceding the date of the filing of the petition, and the collateral for that debt consists of a motor vehicle (as defined in section 30102 of title 49) acquired for the personal use of the debtor, . . . .

Because of its odd placement in the statute as enacted, this text has no clear home in § 1325(a), and thus has been referred to as the "hanging paragraph," which is the designation this opinion will use.⁸

We have previously interpreted this provision. In re Trejos, 374 B.R. at 214-21. In Trejos, we held that the hanging paragraph applies to secured claims in chapter 13, rejecting the contention that its wording removed the statutory basis for treating such claims as "allowed secured claims" under § 1325(a). Id. at 217-18.⁹

1. Hanging Paragraph's Requirements

To receive the treatment mandated by the hanging paragraph, certain conditions must be satisfied. These conditions are as follows:

• The creditor must have a purchase money security interest; and

• The purchase money security interest must secure the debt that is the subject of the claim; and

• That debt must be incurred no more than 910 days before the date of the debtor's filing; and

• The collateral for the debt must be a "motor vehicle;" and

• That motor vehicle must have been acquired for the personal use of the debtor.

In re Trejos, 374 B.R. at 215.

The parties dispute only that Americredit has a "purchase money security interest." In short, the parties have either...