This is a true story. The full details can be found in the case of AmeriCredit Financial Services v. Marlene Penrod, United States Court of Appeals for the 9th Circuit, Docket Number 08-60037.
Imagine driving your 1999 Ford Explorer into the dealership in 2005 and seeing a really nice little Tarus there for only $25,600. You still owe $13,000 on the Explorer but in talking to the sales staff you learn that really is not a big problem. They can take the old car off your hands and get you into the new one; they will even give you $6000 for the old car toward the purchase of the new. In the end you only have to pay $31,700 for a car that sells for $25,600 and you only have to pay interest at 20%. I would have loved to be a fly on the wall during that sales pitch. I am sure everything was made perfectly clear to the buyer.
Some year and a half later the buyer needed the relief of bankruptcy because no longer could all the bills be paid when due. Seeking Chapter 13 relief, the buyer proposed to split the loan against the car into a secured portion and an unsecured portion; the unsecured portion being the $7,000 taken off the old car and transferred to the new car when the new car was purchased. Under the bankruptcy code a Purchase Money Security Interest, a loan secured by a vehicle as part of the purchase, cannot be split unless the purchase took place more than 910 days before the bankruptcy was filed. If that time has passed then the portion of the loan that exceeds the value of the vehicle can be treated as an unsecured loan and paid with the other unsecured debt. In this case since only a bit over 500 days had passed between the purchase date and the day the chapter 13 petition was filed the creditor cried foul; it wanted all of the loan secured, even the part transferred over from the old Explorer to the new Tarus.
In this instance the Bankruptcy Court, the Bankruptcy Appellate Panel, and the 9th Circuit Court of Appeals decided that the $7,000 transferred over from the old Explorer was not part of the Purchase Money Loan. The courts all reasoned that, at least under California law a Purchase Money Obligation is a debt incurred as all or part of the price of the collateral, in this case the Ford Tarus which sold for about $25,600. Purchase money security interests are favorites of the laws of most states and they get the kid glove treatment, pretty much Super Priority, over other types of secured loans (Grant Gilmore, The Purchase Money Priority, 76 Harvard Law Review, 1333 (1963)). Here is where the Court saw the forest from the trees. The purchase money security interest secures the PRICE of what is being purchased. In this case the price of the Tarus was $25,600 not the $31,700 after adding on the balance of the old loan on the old Explorer. The credit company made a valiant effort to redefine the old loan as a necessary expense in acquiring the new car, but the court saw it for what it really was, moving an old debt over to a new car and using the new car as collateral. Really when you think about it, the credit company never really had any expectation in having the new car as collateral for the old debt. Before the buyer even put the keys in the ignition to start the engine and drive the car off the lot thereby reducing the value of the car by several thousand dollars, the lender was already under secured by some $6,100. The technical term of art for this situation is “in the ditch” or “under water.” Anyway, the lender went into the deal knowing the car was worth much less than the loan against it.
So it appears that in the 9th Circuit at least, a creditor cannot bootstrap super priority for its loans by moving old debt to new vehicles, at least if the law of the state in question is the same or similar to the commercial code of California. It actually seems like a pretty fair result. The creditor did not get more than could reasonably be expected by heaping a additional $7,100 in debt on top of a new car and the dealer got the sale and the price of the new car did receive its super priority. On top of it all, even the debtor received what the law of bankruptcy entitled her to get.
Closing disclaimers! This blog simply contains my thoughts and ruminations on certain subjects. They are thoughts in general and are not intended to be given or taken as legal advice. I do not give legal advice until I have had a chance to get a good handle on the facts of a case and have been hired. So if anything in this entry piques your interest or seems to apply to your situation follow it up by consulting an attorney. I am sharing thoughts here, not giving legal advice.