Presentation on theme: "Recall problem 6.4 Debtor purchases a Chevrolet Suburban on May 1, 2004 for his family use, borrowing $25,000 from Creditor to finance the purchase and."— Presentation transcript:
Recall problem 6.4 Debtor purchases a Chevrolet Suburban on May 1, 2004 for his family use, borrowing $25,000 from Creditor to finance the purchase and granting Creditor a security interest in the Suburban. On May 1, 2006, Debtor files chapter 7, owing Creditor $18,000. The foreclosure value of the Suburban is $12,000. The retail value of a like-model vehicle is $15,000, of which amount $500 is attributable to selling costs and $1,000 is attributable to warranties and reconditioning Let’s assume we go with a value of $14,000
“undersecured” On these facts, this Creditor is undersecured They don’t have collateral of sufficient value to cover the debt Outside of bankruptcy, if Cr foreclosed, there’d still be a deficiency balance left
Bankruptcy – still undersecured Nothing about being in bankruptcy changes this sad economic reality for the Cr Consistent with Butner – outside of bankruptcy, Cr has a collateral shortfall. Why any different IN bankruptcy? Note do have a couple of bankruptcy exceptions will discuss
bifurcation basic bankruptcy treatment is simply to acknowledge this economic reality, see 506(a)(1) Bifurcate the undersecured creditor’s claim into two claims: (1) a secured claim in the amount of the value of the collateral, and (2) an unsecured claim for the deficiency
Apply to 6.4 Secured claim = $14,000 (value of collateral) Unsecured claim = $4,000 (deficiency)
Reorganization cases 3 options: SP (secured party) ACCEPTS plan Dr SURRENDERS collateral to SP, SP has unsecured claim for the deficiency CRAM DOWN e.g., Rash, Till 1. Principal = secured claim = $14K 2. Interest SP retains lien Unsecured claim for the deficiency
“Strip Down” In the foregoing hypo, the norm in a reorg case involving cram down of an undersecured SP = STRIP DOWN Means that the SP’s “allowed secured claim” that is paid in full under the plan = the collateral value In prob. 6.4 hypo, “strip down” the $18K claim to just a $14K secured claim Leave $4k balance to be paid with pool of unsecured claims
Exception # 1: home mortgages Hypo: Dr owes SP $150K, secured by home worth $120K (i.e., DR is “upside down” on home) Under 506(a)(1), would say that SP’s claim would be bifurcated into a $120K secured claim and a $30K unsecured claim So can DR “strip down” the home mortgage and cram down SP by paying $120K principal?
No home mortgage strip down NO – cannot strip down a home mortgage, in either chapter 13 or 11 1322(b)(2), 1123(b)(5) – SCOTUS so held in the Nobelman case (condo worth ~ $23K, debt = $71K) Simply a special interest rule protecting home mortgagees Obama administration tried, but failed, to amend in spring of 2009
Hypo? So in our hypo if Dr wants to keep the home will have to keep paying the home mortgage on the original terms Both the principal amount ($150K) And K interest rate (e.g., no Till possibility)
Save the home? All a Dr can do to a home mortgage against the wishes of mortgagee is to CURE a default And if SP already accelerated, reinstate the original terms So do have Drs use chapter 13 (or 11) to save their home, if SP has already accelerated the balance due
Completely underwater? Hypo: Home worth $120K 1 st mortgage = $150K AND now assume also have a 2 nd mortgage = $25K What can the Dr do in its ch. 13 plan vis-à-vis the holder of the 2 nd mortgage? Under 506(a)(1) would say the 2 nd mortgagee is COMPLETELY unsecured – has NO collateral value (because 1 st mortgage consumes entire collateral value)
“Strip off” In this situation, where home mortgage is totally valueless, all cts of appeal allow the DR to treat the 2 nd mortgagee as the holder of a secured claim = $0 And thus allow Dr’s plan to STRIP OFF the mortgage and treat the 2 nd mortgagee solely as the holder of a unsecured claim Why matters? Post-bankruptcy, that home no longer secures the 2 nd mortgage Once satisfy the 1 st mortgage, own home free & clear
But must be ZERO secured value Change hypo: 1 st mortgage = $150K and 2 nd mortgage = $25K But now assume that home is worth $151K Now what can Dr do in plan vis-à-vis 2 nd mortgagee? Now, under 506(a)(1), would say that 2 nd mortgage SP is the “holder of [a] secured claim” for purposes of 1322(b)(2)’s no-home-mortgage-strip-down rule Even though just $1K (151K value – 150K 1 st mortgage) So can’t modify AT ALL – have to treat entire $25K 2 nd mortgage as secured
What if is vacation home? Hypo: Dr owns primary residence in sunny & beautiful Illinois Has 2 nd home, a condo, in Florida Debt = $150K Value = $120K Now what can Dr do vis-à-vis mortgagee in chapter 13 plan? Can “strip down” (e.g., to $120K value) b/c the anti- modification rule of 1322(b)(2) only applies to mortgage on Dr’s “primary residence”
910-day car loan exception Other major exception to normal “strip down” rule for undersecured claims in chapter 13 cases is for car loans subject to the “hanging paragraph” after 1325(a)(5) Effect: “For purposes of ¶ (5), § 506 shall not apply” Applies if: PMSI 910 days of bankruptcy Motor vehicle Personal use
Additional application hanging ¶ Also applies if: PMSI “any other thing of value” One year of bankruptcy
How supposedly works in cram down By providing that “506 shall not apply” “for purposes of paragraph 5”, the intent of Congress, and the way most courts have interpreted it in the standard “cram down” case, is to prevent strip down of undersecured claim Hypo: $18K debt, $14k car value (ch. 13, PMSI 910 days) Can’t strip down “allowed secured claim” from 18 to 14 – b/c only way to do that is via 506(a)(1) bifurcation Note CAN still use a lower cram down interest rate (à la Till) b/c do still apply 1325(a)(5)(B)
What if SURRENDER car to SP? Remember that there are 3 options for dealing with a secured claim in chapter 13 under 1325(a)(5): SP accepts plan Cram down OR – surrender – “the debtor surrenders the property securing such claim to such holder” (1325(a)(5)(C)) What if have a hanging ¶ case with an undersecured SP BUT Dr invokes the surrender option? Issue is whether the SP still has an unsecured claim?
Wright Facts : debtors, Craig Wright and LaChone P. Giles-Wright, purchased a car (a 2006 Dodge Magnum – see next slide)on August 10, 2005 on credit and granted a PMSI to the lender (the wonderfully named “Drive Financial Services”). October 18, 2006, Debtors filed a chapter 13 bankruptcy. Since August 10, 2005 is within 910 days of October 18, 2006 (434 to be exact, if I counted correctly) before they filed chapter 13 bankruptcy, the hanging ¶ applied. The collateral was a motor vehicle, purchased for the debtors’ personal use, and a PMSI was granted, within 910 days of bankruptcy at time of bankruptcy, the debt on the car ($18,845.88) was greater than the car’s value (exact amount not disclosed in briefs or opinion).
Legal question In chapter 13 plan, the debtors proposed to surrender the car to the creditor, as contemplated by § 1325(a)(5)(C). Their Chapter 13 plan provided: “No claim, secured or unsecured, is to be paid to Drive Financial, as the 2006 Dodge Magnum will be surrendered in full satisfaction of the claim.” Drive objected b/c no provision was made for its unsecured deficiency claim
Dr’s argument? What unsecured deficiency claim?? If “section 506 shall not apply,” then from whence does the unsecured claim come? Normally would get bifurcation into secured & unsecured portions of undersecured claim via 506(a)(1), but that no longer applies, by definition
Consistent application of confirmation alternatives Furthermore, denying the undersecured SP a deficiency claim in surrender case is consistent with denying the same deficiency claim in cram down cases We KNOW Congress meant for the collateral to be deemed = debt for purposes of cram down under 1325(a)(5)(B) –> i.e., make Dr pay FULL debt as SECURED to keep car And surrender, under 1325(a)(5)(C), is simply an alternative to (B) -- so same result, right? i.e., no unsecured claim
“hobgoblin of little minds”?, cont. Is it really asking too much to ask that the treatment of 2 alternative options in same subsection be treated in similar manner, absent any statutory basis to differentiate? Or is a “foolish consistency the hobgoblin of little minds”? Operative mechanism – denying application of § 506 (and thus bifurcation) to 1325(a)(5) – is equally applicable to both confirmation options No principled way to say DO bifurcate for surrender cases but do NOT bifurcate for retention cases
Holding? Yes, Virginia, there is a deficiency claim 7 th Circuit in Wright held (and every other circuit to consider has followed suit) that in this surrender case the undersecured creditor DOES still have an unsecured claim
But HOW? One might ask, with 506 off the table – how? Where does this magical unsecured claim come from? J. Easterbrook’s answer in Wright: from state law! “we think that, by knocking out § 506, the hanging paragraph leaves the parties to their contractual entitlements. True enough, § 506(a) divides claims into secured and unsecured components. … Yet it is a mistake to assume, as the majority of bankruptcy courts have done, that § 506 is the only source of authority for a deficiency judgment when the collateral is insufficient. The Supreme Court held in Butner v. United States, 440 U.S. 48 (1979), that state law determines rights and obligations when the Code does not supply a federal rule.”
Surplusage? If Wright is right – does that mean that 506(a)(1) is surplusage? Don’t need 506(a)(1) to do the bifurcation if can just invoke state law anyway
Could DEBTORS make same argument in retention case? If this is correct – that non-application of 506 “leaves the parties to their contractual entitlements,” then could a DEBTOR make exactly the same argument to support bifurcation in a retention case?
“heads I win, tails you lose” And if not, then this sounds a lot like the proverbial “heads I win, tails you lose” game Retention: NO bifurcation when DR is retaining car (so SP gets paid more) Surrender: YES bifurcation when Dr surrenders car (so SP gets paid more)
Butner as a red herring Easterbrook invoked the ghost of Butner’s deference to state law as the basis for his invocation of state law regarding the scope of secured claims and the SP’s entitlement to a deficiency claim But that argument is a red herring. WHY?
Sorry, no Butner Central fallacy of Wright -- under Butner SP can invoke state law to create an unsecured claim that is “allowed” in bankruptcy, even with § 506(a)(1) off the table. Butner does speak to the questions of (i) whether the creditor has a claim at all and (ii) is that claim secured?
Butner, nyet, cont. Butner does not speak to the questions of (i) whether that claim is “allowed” in bankruptcy and (ii) how that allowed claim is allocated in bankruptcy as between secured and unsecured portions. On those questions, there is governing federal law – § 506(a)(1) and the hanging ¶ of § 1325(a) 506(a)(1) IS the bankruptcy ALLOCATION rule Hanging ¶ says that allocation rule not applicable! i.e., NO federal law vacuum for Butner to fill
What about 501 & 502 as allowance rules (rather than 506)? Could SP argue that Wright is right because the fact that the hanging paragraph takes 506 off the table does not undermine the SP’s deficiency claim, b/c the issue of ALLOWANCE is governed by 501 and 502, which are still operative? Problem is that 501 & 502 do not speak to the ALLOCATION issue as between the secured & unsecured portions of undersecured claim – only 506 does that And if did buy that argument, again have no basis to distinguish between surrender and retention cases
What now? What must Drs do to confirm plan? Answer: provide for the car lender’s unsecured deficiency claim in their chapter 13 plan. Example: if after foreclosure the lender had a $3,000 deficiency remaining, that $3,000 unsecured claim would have to be included in the pool of unsecured claims paid in the chapter 13 plan.
Whose ox is gored? Given answer to Q of “what now” – that DRs must include SP’s unsecured deficiency claim in the chapter 13 plan – what is the actual practical effect? i.e. whose ox is gored? DEBTORS? O THER UNSECURED CREDITORS ? NO YES
“goring” is of other unsecured creditors DR is already paying ALL of its projected disposable income to plan payments That PDI is then divvied up amongst unsecured Crs All we do under Wright is increase the claimants – do not increase the size of the pie being divided i.e., it’s a zero-sum game
Example of redistribution Hypo: Assume SP’s unsecured deficiency = $3k w/o Wright: DR pay $6K under plan, to $12K unsecured i.e., 50% w/ Wright: Dr pay $6K under plan, to $15K unsecured i.e., 40% SP paid $1,200 under plan re unsecured claim (40% x $3K) All other unsecured crs thus get $1,200 less (and each gets just 40% rather than 50%)
Undersecured claims in Chapter 7 Now let’s switch focus to what happens to an undersecured claim when the Dr files under chapter 7 In situation where Dr wants to KEEP the collateral Obviously if not keep, and if no “equity” for trustee to capture, then return collateral to SP, who forecloses, and who has an unsecured claim for any deficiency But that unsecured deficiency will be discharged
How can Dr keep collateral in 7? 1 st : for DR, no “cram down” rule like that in reorgs 2 nd : what rules are there? Can “redeem” by cashing out in a lump sum under 722 But redemption is limited – individual dr, tangible personal property, consumer item, nothing for estate AND, worse, Dr has to come up with all $ up front! Lump sum Can “reaffirm” 524(c) If Cr agrees But Cr won’t agree to reaffirm undersecured debt unless Dr agrees to pay ENTIRE debt
What about 506(d)? “To the extent that a lien secures a claim against the Dr that is not an allowed secured claim, such lien is void” pre-Dewsnup, DR argued plain meaning of 506(d), in conjunction with 506(a)(1), mandated strip down. "Allowed secured claim" is a term of art in 506(a)(1), meaning that portion of the total claim supported by collateral value. The unsecured balance of the claim, by necessity, is "not an allowed secured claim." Thus, a plain reading of 506(d) suggests that an undersecured creditor's lien is "void" "to the extent" it is unsecured.
Dewsnup Dr, Aletha Dewsnup, owned farmland worth just $39K when she filed chapter 7, but debt = $120K Thus under 506(a)(1): “allowed secured claim” = $39K “the extent … not an allowed secured claim” = $81K Dewsnup argued that plain meaning of 506(d) was that “such lien is void” “to the extent … not an allowed secured claim,” i.e., for $81K
Practical effect sought Eliminate lien on the farmland for all debt beyond $39K (i.e., for the $81K balance) In effect, would “strip down” the SP’s lien to just $39K If Dr thus could find a way to pay the SP (Lewis Timm) the $39K secured portion, would be entitled to keep the farmland free & clear Even if land subsequently went up in value, SP has no further right to it
Court’s holding Supreme Court refused to allow strip down under 506(d) in a chapter 7 case to the judicially determined value of the collateral
Why not avoid under 506(d)? Court concluded that the “voiding” rule of 506(d) only applies if underlying claim is either: 1. not “allowed” or 2. not “secured” And here, Timm’s claim has been “allowed” and is “secured,” so can’t “void” under 506(d), even in part Thus “allowed secured claim” does NOT mean what it means in 506(a), viz., the amount of the secured claim up to the value of the collateral
Rationale? 1 st, Court was worried about protecting the SP’s deal “the creditor's lien stays with the real property until the foreclosure.” So, if collateral were to appreciate in value post-bk, that should inure to SP’s benefit, b/c that was their bargain 2 nd, looked at history – what was the practice pre-Code? Found nothing other than in reorg cram down rules that allowed a strip down Presumed Congress in 1978 would not have made such a drastic change in law without flagging it in leg. history
Probably right holding The Court’s holding in Dewsnup is probably right, in terms of the intended meaning of 506(d) fits in better with other provisions of Code If Dr wants to cram down, has to jump through reorg hoops – can’t do same thing via chapter 7 And if do want to do in chapter 7, need to either redeem(which can’t for real property) or reaffirm If used 506(d) as DR wished, no one would ever invoke 722 or 524 to keep collateral
Worry about breadth of dictum Post-Dewsnup a lot of concern was expressed about the impact of the Court’s dictum that “the creditor’s lien stays with the real property until the foreclosure.” In particular, worry was that this statement, if taken seriously, would undermine the reorg cram down rules themselves b/c the effect of cram down IS to strip down the cr’s lien to the judicially appraised value, and eliminate lien once Dr pasy that amount But courts have held that the reorg cram down rules still work as they always have, even post-Dewsnup
Surcharging secured creditors Secured creditors may not always recover the full value of their collateral. Under 506(c), may be charged with expenses necessary to preserve or dispose of the collateral: “The trustee may recover from property securing an allowed secured claim the reasonable, necessary costs and expenses of preserving, or disposing of, such property to the extent of any benefit to the holder of such claim.”
Standing? Statute says “the trustee” may bring a surcharge action Does that mean ONLY the trustee? Or could an administrative expense claimant also seek surcharge under 506(c), if trustee (or DIP in chapter 11) does not act? Such claimants argue that they have no remedy if trustee does not act And trustee would not have any incentive to seek surcharge if will only help that claimant
Trustee only Supreme Court settled this question in Hartford Underwriters Insurance Co. v. Union Planters Bank, N.A., holding that the plain language of 506(c) limits standing to a trustee Thus excludes an administrative expense claimant. However, Court left open possibility that admin. claimant could obtain ct. permission to seek surcharge derivatively on behalf of estate (see. fn. 5)
Who gets the benefit of surcharge? By seeking surcharge power, admin claimant was assuming that the amount surcharged would go directly to them But is that right? Wouldn’t recovery of surcharged amount go into the general hopper, and be shared pro rata by ALL admin expense claimants? Would matter if estate administratively insolvent Court did not decide that question in Hartford (see fn 4)
When surcharge? Merits question is when should surcharge secured creditor’s collateral Statute says may recover “reasonable, necessary costs and expenses of preserving, or disposing of, such property to the extent of any benefit to the holder of such claim” Basic policy – no windfall to SP If BENEFIT SP or If SP CONSENTS
Easy examples SP’s collateral is being sold Costs directly related to the sale may be paid out of the sales proceeds under 506(c) Even if the creditor were to make the sale, rather than the trustee, the creditor would have to incur the same types of expenses. Examples include appraisal fees, auctioneer fees, advertising and marketing costs, storage expenses, etc.
What about more general “benefit”? Fights come where trustee argues that the bankruptcy case (especially reorg) more generally “benefited” the SP by keeping the DR afloat and allowing SP over the case to recover a higher going concern value for its collateral And thus seeks to charge admin expenses of chapter 11 against the collateral Argument is that SP should not enjoy the benefits of reorg without incurring the costs
Or as implied “consent”? Same argument may be cast as "implied consent" Argue that SP, by participating in the reorganization and cooperating with the debtor, impliedly consented to help pay the freight for the admin expenses incurred in the reorganization
No – need concrete benefit Prevailing view limits 506(c) recoveries to cases involving direct and immediate benefits to the creditor's collateral, or express consent general rule -- administrative expenses of bankruptcy case are payable only out of the unencumbered assets of the estate, not out of collateral If collateral could be charged for anything more than directly beneficial expenses, or when express consent is given, administrative creditors effectively will have priority over (or at least parity with) secured creditors