MOTOR VEHICLE INDUSTRY BENEFITS FROM BANKRUPTCY REFORM
By: Keith
E. Whann
Deanna L. Stockamp
WHANN & ASSOCIATES, LLC
President Bush signed the biggest rewrite
of the Federal Bankruptcy Laws in the past 25 years on April 20th,
2005 just one week after
the 500-page Legislation
won Congressional approval. Creditor Representatives, including Representatives
for the motor vehicle industry, have been pushing for Bankruptcy Reform for the
past eight years, and it has finally paid off. In six months, when the Law goes
into effect, it will be much harder for debtors to wipe out many of their debts,
including motor vehicle loans.
Under the current bankruptcy system, a federal
bankruptcy judge determines whether individuals must repay some
or all of their debt. An income-based "means-test" will
now be implemented to determine which debtors have the ability to pay back some
of their debts under Chapter 13. Those debtors who have insufficient assets or
income could still file a Chapter 7 bankruptcy, but those with income above their
state’s median income who can pay at least $6,000.00 over five years ($100 a
month) would be forced into Chapter 13. The basic difference between Chapter
7 and Chapter 13 is that under Chapter 7 the debtor’s nonexempt property is liquidated
to pay as much as possible of the debtor’s debts, while in most Chapter 13 cases
a portion of the debtor’s future income is used to pay as much of the debtor’s
debts as is feasible considering the debtor's circumstances.
A major benefit
of Chapter 13 Bankruptcy for debtors is that it allows them to
lower the amount they owe on most secured debts (called a "cram
down").
Secured debts are those that cover items which, if you do not pay, have to be
returned to the creditor, such as motor vehicles and furniture. When a vehicle
is financed, the value of the vehicle often decreases faster than the loan is
being repaid and the loan amount typically includes sales tax and the cost of
other products and services. For example, a vehicle purchased two years ago may
be worth $5,000.00, but the amount owed on the loan may be $8,000.00. These types
of debts can be "crammed down" in Chapter 13, requiring the debtor
to pay only the value of the property at the time of filing the bankruptcy.
Under
a Chapter 13 bankruptcy, debtors can also reduce the interest that has to be
paid on a secured debt even if the debtor agreed contractually to pay a
higher rate. For instance, debtors who agreed to pay 18-24% interest would
only have to pay most secured debts at the prime rate plus 1-3%,
depending on the
circumstances of the case. The combination of cramming down a secured loan
and reducing the interest rate left many creditors collecting as
little as a penny
for every dollar owed over a longer period of time. If a debtor was behind
on payments for a secured loan or simply could not afford the monthly
payment due
to the high interest rate, they were all too often advised to file a Chapter
13 bankruptcy.
The National Independent Automobile Dealers Association, working
with the Coalition for Financial Responsibility, was successful
in getting an exemption from cram
down for motor vehicle loans that will protect the vast majority of loans
extended to consumers purchasing used motor vehicles. Under the
new Law, a debtor will
have to pay the entire amount of the outstanding loan on a motor vehicle
purchased 2 1/2 years (910 days) prior to filing, compared to the
exemption for other
industries which only applies to loans generated within one year prior to
filing. It will
also be more difficult to enter into a redemption agreement, which a debtor
might have considered under Chapter 7, by requiring the amount of an allowed
claim
secured by personal property to be based on the retail “replacement value”
of the collateral.
Several other provisions will also benefit the motor vehicle
industry. The new Law extends the length of time to perfect a
security interest in property
from
20 to 30 days after the debtor receives possession of property and still
be afforded protection under the preferential transfer provisions. Dealers
generally
have
30 or more days to perfect a security interest under state law, but under
the Federal Bankruptcy Code, if they failed to do so within 20 days and
a debtor
filed bankruptcy within 90 days of the purchase of the vehicle, the trustee
could void the transfer of the vehicle and the status of the creditor would
move from
that of secured to unsecured. As many dealers have experienced first hand,
if a retail installment sales contract has been assigned to a third party
lender, a preferential transfer voidance quickly triggers a motor vehicle
dealer’s
obligation
to repurchase the contract under most, if not all, lenders’ dealer agreements.
These
are only a couple of the changes that will occur. Debts for luxury
goods and services worth more than $500 that were purchased on or within
90 days
before the order for relief are presumed nondischargeable; more documentation
will be
required from debtors wishing to file bankruptcy and repeat filings will
be discouraged; and debtors will be required to undergo credit counseling
before
filing for bankruptcy
and cannot obtain a final discharge unless they complete a course in
financial management. Bankruptcy Reform has been a long time coming,
but the benefits
to motor vehicle dealers can be significant, especially for those engaging
in Buy
Here-Pay Here financing or operating a related finance company.
The information
contained herein has been provided by Keith E. Whann and Deanna
L. Stockamp of the Law Firm of Whann Associates, LLC, and
is for
general information
purposes only. You should contact legal counsel for specific application.
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