Dealing with the Chapter 13 Bankruptcy "Cram-Down" Provision
Keith E. Whann
Despite a booming economy, the credit worthiness of the average
consumer has been on a steady decline over the past several years.
In 1997, over 1.3 million people filed Chapter 7 or Chapter 13
bankruptcy petitions. Given
the explosive number of new consumer bankruptcies, more and more
automobile dealers are being affected by a phenomena affectionately
referred to as a “cram-down.” The
Chapter 13 “cram-down” provision allows debtors to retain collateral
as long as they offer repayment of the “secured portion” or fair
market value of the collateral in their repayment plan.
The balance of the indebtedness that exceeds the fair market value
of the collateral is considered to be unsecured and is placed at the
lowest priority of payment. In
1997, the U.S. Supreme Court, interpreting the cram-down provision, was
hailed as having ruled on the creditors’ side in the case of Associates
Commercial Corp. v. Rash.
main issue in Rash was whether the value of the equipment should be
its wholesale value or its retail value.
The Supreme Court held that “the value of the property (and thus
the amount of the secured claim under §506(a)) is the price a willing
buyer in the debtor’s trade, business or situation would pay to obtain
like property from a willing seller” or “the cost the debtor would
incur to obtain a like asset for the same proposed use.” Therefore, whether replacement value is the equivalent of
retail value, wholesale value, or some other value depends on the type of
debtor and the nature of the property.
The balance owed by a debtor over the fair market value of the
collateral is treated as unsecured debt.
many in the industry thought that the imposition of a replacement value
standard in determining the value of the collateral would substantially
improve the secured creditor’s position, automobile dealers have not
received a significant benefit from Rash.
Consider for instance the In re Jones decision rendered by
the United States Bankruptcy Court for the Northern District of Illinois.
the case of In re Jones, Money Store Auto Finance, Inc., the
lienholder on the debtor’s automobile, filed a secured claim in the
amount of $21,182.74, consisting of $14,053.13 in principal and $7,029.61
in interest. The debtor
objected, arguing that the Money Store’s secured claim should be limited
to $13,675 and that the remainder should be treated as an unsecured claim.
The Court agreed with the
to the Court, the claim is only secured to the extent of the value of the
collateral. In other words,
the claim for interest is unsecured.
The Court based its decision on 11 U.S.C. §506(a) which provides
in relevant part that “[a]n allowed claim of a creditor secured by a
lien on property in which the estate has an interest...is a secured claim
to the extent of the value of such creditor’s interest in the estate’s
interest in such property... and is an unsecured claim to the extent that
the value of such creditor’s interest...is less than the amount of such
allowed claim...” In
addition, the Court followed the rationale set forth in Rash stating that the value of the property was the price a willing buyer in
the debtor’s trade or situation would pay to obtain like property.
With respect to the appropriate date for valuation purposes in a
Chapter 13 cram-down, the Court held that the collateral should be valued
as of the day the plan is confirmed.
addition to determining the “value of the property” and the
“appropriate time for valuation,” the Court also addressed the issue
of the amount of interest that should be allowed.
Pursuant to §1325(a)(5)(B), a secured creditor in a Chapter 13
case is to receive payments under the plan totaling no less than the value
of its interest in the collateral as of the effective date of the plan.
The Court held, however, that the value of “interest” is only
in the secured value of the principal claim and a proper rate of interest
to be applied thereto, but not in the contract rate of interest thereon.
The court said: “The Bankruptcy Code protects the creditor’s
secured interest in the property, not the creditor’s interest in profit
it had hoped to make on the loan.”
The Court further held that the appropriate discount rate is one
that approximates the creditor’s cost of funds in its business, the
rationale being that a creditor with a secured claim is not harmed if it
receives interest that compensates it in full for additional interest
costs incurred due to the deferral of payment.
Hence, the appropriate rate for discounting a secured creditors
claim to present value was the “market rate” or “prime rate”
because it is the actual cost of money for a reliable borrower and it
allows the market to make the necessary risk assessment.
essence, the effect of the “cram-down” provision is threefold.
First, it reduces the amount of the secured claim to the value of
the property at the time the bankruptcy plan is confirmed.
Second, it provides the debtor with more time to pay the loan.
Third, it reduces the value of interest to the prime rate.
For example, a three (3) year loan of $10,000.00 at an interest
rate of 18 percent may be reduced to a claim of $6,000.00 payable over a
period of six (6) years at the prime interest rate.
Should the debtor decide he doesn’t want the car anymore, he can
simply stop paying the trustee and abandon the plan.
There is no penalty for a debtor who doesn’t live up to the terms
of the bankruptcy plan.
although the Rash case provided that a higher standard of value
should apply when a debtor proposes to “cram down” the collateral in a
Chapter 13 case, the practical effect of interpreting the “replacement
value” has changed very little. However, the impact of the overwhelming number of
bankruptcies has not escaped the attention of Congress.
The 105th Congress introduced two Bills, House Bill 3150, the
“Consumer, Lenders and Borrowers Accountability Act of 1998,” and
Senate Bill 1301, the “Consumer Bankruptcy Reform Act of 1997” in an
effort to bring about Bankruptcy Reform.
Both Bills tended to favor Chapter 13 filings, but they also
contained relief from the Chapter 13 cram-down provisions.
Efforts by members of Congress to add the Bill in the form of an
amendment to the Omnibus Spending Bill, however, were unsuccessful.
106th Congress continued the crusade for bankruptcy reform, however,
introducing two Bills. H.R. 833, The Bankruptcy Reform Act, was identical to the
Bankruptcy Bill passed by the House the previous year, and S. 625, The
Bankruptcy Reform Act of 1999. Unlike
last year, the consensus is that some type of Bankruptcy Reform Bill will
pass this year and 18 will include provisions requiring that debtors file
under Chapter 13 of the Code rather than under Chapter 7 in certain
circumstances. Therefore, it is extremely important that any reform also
include relief from the Chapter 13 cram-down provision.
Several industry groups
formed the Coalition for Financial Responsibility and have worked
diligently to obtain that relief from cram-down in the form of an
amendment. Currently, retail
loans generated within six months of the filing of the bankruptcy petition
are exempt from cram-down in both the House and Senate Bills which have
already been passed by the respective chambers of Congress.
Although the cram-down relief provisions in both the House and
Senate Bills as passed are uniform, there are other provisions in the
Bills in which there are differences.
Among them are the numerous amendments which do not pertain
directly to bankruptcy reform and were added to the Senate Bill shortly
before it passed. A
Conference Committee will attempt to work out a compromise on those
provisions. Given the problems which consumer bankruptcies and the
cram-down provisions are creating for the motor vehicle industry,
bankruptcy reform legislation is a priority for the industry as a whole.
All of its members should be taking a leadership role in attempting
to make sure that cram-down relief is preserved if Bankruptcy Reform moves