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One provision of the 2005 amendments to the Bankruptcy Code that has divided the courts is how to interpret the so-called “hanging paragraph” added to Section 1325(a), that part of Chapter 13 of the code that deals with plan confirmation. Generally, the “hanging paragraph” states that as to certain secured vehicle loans, Section 506 does not apply. Though this provision has generated many decisions, until now no court at the circuit level had addressed the issue. One court finally has. In re Wright presented the following facts: The debtors owed more on their secured auto loan than their car was worth. The purchase occurred within 910 days of the filing of the Wrights’ Chapter 13 petition. Pre-amendment, under Section 506(a), the claim of the lender in this case would be divided into two parts: a secured portion, equal to the value of the collateral (the car), and an unsecured portion representing the difference between the amount owed on the loan and the value of the car. Each portion of the claim would have to be dealt with under a plan. However, certain major players in the consumer bankruptcy area believed that in doing so, they were at a great disadvantage. By virtue of the U.S. Supreme Court’s decisions in Till v. SCS Credit Corp. and Associates Commercial Corp. v. Rash, Chapter 13 debtors could retain their auto, despite contractual provisions allowing creditors to repossess, by making monthly payments that a bankruptcy judge determined were equal to the market value of the asset, with an “appropriate” interest rate (instead of the contract rate). According to lenders, this resulted in a payment stream often falling short of a lender’s benefit of the bargain. As a result, Congress added the “hanging paragraph” to Section 1325. It states, in relevant part, as follows: ” . . . 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 . . . .” The majority of bankruptcy court decisions have concluded that because under the “hanging paragraph” Section 506 is inapplicable, creditors may not divide their car loans into secured and unsecured portions. But Chapter 13 debtors may surrender the collateral to the lender and, under Section 1325(a)(5)(C), fully satisfy the debt based on surrender. The effect of this result, some have noted, is that the loan becomes a non-recourse loan, regardless of what the loan document provides. By contrast, a minority of courts have concluded that since Section 506 of the Bankruptcy Code does not apply, then traditional principles of law (i.e., the Uniform Commercial Code and state contract law provisions) apply, and unless the contract is specifically a non-recourse contract, the claim should be divided into two parts, secured and unsecured, and both must be dealt with under a plan. In Wright, the bankruptcy court adopted the minority view, and because the plan as drafted called for surrender of the vehicle in full satisfaction of the entire claim, that court refused to confirm. Recognizing that this issue has divided the courts, the bankruptcy court took an unusual step: relying on 2005 amendments to 28 U.S.C. 158, it, on its own motion, certified the issue as one deserving of direct appeal to the 7th U.S. Circuit Court of Appeals. The 7th Circuit agreed, noting that this issue has been “stuck” in the bankruptcy courts, that the issue is frequently confronted and that “[l]ower litigation costs for thousands of debtors and creditors may be achieved by expediting appellate consideration of this case.” The circuit court affirmed, with Judge Frank H. Easterbrook writing for the panel. Those courts adopting the majority view, he stated, were mistaken in thinking that Section 506 is the only source of authority for a deficiency when the value of collateral is insufficient to satisfy a secured claim. Under the Supreme Court’s decision in Butner v. United States, if the Bankruptcy Code does not supply a federal rule, then state law determines rights and obligations. Here, the contract signed by the Wrights was explicit – the buyers were liable for any deficiency between the value of the collateral and the amount due under the loan. Indeed, the contract at issue here also specifically provided that the provisions of Article 9 of the Uniform Commercial Code, which calls for the same remedies, would apply to the loan agreement. The anomaly of a different result, stated the court, was evident by the following example: If the Wrights had surrendered their car one day before filing for bankruptcy, there would be no question of the creditor having the right to seek a deficiency; yet by waiting until after filing, the Wrights would be able to turn a recourse loan into a non-recourse loan, when nothing in the code specifically so provides. It is “hard to believe,” stated the court, that Congress intended, in such an indirect way, to fundamentally change this type of consumer lending from recourse to non-recourse. Those who argue the contrary view suppose that state law is irrelevant unless specifically implemented by the Bankruptcy Code. Butner and its progeny, however, dictate just the opposite. Accordingly, the circuit affirmed the bankruptcy court and has now made the minority position the law of the 7th Circuit. The opinion in Wright was filed on July 3. Two days later, the Bankruptcy Appellate Panel for the 10th Circuit decided In re Quick. The panel, contrary to the holding of the 7th Circuit, concluded that the majority view – that under the “hanging paragraph,” surrender constituted complete satisfaction of the car lender’s claim – was the correct approach. The panel’s opinion was grounded in its view that the language of the “hanging paragraph” was unambiguous. That paragraph states that a debtor no longer has a bifurcation tool at his/her disposal in cases where the paragraph applies, and the debtor must treat the claim as fully secured if retention is desired. Cram down in such instances, in short, has been eliminated. What makes this particular BAP opinion stand out? Simple. Not only was it decided after Wright, it actually cited Wright. Thus, the bankruptcy appellate panel, with full knowledge of the 7th Circuit’s views, rejected those views. And with that, the panel left muddled and uncertain the ultimate answer to the problem posed by the “hanging paragraph” of Section 1325(a). MYRON A. BLOOM is a shareholder with the firm of Hangley Aronchick Segal & Pudlin. His practice is concentrated in the areas of corporate organization, bankruptcy, commercial workouts and creditors’ rights.

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