Bankruptcy

In bankruptcy, there are competing policy arguments about the proper scope of the hanging paragraph.  The car lender argument is that it is unfair for debtors to be able to cram down recent car loans, and a lot of car loans (maybe as high as 40 percent, and growing, of new car loans) involve paying off the unpaid balance on the last car loan.  Another way the argument has been put is that Congress intended only good things for car lenders in the 2005 law.  The opposing argument is that the slight of hand of turning an undersecured loan into a fully secured one should be limited as much as possible because it prejudices (other) unsecured lenders, encourages risky, highly leveraged loans and makes it hard for debtors to afford to hold on to collateral in chapter 13 (that's why we are talking about mortgage cramdown).   Under this view, since the old negative equity isn?t used for purchase of the new car, one can draw a line and exclude negative equity from the reach of the hanging paragraph (and maybe the whole loan, under the ?transformation rule? as opposed to the ?dual status? rule, but let?s not go there in the interests of getting to the basic state law issue as cleanly and quickly as possible).

So what are the full state law implications of treating as purchase money the negative equity on an old loan when it is rolled into a purchase money loan?  Could this be problematic in commercial secured lending? Could it be troublesome in consumer purchase money lending outside bankruptcy?

These questions are likely to be on the minds of the justices of the New York Court of Appeals when they decide later this year whether, as a matter of state law, a ?purchase money obligation? under U.C.C. section 9-103(a)(2) includes old negative equity.  The U.S. Court of the Appeals for the Second Circuit certified the question to that court in In re Peaselee  (and also said that the bankruptcy law question should be resolved by interpretation of state law)      http://www.ca2.uscourts.gov:8080/isysnative/RDpcT3BpbnNcT1BOXDA3LTM5NjItYmtfb3BuLnBkZg==/07-3962-bk_opn.pdf .  The NY court accepted the question late last year.  http://www.law.cornell.edu/nyctap/I08_0165.htm  Briefing will be coming up in a few months.

One could argue that using state law on this question in bankruptcy is a mistake.  The state law issue does not involve questions about the extent of cramdown; that is a pure bankruptcy concern.  But the Bankruptcy Code does not define ?purchase money security interest,? and using the Butner principle, the Second Circuit said state law determines the definition for bankruptcy purposes.  So let?s assume that state law will control.

So, supernerds, you know who you are.  If you got this far, you probably qualify.  What?s the right policy answer under state law?  As a technical matter, it seems pretty clear that the bankruptcy courts that have treated negative equity as part of purchase money obligations have not understood Article 9.  The history of the definition of purchase money obligation is that it covered credit sales and third-party financing.  The language ?incurred in connection with acquiring rights in? the collateral was used to refer to the latter (that is, loans incurred from a third party and used to purchase the collateral from the seller), and not in order to cover paying off old loans by rolling them into a new purchase money loan. See http://www.nacba.org/s/45_50fc1f2acc4e329/  But beyond that technical legal argument, what policy arguments are there that bear on the interpretation issue under state law?