Seventh Circuit Rejects Cramdown Attempt; Holds PMSI Includes Negative Equity

On March 1, the U.S. Court of Appeals for the Seventh Circuit affirmed a decision from the Bankruptcy Court for the Northern District of Illinois that held that an auto loan creditor’s purchase-money security interest (PMSI) included the financing of negative equity from a trade-in vehicle, and thus rejected the debtor’s attempt to "cramdown" his claim. In re Howard, No. 09-3181, 2010 WL 680974 (7th Cir. Mar. 1, 2010). In this case, the debtor traded in a vehicle in which he held "negative equity" (i.e., the amount owed on the trade-in vehicle exceeded the value of that vehicle) in conjunction with financing a new vehicle purchase. The amount financed to purchase the new vehicle included the "negative equity" from the trade-in vehicle. Several months after purchasing the new vehicle, the debtor filed for Chapter 13 bankruptcy protection. The debtor sought to "cramdown" his Chapter 13 plan by bifurcating the creditor’s claim into (i) a secured portion, and (ii) an unsecured portion (the negative equity from the trade-in vehicle), and the creditor objected to this proposed treatment of its security interest. The bankruptcy judge sustained the creditor’s objection, relying on the "hanging paragraph" of Section 1325(a) of the U.S. Bankruptcy Code, which excludes certain bankruptcy claims from "cramdown" when the creditor has a PMSI. On appeal, the Seventh Circuit relied on the Illinois Motor Vehicle Retail Installment Sales Act’s language indicating that negative equity is part of the “deferred payment price,” and the Illinois Uniform Commercial Code’s definition of PMSI to “join the other courts in ruling that negative equity can be part of a [PMSI] and if thus secured is not subject to the cramdown power of the bankruptcy judge in a Chapter 13 bankruptcy.” The opinion, authored by Judge Posner, noted that, although the statutory language did not necessarily require this finding, including negative equity in the PMSI “may be essential to the flourishing of the important market that consists of the sale of cars on credit” and “Article 9 does not seek to discourage credit transactions.”