Bankrupt? Pay your full car-loan debt anyway

The law used to allow some people who filed for Chapter 13 bankruptcy to escape a portion of their auto loan debt, keep their vehicles and pay a lower monthly payment. The practice was called a "cram-down" in auto-lending parlance, and lenders didn't like it at all.

Now, thanks to a little-noticed provision of the 2005 bankruptcy law revision, the crammer and the cramee have changed places. Filers who want to keep driving their vehicles must pay the total amount owed if they purchased their vehicles within the 30 months prior to filing, regardless of the vehicles' actual values.

John Rao, staff attorney for the National Consumer Law Center, explains that before the law changed, if a consumer owed $10,000 on a loan for a car that was only worth $4,000, the creditor was paid $4,000 as a secured claim. Secured debt is debt backed by property that a creditor can seize if the debtor does not pay. The $6,000 difference became an unsecured claim, debt that the creditor has no assurance will get paid, and if it is, sometimes only at a rate of pennies on the dollar.

"The new law says that if it's a fairly recent loan, the consumer may have to pay the $10,000 plus interest, that is the full balance owed, though the court may reduce the contract interest rate," says Rao.

The rule does not apply if the consumer surrenders the vehicle as part of the Chapter 13 plan. But even surrendering the vehicle, as opposed to paying up what is owed, has been challenged in a Chapter 13 case at the U.S. Bankruptcy Court, Eastern District of Tennessee.

Bankruptcy attorney Tom Dickenson of Hodges, Doughty & Carson in Knoxville, Tenn., explains that Larry and Regina Ezell have offered to surrender their 2003 Nissan Xterra in a Chapter 13 case, in full satisfaction of any claim that the creditor, JP Morgan Chase Bank, might have. Dickenson, who represents a group of eight creditors from the state, argues that it can't be done.

"What we're saying is you can surrender the collateral (the vehicle), but if the collateral is sold and it doesn't sell for enough to pay the debt in full, then we say the creditor is entitled to the unsecured claim.

"If the judge rules in favor of the debtor, what that would mean is all these people out there with car loans can file Chapter 13 and can just surrender vehicles in full satisfaction of the debt. One of the things we argued is that it will provide a windfall to debtors.

"I think this case could have an impact on future decisions."

The National Automobile Dealers Association, or NADA, backed the new Chapter 13 provision. The association claimed in its legislative bulletin in March of last year that cram-downs, or court-ordered reductions of a secured balance, allow an individual to keep the vehicle and own it at a cheaper amount than a nonbankrupt consumer, and the cram-downs increased the price of secured credit.