Hanging Paragraph Update
by: William A. McNeal
Becket & Lee LLP; Malvern, Pa.
One of the myriad changes made to bankruptcy practice by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) is the treatment of a claim for a debt collateralized by a motor vehicle or other personal property of the debtor. More specifically, new language inserted by BAPCPA at the end of 11 U.S.C. §1325(a), nicknamed the "hanging paragraph" because of its physical location and appearance on the page, addresses the treatment of a secured claim arising from a debt.
A majority of bankruptcy courts found that the new statutory language appears to eliminate the bifurcation of a secured claim, pursuant to 11 U.S.C. §506, if a debtor has surrendered the collateral, by finding that such a surrender thereby fully satisfies the claim.[1] According to this line of reasoning the wording of the statute plainly states that "[f]or purposes of paragraph (5), §506 shall not apply" if the debt was incurred within 910 days before petition and if it is collateralized by a motor vehicle, or within one year before petition if it is secured by other personal property. The Turkowitch court explains:
This court concludes that the language of the hanging paragraph is not ambiguous. If §506 does not apply, there can be no bifurcation of the claim, whether or not the collateral is worth less than the claim and whether or not the collateral is surrendered. Thus, removing the bifurcation provisions of §506 means that the 910-claim is satisfied in full by surrender of the collateral under §1325(a)(5)(C).[2]
The court detected a fairness and balance in this approach, observing:
Ironically, the same provision that prevents the debtor from lien stripping and reducing a creditor's allowed secured claim prevents the creditor from claiming a deficiency against the debtor. While this new language may not operate to hoist the 910-creditor by his own petard, surely the creditor may be said to hang by his own paragraph.[3]
Several bankruptcy courts disagreed, holding that the nonbankruptcy law afforded a creditor recourse to pursue his deficiency claim if one arose after he disposed of the collateral.[4]
More recently, several circuits have considered the issue, unanimously disagreeing with the preceding majority of bankruptcy courts. The Fourth, Sixth (albeit in a divided opinion), Seventh, Eighth, Tenth and Eleventh circuits all held similarly: "[A] creditor may pursue an unsecured deficiency claim when the debtor surrenders a 910 vehicle. The deficiency claim is to be governed by the parties' contract and applicable state law, and will depend on whether the contract and state provide for recourse."[5] They reasoned that while the "hanging paragraph" may eliminate application of 11 U.S.C. §506, it is well recognized that state law provides rights and obligations absent to any rule provided by the Bankruptcy Code.[6] Furthermore, according to the court, this accords with the intent of Congress, which did not intend, in adding the "hanging paragraph," to harm a lender when a debtor surrenders his vehicle/collateral purchased within 910 days before petition.[7]
Thus, based on the more recent, authoritative appellate reviews, as the Barrett court opined, "in light of the foregoing, it seems safe to say that the previous minority view is now the majority view."[8]
1. See In re Turkowitch, 355 B.R. 120 (Bankr. E.D. Wis. 2006); see also Daimler Chrysler Fin. Servs. Ams. LLC v. Barrett (In re Barrett), No. 07-14796, 2008 U.S. App. LEXIS 20466, at *8 (11th Cir. Sept. 29, 2008).
2. Turkowitch, 355 B.R at 125-26.
3. Id. at 127 n.2.
4. Barrett, No. 07-14796, 2008 U.S. App. LEXIS 20466, at *9.
5. Id. at *20; see also Tidewater Fin. Co. v. Kenney, 531 F.3d 312 (4th Cir. 2008); AmeriCredit Fin. Servs. Inc. v. Long (In re Long), 519 F.3d 288 (6th Cir. 2008); In re Wright, 492 F.3d 829 (7th Cir. 2007); Capital One Auto Fin. v. Osborn, 515 F.3d 817 (8th Cir. 2008); AmeriCredit Fin. Servs., Inc. v. Moore, 517 F.3d 987 (8th Cir. 2008); Daimler Chrysler Fin. Servs. Ams. LLC v. Ballard (In re Ballard), 526 F.3d 634 (10th Cir. 2008); accord, Wells Fargo Fin. Acceptance v. Rodriguez (In re Rodriguez), 375 B.R. 535 (B.A.P. 9th Cir. 2007).
6. Barrett, No. 07-14796, 2008 U.S. App. LEXIS 20466, at **10-11, 17.
7. Id. at **19-20.
8. Id. at *18.