Goodbye Negative Equity!

One of the changes under the 2005 BAPCPA is that car creditors’ claims cannot be valued (i.e., paid only the value of the car or other collateral) if the car was purchased within 910 before the bankruptcy filing. This cut down significantly on the amount of cars that could be valued in Chapter 13.

One problem that came up was the problem of “negative equity,” i.e., when a car is traded in and is worth less than what is owed on it, the dealership will often roll the extra debt into the new purchase. So, for example, if you trade in your 2002 car worth $5,000 when you owe $10,000 on it, your new car loan would be $5,000 more than it would have been otherwise. I will frequently see clients with $5,000, $10,000 or even $15,000 in negative equity on a vehicle. The question is whether the “negative equity” can be valued at its true worth (zero) or whether the whole amount of the loan has to be paid.

The Ninth Circuit addressed this question in In re Penrod, adopting the dual status rule. The dual status rule means that the portion of the debt allocable to negative equity may be valued because it is not “purchase money” and the portion of the debt that is not for “negative equity” cannot be valued. This ruling makes the most sense practically, because in most of those situations, the Debtor would not be able to afford the car with negative equity, whereas the Debtor could afford the car if the “negative equity” could be removed from the amount of the debt.