Cross-collateralized Loans in Bankruptcy

I have talked in here before about the risks involved in doing all your banking with one institution. What I am cautioning against is having your bank accounts with the same institution where you have a car loan, home loan, and signature loan or any combination thereof. To explain one of the reasons to avoid this, I will describe a common scenario: Debtor buys a car using their bank or credit union because of the rates or because of the ease of doing business in the same place. Later, Debtor needs a little extra cash and so they take out a signature line of credit. The bank is eager to offer this line of credit and even gives Debtor a lower interest rate so long as they cross-collateralize the loan against the car. Of course, it is no longer really a signature loan, but a secured loan but we will call it “signature” for convenience.

Debtor ends up having to file bankruptcy and they want to keep their car. Let us say the car is worth $5,000.00 and the purchase loan balance is $7,000.00 with the signature line of credit being another $3,000.00. Debtor qualifies for a Chapter 7 and their budget shows they can afford the payments to reaffirm on the $7k loan, but it is too tight to be able to also reaffirm on the $3k loan. Here is the problem: the bankruptcy court will be reticent to approve a reaffirmation where you are promising to pay back two loans instead of just the purchase money loan AND where your budget does not support it. Your lawyer would be a bit foolish to sign off on such a reaffirmation, but their signature promises that they have reviewed it and that reaffirming both loans would not create a hardship, when clearly it would be a hardship. So, it the reaffirmation has to go to the judge for approval.

The bank is holding all the cards here because that second loan, even though it is a non-possessory, non-purchase money security interest under 11 USC 522(f)(1)(B), is not one that can be stripped off in a Chapter 7 because it is secured against a car rather than household goods or the like. So, to go into a Chapter 7, the Debtor has to decide what is most important and what they can let go of. The Debtor has to play a financial game of chicken and say to the credit union to either let them just pay the purchase money loan alone and keep the car or come on and pick the car up (not literally, there are motions to be filed). Some banks will cut their losses and at least get paid for the purchase money part, but others refuse to make deals believing it makes them look weak.

There is one other option: Chapter 13. If the car was purchased more than 910 days prior to filing bankruptcy and the second loan was incurred more than a year before filing, then great things happen. Under provision 11 USC 506 and 11 USC 1325(a)(hanging paragraph), then the purchase money debt of $7k gets crammed down to the $5k value of the car and the $3k non-purchase loan gets stripped off as an unsecured debt.

To figure out what the best approach is going to be in this circumstance, your attorney will need to look at a lot of different factors and advise you as to the best course of action.

“I meant to do it, but I’m really sorry” doesn’t count in bankruptcy

A recented decision by the Bankruptcy Court for the Western District of Kentucky reveals that bankruptcy is not the answer to relieve all debts, especially ones that come about by “willful” acts. In re Marklin, Case # 09-10939(1)(7) (Bankr.W.D.Ky., 2010) tells the tale of a farmer who borrowed over $100,000 to plant a crop. The bank held a security interest in the proceeds of the crop (a security interest is a legal right to get ownership of an asset if the debt isn’t paid). So far, this is all very common farming and banking practice.

Where things went wrong is that Mr. Marklin, with full knowledge that the bank held a security interest in the proceeds, sold the crop but kept all of the money for his own use. Now, I do not know that Mr. Marklin spent the money on luxury items or if he just used it to live off of and keep the farm going. It doesn’t really make a difference; what mattered to the court is that Mr. Marklin knew the security interest was in place but did what he did regardless.

Section 523(a)(6) of the bankruptcy code says that debts “for willful and malicious injury by the debtor to another entity or to the property of another entity” will not be discharged. Ordinarily, this section is thought to refer to the drunk driver who is not allowed to escape the debt of his injury when he wrecks into someone or an embezzler who stole funds. However, it has broader implications. For the person contemplating filing bankruptcy, it means that your intentions matter and that you need to operate in good faith towards creditors.

File Chapter 7 – Lose your mobile home: How not to do this

A recent decision in the Bankruptcy Court for the Eastern District of Kentucky highlights a mistake made too often in Chapter 7s where the debtor lives in a mobile home. In Kentucky, mobile homes are not terribly mobile and often remain in place and are occupied for decades. The legal term for mobile homes is “manufactured home” which also seems silly because all homes are manufactured in one way or another. Anyway, mobile homes get fixed to the land and people stop thinking of them as titled property such as cars, boats, trucks and trailers. However, they are titled.

Now, when one files a Chapter 7, everything they own and everything they owe go into an estate. They pull things back out by using exemptions and/or reaffirming secured debts. Often debtors keep their homes because they have enough exemption to cover the equity in their home and are able to pay the secured debt payments (the mortgage) when all their other debts are discharged. Each person can claim over $20,000 in homestead exemption using the Federal exemptions. So, if you own a home worth $120,000 and you owe $100,000 secured on the house, then you can use the exemption and keep the house by reaffirming the $100,000 secured debt.

Here is where the problem comes in for mobile homes. The only way a loan is secured against a mobile home is on the title as described in KRS 186A.190. Actually, there is one other way, but it involves surrendering the title and filing stuff with the county clerk and effectively converting the mobile home into a house from a legal standpoint. Anyway, most people do not do that. So, if there is a defect with the security interest on the title, then the loan is not perfected (it doesn’t count) and cannot be reaffirmed.

Like in In re Owens, 09-62087 (Bankr.E.D.Ky., 2010), if the title is defective in regards to the security interest, then you could lose your home. In other words, if there is a problem with the title then you may have no secured loan to reaffirm and not enough exemption to cover the difference. Then, the trustee will keep the mobile home, sell it (if you can’t come up with money to redeem it), and distribute the proceeds to all unsecured creditors. So, if you live in a mobile home, be sure that your bankruptcy attorney examines the title and makes sure that any security interest is properly in place.