Sunday, December 1, 2013

Keeping Your Vehicle Through Bankruptcy

One of the questions most people ask when discussing bankruptcy is whether they can keep their car or truck if they file for bankruptcy. The answer, in most cases, is "yes."

The theory behind bankruptcy administration is that the Trustee takes possession of all your assets and distributes it among your various creditors. In application, the Bankruptcy Code allows a debtor to exempt certain items of property, up to a certain value, from the bankruptcy estate. The values change from time to time, but in most cases, I find that a debtor can exempt all of their assets from seizure. But motor vehicles are also open for special treatment.

If you own your vehicle outright and its value falls at or below the exemption limit, then the solution to keeping the vehicle is simply a matter of exempting it from the bankruptcy estate. The complications arise when the debtor still has an outstanding loan on the car.

The Bankruptcy Code allows a debtor to “reaffirm” an auto loan. This means that, even though the loan could be discharged through bankruptcy, the debtor has chosen to assume liability for the debt once the bankruptcy is completed. It’s as if the auto loan was untouched by the bankruptcy process. It also means that if the debtor defaults on the loan following discharge of the other debt, the loan company can still repossess the vehicle and seek judgment for a deficiency after the vehicle is sold at auction.

Sometimes the vehicle is worth more than the remaining loan balance. This is a fairly rare occurrence, but when it happens, the solution is to find where the equity can be exempted under the Code. Usually, if the equity is just a few thousand dollars, the exemption can be found.

More often, the loan is significantly more than the value of the car. When this happens, another possibility opens up – reducing the actual balance of the loan and paying that amount to the creditor in exchange for free title to the vehicle. In this way, the debtor can realize significant savings in the total cost of the vehicle. How the reduction is made differs between a chapter 7 or chapter 13 bankruptcy.

In chapter 13, the debtor petitions the court to determine the retail value of the vehicle, and the secured amount of the auto loan is “crammed down” to the determined value. This value is entered into the repayment plan as a secured debt and would normally be paid off entirely, while the remaining amount of the loan is treated as unsecured debt, which may or may not be paid off through the Plan. One caveat to this option: cramdown can only be used if you have already owned the vehicle for a minimum of 910 days, or 2 ½ years.

In chapter 7, the process is different, and is referred to as “redemption” of the collateral (the vehicle). The theory is that the lender can repossess the vehicle upon default and sell it at retail value. But it cannot seek a deficiency from the debtor for the remainder of the loan amount, because that obligation was discharged by the bankruptcy. The resale amount is all the lender can expect to recoup from repossessing the vehicle. The process of redeeming the vehicle loan gives the debtor the opportunity to purchase the vehicle from the lender at an amount the lender could expect to receive at resale. Like the chapter 13 cramdown, redemption can allow the debtor to realize a significant reduction in the total purchase price of the vehicle.

Unfortunately, most chapter 7 debtors do not have an extra several thousand dollars available to pay to the lender. As a result, redemption is rarely used, and the debtors most often rely on the reaffirmation process to keep their cars. In some instances, though, the debtor may turn to a redemption loan company to borrow the money necessary to purchase the car. If qualified for such a loan, the debtor would petition the court for an order determining the retail value of the vehicle and allowing them to take out a loan to redeem it. The whole scheme must be in the debtor’s best financial interests for the court to approve it.
So, there you have it. In most instances, a debtor can keep their vehicle when they file for bankruptcy, and in some case, actually realize a significant savings over the total purchase price of their car. When discussing your potential bankruptcy, an experience attorney should be able to discuss these options with you and be willing to work the necessary calculations and tactics to your advantage. If not, look for another attorney.