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Roughly speaking, the “hanging paragraph” to Bankruptcy Code 1325(a), enacted in 2005, requires that a debtor pay the full debt on any automobile acquired within 910 days before bankruptcy – a boon for car financiers. Prior to 2005 the debtor had to pay only the appraised value of the car – usually a lesser amount. But the privilege bestowed on car financiers by the hanging paragraph depends on the financier providing “purchase money” credit. About one-third of the time, however, the financier advances funds to repay a prior car loan as part of the “trade-in” of an old vehicle for a new one. This advance to retire old debt is nick-named “negative equity.” Does the presence of negative equity mean that the loan secured by the new car is not a purchase money loan? The courts have ruled, in the main, that the entire loan is a purchase money loan and so the hanging paragraph applies. Soft-hearted academics favor the debtor and claim that the hanging paragraph no longer applies if the new car secures both a purchase money obligation and the negative equity. This article points out that the financier has a “proceeds” security interest in the new car representing the trade-in of the old car. Therefore, if the old car was encumbered by a purchase money security interest and if the new car is proceeds of the old car, the new car is encumbered by the purchase money security interest that had previously encumbered the old car. On this logic, the courts are correct and the academics are wrong – unfortunately. This by no means implies that the hanging paragraph is wise policy.

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American Bankruptcy Institute Law Review

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bankruptcy, Chapter 13 Bankruptcy, automobiles, security interests



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