Creditors Do Not Have PMSI in Car Loan Portion Related to Negative Equity

The Ninth Circuit Court of Appeals found that a creditor does not have a purchase money security interest (PMSI) in the portion of the debtor’s car loan related to negative equity of a vehicle traded in at the time of a new vehicle purchase; thus, the negative equity portion of the claim may be bifurcated as unsecured.

PMSI refers to a claim on property that affords a lender, who provides financing for goods or equipment, priority ranking over other secured creditors. (11 U.S.C. § 547). Negative equity exists where the value of the asset used to secure a loan is less than the balance on the loan. Negative equity can occur, for example, when a vehicle with an outstanding loan balance is traded in for a new one and that previous balance is added to the new loan. Bifurcation occurs when a creditor’s claim is split into secured and unsecured claims. (11 U.S.C. § 1325(a) prevents bifurcation of certain claims).

The decision created a split from eight other circuits. Under the U.C.C., negative equity is antecedent debt and a lender can only obtain PMSI for new value. Additionally, the Bankruptcy Code only gives preferential treatment to security interests “to the extent that the obligation relates to the receipt of truly new value,” not repackaged old obligations.

KEYWORDS: Purchase Money Security Interest (PMSI), Negative Equity, Antecedent Debt, Claim Bifurcation, Unsecured Claims, Secured Claims, Security Interest, 11 U.S.C. Section 1325, 11 U.S.C. Section 547, Ninth Circuit Court of Appeals, In re Penrod

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