Cars and Bankruptcy Revisited

Thanks to Bob Lawless for inviting me to contribute. In addition to the usual Credit Slips disclaimer--- the opinions in these posts are not the opinions of my employer, the entities who fund it, my fellow employees, or the legal service community in general. Also, I am doing this on my own time.

Before the recent changes to the bankruptcy law, many Chapter 7 debtors who had liens on their cars would exercise the so-called "fourth option”. Some background. There were, and still are, three options that are clearly available to the debtor. If the debtor wants to keep the vehicle, he can redeem (pay what the vehicle is worth, in a lump sum) or reaffirm (reach an agreement with the creditor in which the debtor in essence waives the discharge as to this debt). Another option is to walk away from both the debt and the vehicle (“surrender”).

The fourth option is (was?) to keep the vehicle and stay current on the payments, without reaffirming the debt. The debtor’s position is that the secured creditor could not repossess the vehicle, because the payments were current, so there was no default. The advantage to the debtor of using the fourth option is that if he falls behind, while the vehicle could be repossessed, there would be no liability for any deficiency after the sale of the vehicle. Not surprisingly, the secured lenders would much prefer it if the debtor would reaffirm the debt instead of using the fourth option.

Now this is a fact scenario that doesn’t come up that often in my practice. Not many of my potential Chapter 7 clients have cars that are worth very much, and those that do tend not to be current on their car payments.

For purposes of this post, let’s assume that BAPcpA eliminated the fourth option as a legal right that the debtor has. Though many debtor’s attorneys don’t think that’s the case, that is certainly what the auto lenders think BAPcpA did.

What I find interesting is the different positions that various auto lenders have announced that they will take when confronted with debtors who still try to exercise the fourth option. Some have stated that if the debtor fails to sign a reaffirmation on the original contract terms, they will repossess the vehicle once the automatic stay is no longer in effect, even if the debtor was not in default when the case was filed, and has tendered all post-petition payments on time. They are willing to “eat steel” rather than see their legislative victory on this point undermined. Other lenders have said that as long as the payments come in on time, and there is no other default, they won’t take any steps to repossess the vehicles.

Does the hard line policy make economic sense in the long term?  The plus side for the creditor is that some of the debtor, who seem like good payers but in fact will eventually default, will reaffirm the debt, allowing the creditor to try to collect the deficiency after repossession. The down side is that in some of the cases where the creditor repossesses, the debtor would have made all the payments (or at least would have made payments that exceed the decline in the value of the car before repossession). 

Reports are that so far GMAC, Ford Motor Credit and Chrysler Credit have all taken the hard line position of no tolerance for the fourth option. On the other side, at least one of the finance companies associated with a large Japanese auto maker has taken the “can’t we all just get along" position. If this difference is real, and persists, it will be interesting to see which approach makes more money for the financing companies, and whether it has any effect on future sales of cars. Are the Big Three short sighted, or are the other lenders naive about the American way of debt?

Comments

[Jason Kilborn]

This is so interesting! It strikes me as though this may be one more distinction between the doomed business practices of U.S. automakers and the forward-thinking practices of their Japanese competitors. I hope someone follows up with an empirical study of how this affects business bottom lines on both sides of the Pacific in several years. More and more, I have the sense that both Europe and Asia are poised to leave the U.S. behind in economic development, and it would be particularly sweet if this were one more piece of evidence of that.

[Adam Block]

Is there any additional benefit to the 'hardline' auto lenders for just announcing that policy, but then make decisions on a case by case basis later?