The "Hanging Paragraph" and a Secured Creditor's Surrender Dilemma

One of the many changes made to bankruptcy practice by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) is the treatment of a claim for a debt secured by a motor vehicle or other personal property of the debtor. New language inserted at the end of 11 U.S.C. Section 1325(a) by BAPCPA changed the pre-BAPCPA practice of bifurcating (separating) a secured claim into secured and unsecured components if the value of the collateral was less than the amount of the claim. The new statutory language, nicknamed the "hanging paragraph" because of its physical location and appearance on the printed page, appears to eliminate the bifurcation of a secured claim, allowed by 11 U.S.C. Section 506 if the debt was incurred within 910 days prior to petition and if it is collateralized by a motor vehicle, or within one year prior to petition if it is secured by other personal property.

Prior to BAPCPA, there were several options available for treatment of secured claims in Chapter 13. The first option was an agreement between a debtor and a secured claimant. Neither the "hanging paragraph" nor the current language of 11 U.S.C. Section 1325(a)(5)(A) alters that possibility.

The second option was the so-called "cram down." Under this option, a debtor could retain the property and pay the secured claim over the life of his plan, despite the creditor's objection to the contrary.

In Assocs. Commercial Corp. v. Rash,the United States Supreme Court explained this option:

Under the cram down option, the debtor is permitted to keep the property over the objection of the creditor; the creditor retains the lien securing the claim, see § 1325(a)(5)(B)(i), and the debtor is required to provide the creditor with payments, over the life of the plan, that will total the present value of the allowed secured claim, i.e., the present value of the collateral, see § 1325(a)(5)(B)(ii). The value of the allowed secured claim is governed by § 506(a) of the Code.

The last sentence was important because it effectively allowed bifurcation of the claim into secured and unsecured components.

BAPCPA dramatically changed this option by excepting recently incurred secured debt from bifurcation. In the words of one court, "Debtors must now treat the entire allowed amount of the secured creditor's claim in the plan as one claim. That is what the hanging paragraph requires."

The third option for a debtor was to surrender the collateral. Prior to BAPCPA, any deficiency still owed to the creditor, resulting from the collateral's value being less than the secured claim, was treated as an unsecured claim. Treatment of claims arising from surrendered property, pursuant to the new "hanging paragraph" under BAPCPA, is not as settled. Courts are divided over whether the inapplicability of 11 U.S.C. Section 506 to secured claims described eliminates the bifurcation of a claim after a debtor has surrendered the collateral, such surrender thereby fully satisfying the claim.

Most courts find that the statutory language very clearly and unambiguously eliminates claim bifurcation. The wording plainly states that "[f]or purposes of paragraph (5), section 506 shall not apply" if the debt was incurred within 910 days prior to petition and if it is collateralized by a motor vehicle, or within one year prior to petition if it is secured by other personal property. A Court explained:

...[T]he language of the hanging paragraph is not ambiguous. If § 506 does not apply, there can be no bifurcation of the claim, whether or not the collateral is worth less than the claim and whether or not the collateral is surrendered. Thus, removing the bifurcation provisions of § 506 means that the 910-claim is satisfied in full by surrender of the collateral under § 1325(a)(5)(C).

The court detected a fairness and balance in this approach, observing:

Ironically, the same provision that prevents the debtor from lien stripping and reducing a creditor's allowed secured claim prevents the creditor from claiming a deficiency against the debtor. While this new language may not operate to hoist the 910-creditor by his own petard, surely the creditor may be said to hang by his own paragraph.

A minority of courts do not find the language of the "hanging paragraph" to be clear. For example, one court resorted to an examination of legislative history to inform what it perceived to be ambiguous statutory language. It determined that while Congress certainly could have written into the statute clear and unambiguous language prohibiting a deficiency claim after surrender of property, it did not.

While the "hanging paragraph" clearly prohibits bifurcation of a claim for debt recently incurred, it does not preclude a secured claimant from pursuing any applicable state law remedy, including an unsecured claim, for a deficiency resulting from a debtor's surrender of the collateral. One appellate court elaborated:

It seems extremely unlikely, given the purposes expressed in the titles of the amendments, that the intent of the amendment was to eliminate the long existing right of creditors in bankruptcy to an unsecured deficiency claim.... Even those courts that have adopted the majority position denying deficiency claims have acknowledged that the result is probably not what Congress intended, but have figuratively shrugged their shoulders and relied on the conclusion that the statute unambiguously requires a contrary result.

Thus it seems that, as so often happens, what is clear and unambiguous to one court is not so to another. While the "hanging paragraph" of 11 U.S.C. Section 1325(a) appears to eliminate the bifurcation of a secured claim pursuant to 11 U.S.C. Section 506 if the debt was incurred within 910 days pre-petition and if it is collateralized by a motor vehicle, or within one year pre-petition if it is secured by other personal property, it may not completely deny a creditor any recourse to satisfy a deficiency created by the surrender of collateral that is worth less than the amount of the creditor's claim.

This is another issue under BAPCPA that is expected to go through the appellate process and eventually reach the Supreme Court. Until then, secured creditors are governed by the divergent opinions of how their claim will be treated. Thus, the jurisdiction of the court will determine whether a deficiency claim will be allowed after surrender.