GAP and the Bankruptcy Code’s ‘Hanging Paragraph’

Over the last dozen or so years, we’ve written, from my count, nine articles about the Bankruptcy Code’s “hanging paragraph.” The hanging paragraph, a 2005 creation, got its name because it was stuffed between Sections 1325(a)(9) and 1325(b)(1) without its own alphanumeric designation.

The hanging paragraph allows creditors that meet certain criteria to receive secured treatment for the full value of their claims, not just the amount attributable to the value of their collateral. In particular, the hanging paragraph applies to a claim “if the creditor has a purchase money security interest securing the debt that is the subject of the claim, the debt was incurred within the 910-day period preceding the date of the filing of the petition, and the collateral for that debt consists of a motor vehicle … acquired for the personal use of the debtor, or if collateral for that debt consists of any other thing of value, if the debt was incurred during the one-year period preceding that filing.”

All of the articles we’ve written have focused on whether a creditor that financed negative equity is eligible for protection under the hanging paragraph or whether a car is deemed to have been purchased for the debtor’s personal use. A recent case deals with a new topic — the intersection between the financing of GAP insurance and the hanging paragraph.
Let’s take a peek at what happened in that case.

In October 2017, Denice Madrid-Baskin financed her purchase of a used Honda Accord for $14,626, which included $295 for GAP insurance. In 2019, Madrid-Baskin filed a Chapter 13 bankruptcy petition. Westlake Financial Services, the assignee of her retail installment contract, filed a secured proof of claim for $10,537. Madrid-Baskin filed a Chapter 13 plan in which she proposed to pay Westlake $7,655, which she contended was the current value of the Accord, plus interest over five years.

The Chapter 13 trustee objected to the plan’s treatment of Westlake’s claim, contending that the hanging paragraph protected the majority of Westlake’s claim (other than the amount attributable to GAP insurance) from being crammed down because Madrid-Baskin bought the Accord for her personal use within 910 days before her bankruptcy filing and Westlake has a purchase-money security interest in the car. Madrid-Baskin claimed that because the transaction included the purchase of GAP insurance, the debt for which Westlake was not entitled to a purchase-money security interest, Westlake’s purchase-money security interest in the Accord was destroyed.

The U.S. Bankruptcy Court for the District of Colorado agreed with the trustee and denied confirmation of Madrid-Baskin’s plan. The court recognized that courts are split on whether debt for the purchase of GAP insurance is entitled to purchase-money security interest status. However, it noted that it need not decide the issue because the trustee conceded that the portion of the debt attributable to the purchase of the GAP policy was not entitled to purchase-money security interest status, as GAP insurance does not have a sufficiently close nexus to the acquisition of a car.

The court went on to embrace the “dual-status rule,” based on binding appellate court precedent, and determined that Westlake’s purchase-money security interest in the car was not transformed just because a portion of the debt was attributable to the purchase of GAP insurance. Because the GAP insurance was 2.6 percent of the original financing, the court determined that 2.6 percent of Westlake’s claim ($274) may be crammed down while 97.4 percent of the claim ($10,263) may not be crammed down due to the hanging paragraph’s protection.

If you’re faced with a customer attempting to cram down the portion of your claim that represents the financing of GAP insurance, this case will not help you because the trustee in this case surprisingly conceded that point. However, if, as in this case, the debtor argues that because you financed GAP insurance, your entire claim can be crammed down, this case will certainly help.

In re Madrid-Baskin, 2020 Bankr. LEXIS 2293 (Bankr. D. Colo. August 25, 2020).

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