Fifth Circuit limits Chapter 13 enforcement rights

The Fifth Circuit Court of Appeals^[1] recently issued a lender-friendly ruling regarding the treatment of consumer loans in Chapter 13 bankruptcies. Specifically, the ruling changes how borrowers can avail themselves of the Chapter 13 “cramdown” provisions, which allow debtors adjust debts on personal property by paying the value of an item at an adjusted interest rate, rather than the loan balance at the contract rate.

In Evolve Federal Credit Union v. Barragan-Flores (5^e Cir., No. 18-50420), the court considered a Chapter 13 plan filed by the debtor, who had taken out two car loans from the credit union. Each loan contained a standard “cross guarantee” clause, making each vehicle a guarantee for the other loan. The debtor’s Chapter 13 plan proposed to return one vehicle and keep the other with an adjusted balance and interest rate, pursuant to 11 USC § 1325(a)(5).

In accordance with standard practice, the bankruptcy court approved the plan, over the objection of the credit union. The credit union appealed and the district court overturned. The debtor then appealed to the Fifth Circuit, which upheld the district court.

According to the Fifth Circuit, cross-secured loans constitute a single obligation, which prevents a debtor from treating different collateral elements differently under Section 1325(a)(5). This provision allows debtors to adjust secured debts in one of the following ways:

1. The secured creditor agrees to the Chapter 13 plan.
2. The debtor assigns the property securing the loan to the creditor.
3. The debtor invokes the eviction provision and adjusts the debt to the present value of the personal property in question.

Citing both the U.S. Supreme Court and Fifth Circuit precedent, the court ruled that a debtor could not combine steps two and three, posting some security and keeping other items at a value. piled up, where ownership secures a single bond. The previous Fifth Circuit case to settle this issue reached this conclusion in the context of a single loan with multiple elements of security. Barragan-Flores now extends this rule to cross-secured loans.

Significantly, lenders can still allow debtors to post certain collateral and retain other items if they determine it is in their business interest. They can simply refuse to oppose a plan that is otherwise wrong and allow the plan to be confirmed. However, in situations where debtors attempt to effect a “partial cramdown” by splitting cross-collateralized loans, lenders can now oppose and force debtors to return all collateral or reduce the value and rate of interest of all elements.

[1] The Fifth Circuit hears appeals from the federal district courts of Texas, Louisiana and Mississippi. His holdings set binding precedent for federal district courts and state bankruptcy courts.