Understanding Cramdown in Bankruptcy

There are certain advantages to filing for bankruptcy under Chapter 13 of the Bankruptcy Code. One significant advantage is the ability to modify the rights of a secured creditor. This means the debtor can actually change the terms of a contract with a creditor through bankruptcy in a provision generally referred to as cramdown.

The cramdown provision reduces the amount owed to the fair market value of the collateral that secures the debt. The fair market value is determined by obtaining an appraisal or using another established method of assessing an item’s value.

Types of Debts Permitted for Cramdown

Cramdown is limited to certain types of secured debts, such as furniture or a vehicle. The cramdown provision cannot be used for a home mortgage. The asset must be personal property and, depending on the type of asset, there may be a minimum period of time that must have passed from the time the debtor took out the loan on the item before cramdown is permitted.

For example, an individual cannot cramdown a car loan for a car that was purchased within 910 days prior to filing bankruptcy, and cannot cramdown the secured debt for other types of personal property that were purchased within one year of filing bankruptcy. If the debt was incurred in less than the applicable time period, the full amount of the debt must be paid pursuant to the debtor’s Ch. 13 repayment plan.

How Cramdown Works

A car loan is a common secured debt that a debtor can cramdown in bankruptcy. For example, an individual purchases a car for $30,000 with monthly payments of $500 payable over 60 months at 0% interest. Three years later, the individual files Chapter 13 bankruptcy. So far, a total of $18,000 has been paid with $12,000 remaining on the loan balance.  However, because of depreciation, the fair market value of the car is only $7,000. The debtor owes $5000 more than the car is worth.

Under the cramdown provision, it is possible to reduce the amount owed on the car loan to the fair market value of the car, which is $7,000, and the Chapter 13 creditor must accept the reduced amount. The debtor includes the reduced debt in the repayment plan, which allows the debtor to make payments over a period of 3 to 5 years. In this way, the individual not only gets rid of $5,000 of debt, but also gets more time to repay the creditor, which necessarily lowers the individual’s car payment. Instead of paying $12,000 over 2 years at the rate of $500 per month as set forth in the original contract, the individual owes only $7,000, and the payments can be stretched out over a 5-year period. Once the repayment plan has been completed, the debtor owns the car and the creditor is deemed fully paid and can no longer seek any further payments from the debtor.

When a Co-signer Is Involved

One problem that may arise is when there is a co-signer on the debt. Using the above example, if there was a co-signer on the car loan, and the co-signer is not filing bankruptcy, the co-signer remains responsible for the total amount owed on the loan. Therefore, even though the debtor is able to get rid of $5,000 of secured debt, the co-signer is still responsible for the full amount. The creditor may be obligated to accept $7,000 from the debtor pursuant to the Chapter 13 repayment plan, but the creditor also has the right to go after the co-signer to collect the additional $5,000 owed on the original loan.

Case Studies: Understanding Cramdown in Bankruptcy

Case Study 1: The Smiths’ Car Loan Cramdown

John and Sarah Smith purchased a car for $30,000 with monthly payments of $500 payable over 60 months at 0% interest. After three years, they find themselves facing financial difficulties and decide to file for Chapter 13 bankruptcy.

At this point, they have paid a total of $18,000, but $12,000 remains on the loan balance. However, due to the depreciation of the car, its fair market value is only assessed at $7,000. This means the Smiths owe $5,000 more than the car is currently worth.

Utilizing the cramdown provision, the Smiths can reduce the amount owed on the car loan to the fair market value of $7,000. The Chapter 13 creditor must accept the reduced amount, and the Smiths include the adjusted debt in their repayment plan. This allows them to make manageable payments over a period of 3 to 5 years, providing financial relief.

By successfully cramming down the debt, the Smiths not only eliminate $5,000 of their debt but also secure additional time to repay the remaining amount, resulting in a lower monthly car payment.

Case Study 2: Co-signer Liability in Cramdown

In a different scenario, consider the case of Mike and Lisa Thompson. They also purchased a car using a loan, and Lisa’s mother, Barbara, co-signed the loan agreement. Unfortunately, due to unforeseen circumstances, Mike and Lisa encounter financial hardship and decide to file for Chapter 13 bankruptcy. Like the previous example, the fair market value of their car is assessed at $7,000 while $12,000 remains on the loan.

Through the cramdown provision, Mike and Lisa can reduce the debt to the fair market value, making it $7,000. The Chapter 13 creditor must accept this adjusted amount. However, it is important to note that even with the successful cramdown, Barbara, as the co-signer, remains fully responsible for the original loan amount of $12,000. The creditor retains the right to pursue Barbara to collect the additional $5,000 owed on the loan.

Case Study 3: Furniture Loan Cramdown

Let’s consider the situation of James and Emma Johnson, who had taken out a loan to purchase furniture for their home. The furniture loan amounted to $10,000, and they were making monthly payments of $200. However, due to financial difficulties, they decide to file for Chapter 13 bankruptcy.

Upon evaluation, the fair market value of the furniture is determined to be $6,000. Under the cramdown provision, James and Emma can reduce the debt to the fair market value of $6,000, and the Chapter 13 creditor must accept this adjusted amount. They include the adjusted debt in their repayment plan, allowing them to make affordable monthly payments over the designated period.

As a result, they successfully eliminate $4,000 of their debt and gain the opportunity to repay the remaining amount within a manageable timeframe.