Partial Surrender of Personal Property Secured by a Cross-Collateralized Loan Under § 1325(a)(5)

By Maxwell Milavetz and Sarah Laybourne

Cross-collateralized loans are attractive to creditors who can leverage equity in one piece of collateral toward security interests in other collateral. Cross-collateralization is especially attractive for vehicles that depreciate quickly and at different rates depending on various factors, such as make, model, year and mileage. It is no surprise that cross-collateralized property frequently appears in chapter 13 plans.

In a chapter 13 plan, a debtor may propose surrendering some cross-collateralized property and “cramming down” others. Whether such treatment is authorized under 11 U.S.C. § 1325(a)(5) is a matter of lengthy and ongoing debate among courts.

Some courts have held that partial surrender and partial cramdown of collateral is allowed under the Bankruptcy Code due to the “or” conjunction at the end of § 1325(a)(5)(B)(iii)(II), while other courts, including the Fifth Circuit Court of Appeals, have held that such partial treatments are inconsistent with the Code. These two dynamics may be understood as a “combination treatment” and a “mutually exclusive treatment.” This article explores the tensions in this area of law through an examination of case law on both sides of the issue.

The Setup

Prior to examining the case law, consider a hypothetical example. An individual named Ace executes a promissory note and secures the loan against several pieces of personal property: a car, motorcycle and fishing boat. At the time of the loan, the pre-interest balance was fully secured against the collateral. Unfortunately, a few years later, the property has significantly depreciated, and Ace is unable to continue making payments on the loan. He is willing to let go of the motorcycle and the fishing boat, but desperately needs his car to get to work.

Facing repossession, Ace files for chapter 13. A creditor files a proof of claim for the loan secured by the car, motorcycle and fishing boat. Ace’s chapter 13 plan proposes surrendering his motorcycle and fishing boat but keeping his car. The plan proposes paying the car’s present value over the life of the plan. The creditor objects, asserting that § 1325(a)(5) does not permit Ace to treat his car differently than his motorcycle and fishing boat in his plan. In other words, the creditor argues that if Ace wants to retain the car, he must retain all three items. Is surrendering certain assets secured by a single loan while retaining and cramming down on others permissible under the Bankruptcy Code?

Now suppose instead of one loan, Ace took out separate loans on the car, motorcycle and fishing boat at different times from the same creditor. Each loan agreement contains identical cross-collateralization clauses. Is surrendering certain cross-collateralized assets while retaining and cramming down on others permitted under the Code? In the context of § 1325(a)(5), the contours of this question are less than clear.

Section 1325(a)(5)’s Requirements

Section 1325(a)(5) provides that a debtor must demonstrate one of three treatments as to each allowed secured claim when seeking confirmation of a chapter 13 plan. First, the holder of the secured claim could accept the proposed treatment in the plan under § 1325(a)(5)(A). Second, the debtor could surrender the encumbered property under § 1325(a)(5)(C). Third, the debtor could invoke the cramdown provision under § 1325(a)(5)(B).1 In sum, if a secured creditor does not accept its treatment, the plan must propose to surrender the collateral, or retain it and comply with § 1325(a)(5)(B).

In our hypothetical, Ace’s plan treats the lender’s secured claim in a combination way: He wants to surrender his motorcycle and fishing boat under § 1325(a)(5)(C). He then wants to utilize § 506(a), authorized by § 1325(a)(5)(B), to cram down the car’s value, which has depreciated from the date of the loan.

Courts are split as to whether § 1325(a)(5) authorizes combination treatments of cross-collateralized personal property or multiple items of property secured by a single loan. Some courts permit a debtor to combine the cramdown and surrender alternatives in § 1325(a)(5)(B) and (C). Other courts read the statute to permit only a total surrender or a cramdown. The law is in flux.

Partial Surrender of Property Securing a Single Loan Is Permitted Under § 1325(a)(5)

On the combination side, In re Salter is an informative case2 in which the debtors borrowed funds to purchase various vehicles and equipment, including a tractor, an excavator and a bucket. A single loan secured the property. The debtors’ plan proposed retaining the tractor while surrendering the excavator and bucket.3

When presented with the proposed combination treatment plan, the U.S. Bankruptcy Court for the District of Kansas held that § 1325(a)(5) allows for the partial surrender of property secured by a single loan. First, the court explained that the “fundamental concepts of debtor-creditor law, under which debtors always have the ability ... to surrender unnecessary collateral,” set a precedent for allowing the partial surrender of encumbered personal property.4 Second, the court noted that “the plain language of § 1325(a)(5) is read in light of Congress’s explicit command in § 102(5) that ‘or’ be read as nonexclusive.”5 Third, the court reasoned that “§ 1325(a) ‘does not tell a debtor what he can and cannot propose,’ but rather ‘tests what has been proposed.’”6

As long as the partial surrender does not diminish the collateral’s value as an undivided whole, the court noted that partial surrender is consistent with the purpose of § 1325(a)(5), which “aims to provide full value for the secured creditor’s allowed claims.”7 The court continued that § 1325(a)(5) solves the worry of whether debtors would be incentivized to subdivide their personal property “down to the last nut and bolt,” explaining that “[r]equiring that debtors demonstrate that partial surrender does not impair the value of collateral as a unit effectively avoids this problem.”8

The Salter decision relied heavily on the reasoning of a bankruptcy decision from the U.S. Bankruptcy Court for the Middle District of Georgia.9 In In re McCommons, the court looked to the text and legislative history behind § 102(5), the statute that governs the rules of construction within the Code. Section 102(5) states that the word “or” within the Bankruptcy Code “is not exclusive.” The court observed that the “legislative history to Section 102(5) reads ... if a party ‘may do (a) or (b)’ ... then the party may do either or both. The party is not limited to a mutually exclusive choice between the two alternatives.”10

Combination Treatment of Cross-Collateralized Property Is Impermissible Under § 1325(a)(5)

The Fifth Circuit is the only court of appeals to have addressed the issue in the context of a chapter 13 case. It held that combination treatment of encumbered assets is impermissible under the Bankruptcy Code in the context of one loan secured by multiple items of collateral. In In re Williams,11 the Fifth Circuit found that the provisions of § 1325(a)(5) are mutually exclusive. In this case, the chapter 13 debtor granted a creditor a nonpurchase money security interest in various items of personal property.12 The debtor proposed a chapter 13 plan that would return some of the items to the lender and pay the present value for the remainder.

The Fifth Circuit drew upon a U.S. Supreme Court case, Associates Commercial Corp. v. Elray Rash,13 wherein the Supreme Court stated that if a creditor “does not accept a debtor’s Chapter 13 plan, the debtor has two options for handling allowed secured claims: surrender the collateral ... or, under the cram down option, keep the collateral over the creditor’s objection and provide the creditor ... with the equivalent of the present value of the collateral.”14 The Fifth Circuit interpreted the Supreme Court’s statement regarding a debtor’s “two options” as excluding the option of combination treatment for collateral secured by the same loan. Further, the Fifth Circuit engaged with the textual argument supporting the combination theory. It wrote that “[a]lthough 11 U.S.C. § 102(5) states that ‘or’ is not exclusive, it does not follow that Congress intended the word ‘or’ to create a fourth alternative.... The plain language of the statute does not give the debtor the right to adopt a combination of the options offered in (B) and (C).”15

More than 20 years later, faced with interpreting § 1325(a)(5) in the context of multiple loans cross-collateralized against multiple assets, the Fifth Circuit followed its decision in In re Williams and again held that a “[p]lan must select the same § 1325(a)(5) option for both items of collateral” notwithstanding the fact that multiple loans encumber multiple pieces of collateral.16

The debtor in In re Barragan-Flores had obtained two different loans from a credit union to purchase two vehicles.17 Both loans contained a cross-collateralization clause, which stated that “collateral securing other loans ... may also secure this loan.”18 The debtor’s chapter 13 plan proposed retaining one car and cramming down on that loan, while surrendering the other car for the satisfaction of the other loan.19 The bankruptcy court confirmed the plan over the credit union’s objection, while the district court, following In re Williams, reversed.20 Ultimately, the Fifth Circuit affirmed the district court and relied on In re Williams, noting that any other result would be “contrary to the plain language of § 1325(a)(5).”21

In the intervening two decades between In re Williams and In re Barragan-Flores, several other courts have adopted the Fifth Circuit’s reasoning. In In re Lemming,22 the U.S. Bankruptcy Court for the Northern District of Georgia agreed with the Fifth Circuit, writing that the “plain language of ‘the property securing such claim’ in Section 1325(a)(5)(C) does not expressly provide for surrender of ‘some’ or ‘part’ of the property, but instead appears to provide for ‘the entire collateral.’ This interpretation is bolstered by the fact that Section 506(a) does not provide a means to bifurcate a single oversecured claim into several smaller secured claims.”23

Next, in In re Davis,24 the U.S. Bankruptcy Court for the Southern District of Ohio cited In re Williams with approval. The bankruptcy court held that the mutually exclusive approach “avoids courts determining the minutiae of what can ... and cannot be surrendered and valuing individual pieces of collateral and subdividing such value from cross-collateralized claims.”25

Finally, in In re Covington,26 issued prior to In re Williams, the U.S. Bankruptcy Court for the Eastern District of Tennessee expressed concern that allowing the combination treatment of encumbered assets would “be tantamount to a finding that a creditor in a Chapter 13 case who has a single claim may, at the whim of the debtor, be compelled to bifurcate the secured portion of its claim into as many individual claims as it has items of property securing its claim.”27

The Second Circuit has also considered the combination treatment issue, albeit in a chapter 12 case. In In re Kerwin, the Second Circuit unequivocally endorsed the mutually exclusive interpretation of § 1225(a)(5).28 Although In re Kerwin’s application is limited due to its involving a chapter 12 plan, Kerwin may carry significant persuasive weight, given that § 1225(a)(5) is similar to § 1325(a)(5).

Uniquely important in the tension between the two approaches is the mutual reliance on the plain text of § 1325(a)(5). On the one hand, combination-endorsing courts adopt a textualist argument of reading the “or” located at the end of subsection (a)(5)(B)(iii)(II), drawing on the rule of construction set forth in § 102(5).29 On the other hand, mutually exclusive courts look to the language of “the debtor surrenders the property securing such claim” of subsection (a)(5)(C) to contend that “the property” means the entire property and not a portion or a part of the encumbered property.30

In addition, as expressed in Williams and Barragan-Flores, several courts adopting the mutually exclusive approach drew on the Supreme Court’s reasoning in Associates Commercial Corp. v. Elray Rash. However, Rash arguably only referenced § 1325(a)(5) as dicta, and the court’s language of “the debtor has two options for handling allowed secured claims” does not seem to truly endorse the mutually exclusive theory.31

Conclusion: Play Your Cards Right

For a chapter 13 debtor with cross-collateralized loans on multiple vehicles or a single loan secured by multiple items of collateral, what options are available under § 1325(a)(5)? The split in authority on this issue gives debtors in jurisdictions outside the Fifth Circuit the option to propose combination plans. Debtors can cite the Salter line of cases for support that a combination surrender and cramdown is permissible.

This issue could be an excellent candidate for appeals to other circuits, or even a petition for a writ of certiorari. However, given that much of the collateral subject to these combination plans consists of quickly depreciating assets (e.g., cars, boats, appliances and other pieces of personal property), the cost of an appeal will likely prove prohibitive in most consumer cases. Parties interested in appealing this issue should closely monitor the case law as it develops to determine whether they have a royal flush or a bad hand.

Maxwell Milavetz is a term law clerk, and Sarah Laybourne is career law clerk, with the U.S. Bankruptcy Court for the District of Utah in Salt Lake City.