Filing ‘13’ Immediately After Renewing a Title Loan Might Be Bad Faith

Reversing the bankruptcy court, a district judge in Montgomery, Ala., wrote an opinion that could be read to mean that someone may not renew a title loan and immediately file a chapter 13 petition to reduce the interest rate and pay off the loan over several years.

The appeal involved two chapter 13 debtors. One first obtained a monthly title loan on her car and had renewed the loan four times. The lender had repossessed the car for nonpayment. The annual interest rate was almost 134%.

The first debtor consulted with an attorney and paid the fee to renew the loan and regain possession of the car. She filed a chapter 13 petition the next day. The plan called for paying off the loan over 58 months at an annual interest rate of 3.25%.

The second debtor had a monthly title loan at an annual interest rate of almost 207%. He filed a chapter 13 petition two days after renewing the loan the first time. His plan proposed to pay off the loan over 48 months at an annual interest rate of 5.25%.

Both debtors testified that they had decided to file chapter 13 petitions before they renewed their loans. Both loan agreements contained the same representations:

[The Borrower] represents, warrants, acknowledges and agrees . . . [that the borrower is] not a debtor in bankruptcy. [The borrower does] not intend to file a federal bankruptcy petition.

Objecting to confirmation, the lender contended that the plans were not filed in good faith and violated Section 1325(a)(3) because the debtors misrepresented their intentions about bankruptcy. The lender said it would not have renewed the loans had it known that bankruptcies were in the offing.

The bankruptcy court overruled the objections, ruling that representations about bankruptcy were unenforceable in violation of public policy. The bankruptcy court confirmed the plans, but the lender appealed.

District Judge R. Austin Huffaker, Jr., reversed and remanded with instructions for the bankruptcy judge to reconsider whether the debtors filed the plans in good faith.

The Representations Weren’t Void

Judge Huffaker first considered whether the “no bankruptcy representations” were in violation of public policy and could not be considered in evaluating the debtors’ good faith.

The bankruptcy judge “misconstrued the operative language,” Judge Huffaker said. The representations were “not a prepetition waiver of any rights in bankruptcy.” (Emphasis in original.) In addition, he said that the bankruptcy court did not consider the legitimate reasons for the representations.

The representations did not require the borrowers to abjure bankruptcy permanently, Judge Huffaker said. The representation, he said,

does not prohibit a debtor from later forming the intent to file for bankruptcy after signing the pawn agreement; it only requires the debtor have no such intent at the time of execution.

“But here,” Judge Huffaker said, “there was no intervening change because the debtors testified that they had the intent to file for bankruptcy protection when they entered into their pawn agreements.”

Judge Huffaker said that the bankruptcy judge erred by failing to consider the representations in the good faith analysis under Section 1325(a)(3).

The Kitchens Factors

In In re Kitchens, 702 F.2d 885 (11th Cir. 1983) (per curiam), the appeals court laid out 11 factors to consider in deciding whether a debtor acted in good faith. The lender contended that the bankruptcy court failed to consider the tenth factor:

the circumstances under which the debtor has contracted his debts and his demonstrated bona fides, or lack of same, in dealings with his creditors.

Rather than evaluate the debtor’s conduct, Judge Kitchens said that the bankruptcy court excoriated the lender for its “predatory loans” and “astronomical interest rates.” But “none of these considerations are appropriate for determining the debtors’ bona fides,” he said. (Emphasis in original.) The loans were not usurious under Alabama law.

Judge Huffaker said that the bankruptcy court should have considered the debtors’ “clearly relevant” and “admitted intent” to file bankruptcy “almost immediately after executing the pawn agreements.” He therefore remanded for the bankruptcy court to reconsider the tenth Kitchens factor.

Although vacating the confirmation orders and remanding for “further proceedings consistent with this decision,” Judge Huffaker “expresse[d] no view as to what impact, if any, such reconsideration might have on the ultimate issue of whether the debtors proposed their plans in good faith.”

Observations

At minimum, the opinion by Judge Huffaker questions every chapter 13 debtor’s good faith after renewing a title loan. At the extreme, the opinion could preclude confirmation of a chapter 13 debtor by any debtor with a title loan.

In the two cases on appeal, the debtors filed chapter 13 petitions two or fewer days after renewing month-to-month title loans. How many days must elapse after renewing a title loan before the debtor is unquestionably acting in good faith? Will cases with renewals of title loans inevitably end up in a trial on the debtor’s good faith?

Because title loans are so short-term, many if not most debtors may have resolved to file chapter 13 petitions before renewing loans. Truthful testimony could mean failure of the attempt to save the car in chapter 13.

It would be a different case had the debtors taken down title loans for the first time, spent the proceeds and promptly filed in chapter 13 to stretch out the payout and lower the interest rate. Such situations are covered by Section 523(a). That section might inform the court in considering good faith on remand.

Courts facing the issue should consider the peculiar nature of title loans. They are very short-term loans and are often if not typically renewed. The court might consider the amount of the loan compared to the value of the car, the number of times the loan was renewed, the debtor’s need for the car and the debtor’s use of the proceeds of the loan.

Why would it be worse for a debtor to renew a title loan and pay the interest and fees just before bankruptcy as opposed to defaulting and then filing in chapter 13?

In the cases on appeal, the debtors’ actions were not identical. One debtor renewed the loan to regain possession of the car, a fact weighing against a finding of good faith. However, the debtor could have filed in chapter 13 first and then used the bankruptcy court to regain possession, but filing first would have entailed larger attorneys’ fees, adequate protection payments and delay in obtaining possession of the car.

In good faith findings, courts should consider how title loans are legitimately treated in chapter 13. Lenders cannot automatically repossess cars with defaulted loans. Even if repossessed before bankruptcy, debtors generally can regain possession of their cars if they have not been sold by the lender. Plans can lower interest rates and stretch out maturity.

Can it be bad faith to utilize remedies that the Bankruptcy Code affords to chapter 13 debtors?

Chapter 13 was designed to help debtors save their homes and cars. Courts should consider the lender’s circumstances and the relief afforded by chapter 13, else title loans become a bar to filing successfully in chapter 13.