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.