Upside Down Car Loans in Missouri Redux

A Missouri judge has disagreed with a Kansas colleague about how Missouri law applies to certain car loans with trade-ins. This is a blow for consumers and unsecured creditors and a win for car lenders. It will cause Chapter 13 plans to pay more to car lenders at the expense of unsecured creditors, while potentially making it harder for consumers to reorganize successfully.

As I discussed in September, Kansas Judge Berger had concluded that Missouri would apply the “transformation” rule to car loans that refinanced trade-in debt into the loan for a new car, resulting in “negative” (upside down) equity in the replacement car. Berger relied on two earlier opinions from both Missouri federal districts in reaching his decision. But Missouri Judge Federman disagreed this month.

The Uniform Commercial Code is usually relied upon to determine whether or not a loan is “purchase money” and therefore entitled to special protection under the 910-day car rule. If it is, then the car lender will largely be paid the full amount of the contract instead of just the underlying value of the car. This can be thousands of dollars of difference, especially if the consumer traded-in a highly-depreciated car with a lot of debt on it.

Judge Federman concluded in the In re Weiser case that Missouri’s UCC would allow the inclusion of negative equity in the “purchase price” of the car, although in fact it was only used to payoff the traded-in car’s debt.

Weiser is partly based on the idea that the trade-in payoff has a “close nexus” with the actual cost of acquiring the new car, like paying sales tax and licensing charges. Indeed, Weiser relies on the debtor’s financial burden to hang her.

Weiser’s reasoning is terribly flawed. Without comment, Weiser assumes that the subjective financial capabilities of the parties will dictate whether PMSI status attaches or not. This is hardly dictated by the UCC or Comments.

Weiser confuses a debtor’s ability to pay particular obligations with what obligations may be required in order to close a deal. It states categorically that “…the Debtor testified she could not have purchased the [new car] unless …” the trade-in refinancing was allowed. In a footnote, the judge specifies that the debtor testified she could not afford to make two simultaneous car payments and therefore needed to do the trade-in to manage her finances.

Perhaps inadvertently, Weiser says that whether PMSI status is accorded to a transaction depends on whether the consumer could afford to simply keep and maintain payments on the old car or was financially-constrained enough to have to trade-in that car. The confusion of a consumer’s “ability to pay” with whether trade-in refinancing is required in order to obtain ownership of a new vehicle undermines the objective standards sought under the UCC.

Weiser, and other cases that apply such an “ability to pay” substitute for the objective UCC standards, reflect more the outlook of bankruptcy judges in consumer cases. We spend a lot of time trying to divine the reasons behind past financial decisions in bankruptcy court. But if such subjective intentions dictated the result, then the UCC drafters and judges could have saved a lot of time and ink searching for objective criteria to apply.

The debtor may not need or want two car loans and a lender may be disinclined to make a loan to a strapped consumer if other loans are pressing. These are certainly reasonable. But these financing decisions — whether to lend or whether to borrow — are not in themselves closely linked to the actual costs of obtaining title to a car, like sales tax and licensing fees might be. By conflating these concepts, the courts are coming close to saying that the rules are different for higher-income consumers (who could afford to have multiple car loans) — or spendthrifts (who just want multiple car loans and find equally foolish lenders) –  than their lower-income brethren.