The Fifth Circuit Court of Appeals^[1] recently issued a favorable decision for lenders regarding how consumer loans are treated in Chapter 13 bankruptcies. Specifically, the decision alters how borrowers can avail themselves of Chapter 13’s “cramdown” provisions, which allow debtors to adjust debts on personal property by paying the value of an item at an adjusted interest rate, rather than the loan balance at the contract rate.

In Evolve Federal Credit Union v. Barragan-Flores (5^th Cir., No. 18-50420), the court addressed a Chapter 13 plan filed by the debtor, who had two vehicle loans with the credit union. Each loan contained a standard “cross-collateralization” clause, making each vehicle collateral for the other loan. The debtor’s Chapter 13 plan proposed to surrender one vehicle, and to retain the other with an adjusted balance and interest rate, in accordance with 11 USC § 1325(a)(5).

Consistent with routine practice, the bankruptcy court approved the plan, over the credit union’s objection. The credit union appealed, and the district court reversed. The debtor then appealed to the Fifth Circuit, which affirmed the district court.

According to the Fifth Circuit, the cross-collateralized loans constitute a single obligation, which bars a debtor from treating different items of collateral differently under § 1325(a)(5). That provision allows debtors to adjust secured debts in one of the following ways:

1. The secured creditor accepts the Chapter 13 plan.
2. The debtor surrenders the property securing the loan to the creditor.
3. The debtor invokes the cramdown provision and adjusts the debt to the present value of the personal property at issue.

Citing both US Supreme Court and prior Fifth Circuit precedent, the court held that a debtor cannot combine steps two and three, by surrendering some collateral and keeping other items at a crammed-down value, where the property secures a single obligation. The prior Fifth Circuit case to address this issue had reached this conclusion in the context of a single loan with multiple items of collateral. Barragan-Flores now extends this rule to cross-collateralized loans.

Significantly, lenders can still allow debtors to surrender some collateral and keep other items if they determine that doing so is in their business interest. They can simply decline to object to a plan that is otherwise objectionable, and allow the plan to be confirmed. However, in situations where debtors try to effectuate a “partial cramdown” by splitting off cross-collateralized loans, lenders can now object and force debtors to either surrender all collateral or cram down the value and interest rate on all items.