Evolve Federal Credit Union v. Barragan-Flores

Loan Cross-Collateralization FCU v. Barragan-Flores

Written by Taher Kameli & Chathan Vemuri

The practice of cross-collateralization involves using an asset as collateral for another loan in addition to an earlier loan.[1] In the event that a debtor cannot make repayments on either loan on time, lenders can force the liquidation of the asset and use the proceeds to repay the debt on the loan.[2] This practice is used in “various forms of financing, from mortgages to credit cards.”[3] Should the debtor be unable to make timely payments on either of the loans, the debtor can establish a bankruptcy plan under §1325(a)(5) of the Bankruptcy Code and adjust the secured debt.[4] Under, §1325(a)(5) of the Bankruptcy Code, there are three available options for adjusting secured debts: 1.) the holder of the claim, the creditor, accepts the plan; 2.) “the debtor surrenders the property securing the loan to the creditor; or 3.) the debtor invokes the cramdown provision and adjusts the debt to the present value of the personal property at issue.”[5] But what if some debtors only surrender some collateral while keeping other items with an adjusted balance on the loan and interest rate? Is this permissible over the objection of the creditor(s)?

 

The U.S. Court of Appeals for the Fifth Circuit has held that it is not so in its recent ruling on the topic.[6] In the case Evolve Federal Credit Union v. Barragan-Flores, the Fifth Circuit ruled that under §1325(a)(5) of the Bankruptcy Code, debtors could select different options for each allowed secured claim for the purpose of paying off loans.[7] However, that did not mean that §1325(a)(5) allowed a debtor to “select different options for different collateral securing the same claim.”[8] According to the Court, the use of the word “or” in the statute concerning the options “makes it clear that debtors may only choose one of those three options for each claim,” and to choose different options for different collateral securing the same claim would violate §1325(a)(5).[9]

 

In Barragan-Flores, the defendant debtor filed a Chapter 13 bankruptcy petition after having entered into two loan agreements with the plaintiff credit union to fund the purchase of two vehicles.[1] Both vehicles were in his possession at the time he filed for bankruptcy.[2] Both of the loan agreements had a cross-collateralization provision that said: “Collateral securing other loans with the Credit Union may also secure this loan.”[3] As such, both vehicles cross-collateralized each loan agreement.[4] But since the defendant could no longer afford to keep both of the vehicles,  he set up his Chapter 13 Bankruptcy plan so that he would retain one car, “cram down” its loan, and surrender the other vehicle to the plaintiff as collateral for the other vehicle’s loan.[5] But the plaintiff objected to this partial surrender of collateral as being barred by the cross-collateralization provisions for both of the loan agreements.[6] The dispute was taken to the bankruptcy court which confirmed the plan.[7] The plaintiff appealed the decision to the District Court, who reversed the bankruptcy court’s order confirming the plan, which the defendant in turn appealed to the Fifth Circuit.[8]

 

As noted above, the Fifth Circuit upheld the district court ruling and held that the defendant could partially surrender collateral that way.[9] The Fifth Circuit looked to an earlier Fifth Circuit case, Williams v. Tower Loan of Mississippi (In re Williams), to make its ruling.[10] In that case, the Fifth Circuit held that §1325(a)(5) did not give a debtor the right to adopt a combination of the offered options, as per its own language.[11] The Fifth Circuit also noted that in the Williams case, it cited both Second Circuit and Supreme Court precedent, which both argued that a debtor could not combine options under §1325(a)(5), and, in the case of the Second Circuit precedent, that surrender of the property under option C of the Act meant all of the collateral, not just part of it.[12] In this case, the Fifth Circuit noted that the District Court rejected the distinction between the Williams case and this case, as it focused on the number of claims at issue, rather than “the treatment of the collateral securing the claim at issue.”[13] The defendant’s error in this case was that he thought he could surrender only one his lines of collateral, that is, one of his vehicles, and keep the other vehicle.[14] By doing that, the defendant was effectively choosing different options under §1324(a)(5) for different collateral, which was expressly prohibited by the earlier Fifth Circuit precedent.[15] Effectively, the Fifth Circuit took the Williams holding that debtors must select the same §1325(a)(5) option for all lines of collateral securing one loan, not several, and extended it to apply to cross-collateralization of loans.[1]

 

This ruling is significant as it limits the ability of debtors to keep and cram down value of some collateral while only surrendering some collateral under §1325(a)(5).[2] Yet it does not serve as an absolute bar on debtors surrendering only some collateral while keeping other collateral.[3] Creditors can permit this at their discretion if they feel it would be in their best business interest to do so.[4] But debtors cannot split off cross-collateralized loans, surrendering some to pay off loans and keeping others to adjust their value over the objections of creditors.[5]

 

Please fill out the form below or give us a call at +1 (312)-233-1000 if you have any questions on the recent Fifth Circuit ruling in Barragan-Flores, and how it might affect your loan-supported collateral in this Circuit.

 

[1] Id. at 9-10.

[2] Hammons, Chad J., Fifth Circuit Limits Chapter 13 Cramdown Rights, Nat’l Law Rev. (Jan. 28, 2021) available at https://www.natlawreview.com/article/fifth-circuit-limits-chapter-13-cramdown-rights (citing 11 U.S.C. §1325(a)(5)).

[3] Id.

[4] Id.

[5] Id.

[1] Id. at 2.

[2] Id.

[3] Id.

[4] Id.

[5] Id.

[6] Id. at 2-3.

[7] Id. at 3.

[8] Id.

[9] Id. at 6-7.

[10] Id. at 7.

[11] Id.

[12] Id. at 7-8.

[13] Id. at 9.

[14] Id. at 9

[15] Id.

 

[1] Chen, James, Cross-Collateralization, Investopedia (Upd. Mar. 13, 2020) available at https://www.investopedia.com/terms/c/cross-collateralization.asp

[2] Id.

[3] Id.

[4] Evolve Fed. Credit Union v. Barragan-Flores (In re Barragan-Flores), 2021 U.S. App. LEXIS 1097, 3–4 (5th Cir. 2021).

[5] Hammons, Chad J., Fifth Circuit Limits Chapter 13 Cramdown Rights, Nat’l Law Rev. (Jan. 28, 2021) available at https://www.natlawreview.com/article/fifth-circuit-limits-chapter-13-cramdown-rights (citing 11 U.S.C. §1325(a)(5)).

[6] Id.

[7] Evolve Fed. Credit Union v. Barragan-Flores (In re Barragan-Flores), 2021 U.S. App. LEXIS 1097, 6 (5th Cir. 2021).

[8] Id.

[9] Id.