Car Loan Before Bankruptcy

Getting a car loan before bankruptcy is permissible under certain circumstances, but can pose a couple of potential problems.  The United States Trustee’s office frowns upon incurring new debt before you file your case and has even issued guidelines admonishing attorneys from advising clients to engage in incurring such new debts.  At the same time, the United States Supreme Court has set forth precedence to the effect that if your car or truck is in poor mechanical condition before bankruptcy and you need another one, it is permissible to obtain another car or truck before bankruptcy, even if it means incurring new debt by taking out a vehicle loan.  The Supreme Court has further stated that a lawyer permitted to advise you to obtain a car loan before you file, if you need a more reliable car, and, moreover, under appropriate circumstances it would actually be very wise of your lawyer to give you such advice because it will help you get a fresh start after bankruptcy,

Potential Problems With Getting a Car Loan Before Bankruptcy

There are two common problems that can arise when you buy a car and take out a car loan shortly before bankruptcy.  The first problem relates to the vehicle loan agreement.  Most vehicle loan agreements have provisions that give the dealer some wiggle room to get out of the car or truck loan and surrender of the vehicle if you file too soon after you take out the car loan.  The second problem relates to perfection.  If your car loan lender fails to timely perfect its lien, the trustee will be able to set aside the lien for the benefit of your creditors.  Here are the potential problems to look out for when you buy a car before bankruptcy in San Diego.

Vehicle Loan Agreement

In California, when you buy a car or truck, in most cases you buy from a retail dealer.  The retail dealer gives you a car or truck in exchange for a contract, a piece of paper, that you sign agreeing to make certain payments to the dealer over a period of months or years.  The dealer then attempts to sell that piece of paper (and the right to a stream of payments) to a finance company.  The dealer has usually pre-approved you for the loan and fully expects that the finance company will buy the contract. But if you file bankruptcy immediately after driving your car off the lot, the finance company may get wind of your bankruptcy filing and refuse to buy the contract from the dealer.  To protect itself, a retail dealer typically will have a provision in its contract specifying a period of time, usually 10 days, during which it can cancel the contract if the dealer is unable to sell the contract to a finance company.  If the contract is cancelled, you’ll have to return the vehicle to the dealer.  Therefore, before filing your case, it is imperative to have your San Diego bankruptcy attorney read the vehicle loan contract to make sure you are filing your case after the dealer’s right of cancellation has passed.

Failure to Timely Perfect Lien

When a dealer sells you a car or truck, the dealer, or its assignee (typically a finance company), must timely perfect its lien against the vehicle by filing appropriate paperwork with the Department of Motor Vehicles (DMV) and paying appropriate fees to the DMV.  If the dealer or lender fails to timely perfect its lien, and your case is filed within the 90-day preference period (within 90 days of the date you purchased the vehicle and gave the dealer a lien in the vehicle), then the San Diego bankruptcy trustee can and will set aside the lien as an avoidable preference.   The result is that the dealer and finance company will lose their lien against the vehicle and be left with an unsecured claim in your bankruptcy, meaning they will be treated like credit card lenders in your bankruptcy.  The trustee will then either sell the vehicle and pay the proceeds of the sale to your creditors, or, more commonly, sell it to you for auction value.

Buy Your Car Back For Auction Value

If the dealer or lender fails to timely perfect its lien and the loan transaction occurred during the 90-day preference period, the San Diego bankruptcy trustee will usually offer to sell you the vehicle for its auction value, which would be the same amount that trustee would expect to sell it for.  You can obtain a loan to buy the vehicle, or pay for it with cash.  In many cases, this may end up being a very good deal for you because you end up purchasing your car for the auction value.  But if you don’t have the ability to obtain a loan or the funds to buy the vehicle for auction value, you may end up losing the car or truck.

New Value Defense Not Available

The dealer and lender cannot argue the contemporaneous exchange for new value defense (that is, that the lien was a contemporaneous exchange for new value, namely the vehicle), because by the very fact that the lien was not timely perfected, it necessarily follows that too much time passed between the car loan transaction and the lien perfection for the lien perfection to be a contemporaneous exchange.

You Cannot Claim an Exemption in the Vehicle

Now you may ask, “why can’t I just claim an exemption in the vehicle?” You cannot claim that the car or truck that is the subject of the lien avoidance is exempt under your bankruptcy exemptions.  You have to buy it back from the trustee for the current value of the vehicle. This is because under San Diego bankruptcy law and the provisions governing the automatic preservation of avoided transfers, when the trustee avoids a lien, the lien is preserved for the benefit of the estate and creditors.  This essentially means that the trustee steps into the shoes of the dealer or lender and has the dealer or lender’s lien position (which would be in front of your claim of exemption), and then the trustee can sell the vehicle for the benefit of your creditors.

What If the Trustee Does Not Avoid the Lien

If the trustee does not exercise the right to avoid the lien as a preference, then your San Diego bankruptcy attorney can move to avoid the lien as a preference, and in such case the lien is not preserved for the estate and trustee but is preserved for your benefit.  This means that you can keep the car or truck without paying anyone.  As a practical matter, this will never happen.  If there is any possibility of setting aside the lien, the San Diego bankruptcy trustee will exercise that right and do it for the benefit of your creditors.

Not Wage Garnishment or Bank Levy

The rule prohibiting you from claiming an exemption with respect to a vehicle that is the subject of the lien avoidance does not apply to the lien created by wage garnishments or bank levies, which are involuntary judicial liens.  With a bank levy or wage garnishment, if the lien created thereby is avoided, it is preserved for your benefit and not the benefit of the estate.  This means that your bankruptcy lawyer can help you get the money back.  But you would have to file bankruptcy while the funds are still being held in the hands of the sheriff.  Once the funds are sent by the sheriff to your creditor, you no longer have any ownership interest in the funds, and so there is no property belonging to you that you might otherwise be able to claim an exemption in.