Cite as: Keith M. Lundin, Lundin On Chapter 13, § 78.7, at ¶ ____, LundinOnChapter13.com (last visited __________).
Once upon a time, figuring out whether a claim was secured in a Chapter 13 case was simple: did the creditor comply with the state Uniform Commercial Code, chattel mortgage or real estate mortgage law? In any credit transaction, it was generally true that there was only one protocol or set of conditions that would entitle the lender to a secured claim in the event of bankruptcy. Secured creditor heaven was reserved for those who filled out U.C.C. statements carefully and recorded in the right county.
Then the credit inventors discovered that rental contracts were a slick way around many of the perfection and interest rate problems with ordinary secured transactions. The rent-to-rent industry was born, and overnight it gobbled up a multibillion-dollar chunk of the consumer credit market. The rent-to-renters skate deftly around the rules for the treatment of secured claims in bankruptcy cases.1 The underlying credit transaction is not materially different from the chattel mortgage of old; only the cost to the consumer changed.
But perpetual rental care is not useful if what the consumer wants is cash. The mirror image of financing a purchase in the old days was the pawnbroker—the lender of last resort who would hold your $100 watch as a hedge against repayment of a $25 loan. Sure looks like a secured transaction of some sort. We learned to call it a pledge or a bailment in law school. Possession was perfection against the world. Should be easy to manage a pawn as a secured claim in a Chapter 13 case.
Well, our parents wouldn’t recognize the pawnbroker in its modern incarnations. Some of the same folks who brought us rent-to-rent slipped back into the state legislatures and convinced many to redefine pawn transactions as something other than loans. State pawnbroker statutes now have provisions (copied from the rent-to-rent laws) declaring that a pawn contract is not a security agreement, that the Uniform Commercial Code does not apply and that usury laws are not engaged. Under the typical new era pawn statute, for the advance of a very small sum, the pawnbroker acquires ownership of the debtor’s property of any value, subject to the debtor’s right to “redeem” the property within the contractual redemption period. Increasingly, the debtor does not even deliver possession of the pawned property to the pawnbroker.
Pawn transactions fit the Bankruptcy Code definitions of debt with security agreements. The Bankruptcy Code defines “security agreement” as an “agreement that creates or provides for a security interest.”2 “Security interest” means “lien created by an agreement.”3 “Lien” is further defined as “charge against or interest in property to secure payment of a debt or performance of an obligation.”4 “Debt” means “liability on a claim;”5 and “claim” means “right to payment, whether or not such right is . . . contingent, matured, unmatured, . . . equitable, secured, . . . unsecured; or . . . right to an equitable remedy for breach of performance.”6 Although pawnbrokers try to avoid language that sounds like a loan and a security interest, it is the essence of a pawn transaction that the pawnbroker gives the debtor the use of money in exchange for a “charge against or interest in property” that secures or protects the pawnbroker from nonpayment. The Bankruptcy Code definitions of security agreement and lien neatly fit most pawn transactions.
In a Chapter 13 case, if the pawn transaction is properly characterized, the pawnbroker has a secured claim, and § 1322(b)(2) permits the debtor to modify the pawn contract and manage the claim through the plan like any other secured claim.7 If a pawn transaction is an executory contract, the debtor can assume, assign or reject that contract consistent with §§ 365 and 1322(b)(7).8
Applying Colorado law, the bankruptcy court in In re Lopez9 held that a pawn transaction was “a secured transaction, and therefore, the [pawnbroker] is a secured creditor who can be dealt with in the debtor’s amended plan under 11 U.S.C. § 1322(b)(2).”10 In Lopez, the pawn contract described the transaction as a “pledge” and permitted the debtor to “redeem” her property within 90 days. The Chapter 13 case was filed before expiration of the 90-day period. As explained by the court:
The use of the terms “pledge” and “redeem” certainly indicate that the transaction is one of a loan and security agreement in accord with historical notions. Also, the Contract for Purchase provides that the Debtor can “receive my property by paying the charges set forth”. . . . This would indicate that the Debtor did not relinquish title to the property, but rather intended that the property be used only as security.11
In contrast, in Dunlap v. Cash America Pawn (In re Dunlap),12 the district court held that a Chapter 13 debtor could not use § 1322(b) to manage the claims of a pawnbroker. In Dunlap, the debtor had pawned several items of personal property pursuant to different pawn contracts. At the filing of the Chapter 13 case, the “right of redemption” had expired for some of the contracts but not others. The district court held that even when the Chapter 13 case was filed before expiration of the redemption period, the debtor’s only right was to redeem the property consistent with the contract.13 The court did not explain why § 1322(b)(2) was neutralized by the pawn contract.
The Bankruptcy Code definitions of security agreement and lien are matters of federal law. That a pawn is characterized as something other than a loan and security agreement for state law purposes is not controlling of its characterization in a Chapter 13 case. The courts should carefully scrutinize pawn transactions in Chapter 13 cases. In most pawn situations, the debtor will have pledged personal property worth a great deal more than the amount owed to the pawnbroker. Repayment of that debt and recovery of that personal property may be important features of the Chapter 13 debtor’s fresh start. Section 1322(b)(2) is broad authority for Chapter 13 debtors to modify the rights of pawnbrokers through a confirmed plan.
Modifying the pawn contract and treating the pawn as a security device are not the only possible avenues of attack for Chapter 13 debtors. Always take a good look at the pawn contract and at state law to see whether the pawnbroker followed the rules. For example, in In re Johnson,14 a title pawnbroker repossessed the debtor’s car before the petition. On close examination, the bankruptcy court found that the pawnbroker did not comply with Georgia law with respect to the term of the contract or the grace period for redemption. This was enough to deny the pawnbroker an easy victory with respect to the debtor’s car.
Even more intriguing, in Bell v. Instant Car Title Loans (In re Bell),15 the debtor borrowed $4,000 from a pawnbroker and gave a security interest in a car worth between $10,000 and $12,000. The pawnbroker took possession of the certificate of title and noted the lien. When the 30-day grace period for redemption expired and the debtor did not repay $4,000 plus an $800 interest charge (243.33 percent annual percentage interest rate), the pawnbroker repossessed the car. The debtor filed Chapter 13 and an adversary proceeding for turnover.
The pawnbroker defended that the car was forfeited when the debtor failed to timely redeem. Taking the pawnbroker at its word, the debtor responded that this forfeiture within one year of the Chapter 13 petition was a fraudulent conveyance under § 548 of the Bankruptcy Code. The bankruptcy court enjoined the pawnbroker from disposing of the car pending trial of the fraudulent conveyance:
Arguably, all of the elements for success on the § 548 claim are present here. . . . [A]n involuntary transfer . . . took place within one year before the filing of the Chapter 13 petition. . . . A vehicle worth $10,000 is not reasonably equivalent in value to an obligation of $5,300. . . . Debtor’s schedules . . . could demonstrate that she was, and is, insolvent. . . . If such findings were made, it would follow that the transfer of the vehicle to Pawnbroker is avoidable as a fraudulent transfer under § 548(a)(1)(B), that the vehicle is recoverable from Pawnbroker under § 550, and that the vehicle is property of the estate under § 541(a)(3). Pawnbroker would be obligated to turn possession of it over pursuant to 11 U.S.C. § 542(a). . . . More definite proof of insolvency and value is necessary. . . . Pawnbroker is hereby enjoined from transferring or disposing of the vehicle.16
Bell is food for thought for any Chapter 13 debtor who has lost pawned property within a year of the petition.
1 See § 175.1 [ Fake Leases and Rental Agreements ] § 102.8 Fake Leases and Rental Agreements.
2 11 U.S.C. § 101(50).
3 11 U.S.C. § 101(51).
4 11 U.S.C. § 101(37).
5 11 U.S.C. § 101(12).
6 11 U.S.C. § 101(5).
7 This, of course, assumes that the pawnbroker is not secured only by a security interest in real property that is the debtor’s principal residence. If so, the debtor’s power to modify the pawn contract under § 1322(b)(2) is limited as discussed in § 118.1 [ Most Home Mortgages Cannot Be Modified: § 1322(b)(2) and Nobelman ] § 79.1 Most Home Mortgages Cannot Be Modified: § 1322(b)(2) and Nobelman.
8 See discussion beginning at § 102.1 Debtor Can Assume, Assign or Reject Executory Contracts.
9 163 B.R. 189 (Bankr. D. Colo. 1994).
10 163 B.R. at 191. Accord In re Davis, 269 B.R. 914, 918 (Bankr. M.D. Ala. 2001) (“A pawn broker who holds a motor vehicle certificate of title and a set of keys does not have a perfected security interest on the motor vehicle unless its lien is recorded on the vehicle’s certificate of title. . . . [T]he lien of the pawn broker is not perfected and subject to being avoided. For this reason, the Trustee’s objection to the pawn broker’s claim is sustained and the claim is allowed as unsecured.”); In re Burnsed, 224 B.R. 496, 497, 499 (Bankr. M.D. Fla. 1998) (Motor Vehicle Title Loan Contract by which debtors pledged the title to their car in exchange for a loan was in the nature of a security interest that could be modified under § 1322(b)(2). Florida statute permits security interests “in the bailment of the certificates of title to the motor vehicles.” Debtors pledged title to their 1995 Dodge Ram in exchange for a $4,770 loan. Debtors agreed to repay this loan in 30 days plus a “fee” of 18% per month for a total of $5,628.60. Debtors rolled this loan from month to month and filed Chapter 13 while they were not in default and still in possession of the car. Plan treated the title holder as a secured claim holder to be paid $5,628.60. Title holder moved for relief from the stay claiming that the only interest that came into the Chapter 13 estate was the debtors’ right to “redeem” the car title by paying the full amount of the loan in a lump sum. Because contract recited that the “lender will have a security interest” and Florida law described a title loan as “a loan of money secured by bailment of a certificate of title to a motor vehicle,” parties intended to create a security interest that could be modified under § 1322(b)(2).). See also In re Young, 281 B.R. 74, 77–81 (Bankr. S.D. Ala. 2001) (Failure to object to confirmation binds pawnbroker to plan that treated the pawn transaction as a secured claim, and pawnbroker is not entitled to postconfirmation relief from the stay. “At the time the Debtors filed Chapter 13 . . . the Debtors were within the redemption period set forth in the pawn ticket contract. Therefore, at the time they filed Chapter 13, the Debtors still held a right of redemption in the musical equipment, making it property of the estate under the Bankruptcy Code protected by the automatic stay. . . . Since the redemption period had not expired prior to bankruptcy, § 108(b) of the Code extended the redemption period sixty days after the date the petition was filed . . . . The Debtors’ plan was confirmed prior to the expiration of the extended redemption period given by § 108(b) without any objection from Cash America. . . . Cash America chose not to object to the Debtors’ plan . . . . [H]aving slept on their rights, Cash America cannot now complain about the treatment of its secured claim. . . . [I]ts contract with the Debtor has been modified by the order of confirmation.”).
11 163 B.R. at 191.
12 158 B.R. 724 (M.D. Tenn. 1993).
13 See also In re Walker, 204 B.R. 812, 816 (Bankr. M.D. Fla. 1997) (Because debtor defaulted before the Chapter 13 petition and title holder repossessed truck pursuant to a “Contract of Title Pledge,” the debtor’s property interest in the truck was terminated and the title holder did not violate the automatic stay by selling the truck to a related entity. Debtor pledged 1979 Kenworth tractor trailer to National Title Loan, Inc., pursuant to a “Contract of Title Pledge” in exchange for a loan of $2,028.25. Debtor remained in possession of the truck and was required to repay the loan with a “redemption premium” of 22% of the loan amount per month within 30 days. Debtor defaulted, and in between two Chapter 13 filings, National Title Loan, Inc. repossessed the truck and sold the truck to a related entity. “Debtor signed his Contract of Title Pledge with National Title Loan, Inc. on February 27, 1996. Thus, but for the Debtor’s first bankruptcy filing on March 14, 1996, the redemption period would have expired on April 27, 1997. . . . Debtor failed to redeem the truck prior to the expiration of the redemption period, and the Court finds that his interest in the property was terminated by law on May 14, 1996. National Title Loan, Inc. repossessed the truck on August 16, 1996. The repossession occurred after the expiration of the redemption period, but prior to the debtor’s current bankruptcy filing. Thus, on the date of the repossession, the truck was not property of a bankruptcy estate and was not protected by the automatic stay.”).
14 289 B.R. 251 (Bankr. M.D. Ga. 2002).
15 279 B.R. 890 (Bankr. N.D. Ga. 2002).
16 279 B.R. at 898–99.