In the case of In re Johnson the United States Bankruptcy Court, Eastern District of Virginia, at Richmond, ruled that a Chapter 7 debtor's claim of homestead and poor debtor's exemptions in her automobile should be denied because the debtor had not paid the purchase price of the car, and thus the car was subject to a debt to the credit union that made the loan for the purchase price. Had the car been non-purchase money security interest, the result would have been different.
In determining the facts the Court found that the debtor purchased the car using credit union loan proceeds, that the debtor intended to grant a security interest in the vehicle to the credit union, and that the credit union's lien was not recorded on the vehicle's certificate of title.
The debtor claimed a $5,500 homestead exemption under Virginia Code §34-4, and a $2,000 poor debtor's exemption under Virginia Code § 34-26. The credit union that loaned the debtor the money to buy the car had a purchase money security interest pursuant to Virginia Code §8.9-107(b).
Although a purchase money security interest had attached to the vehicle, a second step of perfection is required for the interest to be enforceable as to third parties -- a notation must appear on the vehicle's certificate of title. Testimony was given that no notation of a security interest appeared upon the title to the car. The credit union, therefore, held an unperfected purchase money security interest in the vehicle.
The Court ruled the credit union's unperfected interest was subordinate to the rights of a lien creditor, and that the statutory definition of "lien creditor" under the Virginia Code included a trustee in bankruptcy.
The Court was left with the question whether the debtor could exempt property in which the credit union held an unperfected purchase money security interest, and in which the value of the property was exceeded by the debt owed on the property. Exemptions under both Virginia Code §§ 34-4 and 34-26 cannot be claimed against debts for the purchase price of the property, or for any part of the purchase price.
The debt created in Johnson was for the purchase price of the car, as the loan application, note and security agreement clearly illustrated. Many of the cases in which Virginia Code §34-5 have been applied have involved a merchant creditor, or an actual seller of the goods for which the purchase price was not paid, rather than a third-party creditor.
The Court held that the debtor's claimed exemptions were improper because they were for property, the purchase price of which had not been paid, and the property was subject to a debt for the purchase price. The Court further held that a third-party creditor could prevail under Virginia Code §34-5 if the creditor successfully showed that its loan proceeds were used to acquire the collateral, and that it had a valid purchase money security interest.
As an alternative basis for its holding that the debtor's claimed exemption of $4,500 was improper, the Court looked to the language of Virginia Code §34-4, which allows an exemption of personal property up to $5,000 "in value", plus personal property of $500 "in value", for each dependent. Even if the exemption were properly claimed, the debtor in Johnson had no equity in the car. The credit union held a purchase money security interest, which was valid between it and the debtor. The value of the car was stated by the debtor to be $18,000 and the loan balance was approximately $19,000. The Court has held on prior occasions, as it did in this instance, that where the debtor has no equity in the exempted property, no exemption exists.
Further, the Court held that because the debt on the car exceeded its claimed value, there was no amount to be claimed exempt under Virginia Code §34-26(8). Finally, the Court noted that if it were to allow the claimed exemptions, the debtor would retain the property exempted, subject to the security interest of the credit union. This would result in the improper outcome in which a creditor holding an unperfected security interest would be placed ahead of the trustee.
The lesson in Johnson - perfect your liens. Remember that had this been a non-purchase money security interest case, the result would have been different there would have been no lien. Set up systems to ensure lien protection.