Bankruptcy: Unperfected Purchase Money Lien

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 is 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.

Collections: No Debt Cure from Extra Payments

In the case of W. Harold Tulley I LLC v. North Richmond Investments Inc., the City of Richmond Circuit Court addressed a case involving an alleged cure of a default by payments made after default.

The Court ruled in Tulley that Plaintiff lender is entitled to a deficiency judgment after foreclosure on real estate that secured a commercial loan. The Court rejected Defendant guarantors’ contention that their additional payments after default cured the default, as such was not provided for under the parties’ contract.

Defendants asserted that the Third-Party Defendant trustees and Plaintiff breached their obligations and duties because they knew or should have known Defendants were not in default. Defendants claimed that the trustees violated their duties under the loan documents, failed to act impartially, failed to acquire the best price upon the sale, sold the property at an inadequate sale price, and as they were never in default, should not have conducted the sale. Defendants contended that the trustees conducted the sale on a sham bid, knowing that Defendants were not in default.

The Court noted that neither the deed of trust and guaranty agreement nor the applicable statute, Virginia Code Section 55-59, lists any of the duties Defendants would have imposed on the trustees in foreclosure sales.

The Court found that both the deed of trust and the guaranty agreement describe default as failure to pay the agreed upon amounts at the agreed upon time on a timely basis. The guarantor stated that upon his tender of the two advance interest payments, there was no agreement regarding how the payments were to be applied, and that he understood they were not required under the financing and deed of trust documents. The Court ruled that Defendants were held properly in default, the amounts due accelerated triggering foreclosure.

Foreclosure: Deed in lieu of Foreclosure

In certain cases it may be more practical for the lender to seek or accept from the borrower a deed in lieu of foreclosure rather than incur the expense of foreclosure – this is at the lender’s discretion. If the lender agrees, in return for voluntarily surrendering the property, the borrower will seek either partial or complete satisfaction of the debt.

Considerations. Before accepting the deed in lieu of foreclosure, the lender must consider many matters:

a.       Value of the property vs. the amount of the debt.

b.     Other debts on the property. A deed in lieu of foreclosure does not extinguish prior or junior liens or encumbrances. Thus the lender, in accepting the deed, accepts the property with the liens. It is possible for the lender to structure the deed in lieu of foreclosure so that it does not release the deed of trust so as to preserve a future foreclosure to extinguish subordinate liens.

Real Estate: Perfecting Mechanic’s Liens

In recent editions of Creditor News we have been discussing the benefits of using real estate to improve creditors’ positions.  Last month we began a discussion of the benefits of using mechanic’s liens to aid in the collection of your debt.

Virginia Code §§43-4, 43-7 and 43-9 provide for the perfection of the lien by general contractors, subcontractors, and laborers and suppliers.  In each section the creditor must file a memorandum of lien at any time after the work is commenced or material furnished, but not later than 90 days from the last day of the month in which he last performs labor or furnishes material, and in no event later than 90 days from the time such building, structure, etc., is completed, or the work thereon otherwise terminated. The memorandum must contain specific information as set forth in the code (and there are forms in the code), and must be filed in the clerk's office in the county or city in which the building, structure etc., or any part thereof is located. The memorandum shall show the names of the owner of the property sought to be charged, and of the claimant of the lien, the amount and consideration of his claim, and the time or times when the same is or will be due and payable, verified by the oath of the claimant, or his agent, including a statement declaring his intention to claim the benefit of the lien, and giving a brief description of the property on which he claims a lien.

In next month’s edition we will explore suits to enforce the lien.

We have experienced attorneys and staff who can examine title, file mechanic’s liens, and litigate to enforce the same.