The bankruptcy “reform” law of 2005 tried to muzzle bankruptcy lawyers.
It included a list of things that bankruptcy attorneys must and must not do. Once of the prohibited things was advising debtors to incur more debt in contemplation of bankruptcy.
So reading it here may be the only way you will hear about this tactic for passing the means test . Your bankruptcy attorney may feel the need to remain silent
The problem of the paid-for car
Bankruptcy’s means test, as interpreted by the US Supreme Court, allows the debtor to deduct the cost of buying a vehicle from income only if there are remaining payments on a loan secured by the car.
If the car is paid for, you get no ownership allowance.
The ownership allowance found in the IRS guidelines is reduced by 1/60th of the total remaining payments, and deducted from current monthly income. This is all part of the process to determine if the debtor has so much available income that they shouldn’t be permitted to file bankruptcy.
So if you owe something on the car, you get to deduct the IRS allowance for car ownership in calculating whether you qualify for Chapter 7.
In the West, that ownership allowance is $478 per month. So we are talking about a significant deduction that might get you into the bankruptcy chapter of your choice.
Fix for the paid-for car
So, debtors with cars with no liens can consider whether they want to assure themselves of getting the ownership allowance by borrowing a small amount of money prior to filing and pledging their car as collateral for repayment of the debt.
The loan could be from a credit union or other conventional lender. Or the loan could be from a friend or family member.
Creating a claim secured by vehicle
The loan against the car only works to get you a means test deduction if the loan is legally secured by the car.
The requirements for a valid secured debt on a vehicle are
- a written promissory note
- a written security agreement
- perfection of the lien by filing with DMV
The written note is easy: it is the “I promise to pay to NAME” statement. It includes the amount of the debt, the interest rate, and when the payment is due. It could be due in a lump sum months from now, or payable monthly, or due on demand.
A security agreement is like a deed of trust for assets other than real estate and contains the “language of grant” by which the owner of an asset grants, or conveys, an interest in the asset to secure a debt.
The promissory note may function as the security agreement if it contains language such as “I pledge my car, described as…., as security for my obligation to pay.”
Perfection of the security interest in a registered vehicle is accomplished by adding the information about the lien holder ( the lender) to the certificate of title of the vehicle and filing that title, showing the existence of the lien, with the California DMV.
If the certificate of title is not filed with the DMV, the lien is not perfected. It is unknown whether an unperfected lien on a car would be sufficient to entitle the debtor to the car allowance.
There is a belief among non lawyers that taking possession of the certificate of title creates a lien in the person who has the title. Not so.
The only way to create a valid lien on a vehicle (at least in California, where I practice) is to follow the steps above: written note; language of conveyance of a security interest; perfection by filing the certificate of title with the DMV.
Of course, there must be a real exchange of money behind this transaction. It is not enough to merely claim that you pledged your car for a loan.
Get a real loan, perfect the lien, then consult a bankruptcy lawyer. There is nothing in the Bankruptcy Code to prevent your lawyer from grinning at you.
Image courtesy of nannetteturner.