While vehicle cramdowns in a Chapter 13 plan are fairly commonplace, vehicle accidents that result in a total loss create problems for both lenders and debtors after plan confirmation. The questions that must be answered are:
- Who is entitled to insurance proceeds payment?
- What should lenders do to protect themselves?
Most debtors rely on their vehicles to travel to and from work so that they can continue to fund their plan. Therefore, they need to purchase a replacement vehicle after an accident. Their primary option is to use the insurance proceeds for this, so they must file a motion to substitute collateral with the bankruptcy court. If granted, this motion allows the vehicle lender’s lien to be swapped from the damaged vehicle to the new one.
Lenders are at risk under these circumstances, though. To assure adequate protection, the lender should engage counsel as soon as it learns of the loss. Then, counsel should object to the debtor’s motion to substitute collateral to ensure that the lender approves the replacement vehicle and that the order granting the motion is drafted correctly. The lender doesn’t want the debtor to obtain a replacement vehicle that is vastly inferior in quality and value, so it’s important to know the value of the proposed replacement vehicle. If the replacement is substantially inferior and the debtor has another serious accident, the lender could suffer an unnecessary financial loss.
In addition, the lender should ensure that the lien is properly placed on the replacement vehicle. Lenders and their counsel are typically more experienced with this than debtors and debtors’ attorneys, so lenders should be involved in this step as well. They should also amend the bankruptcy plan to reflect the new vehicle specifics.
Presuming the debtor’s motion to substitute collateral is resolved to the satisfaction of all parties, the plan should continue with no interruption in disbursements. However, if the insurance proceeds are more than the lender’s claim amount, the proceeds either become the property of the estate or are held in escrow subject to the lender’s lien, depending on the circumstances. Two recent cases demonstrate both of these options.
In Kentucky, the courts don’t allow the lender to keep the surplus insurance proceeds but will allow them to be held in escrow pending discharge of the Chapter 13 plan. Most courts rely on the reasoning contained in In re Kelley, No. 11-51197, Doc. 92, p. 3 (Bankr. E.D. Ky. Nov. 8, 2012). In Kelley, the bankruptcy court crammed down the interest rate on the debtor’s 2008 Chevy Equinox. After plan confirmation, the vehicle was a total loss after an accident. The insurance proceeds were more than the amount of the lender’s remaining claim amount, and the debtor didn’t need to purchase a replacement vehicle. The lender argued that because it was the named insured on the insurance policy, it was entitled to the full amount of the insurance proceeds, including the surplus.
Conversely, the debtor argued that the lender was only entitled to the amount of its claim because it was bound by the terms of the confirmed plan. While the court held that the lender wasn’t entitled to the surplus proceeds immediately, it did allow the lender to retain its lien on the remaining proceeds pending bankruptcy discharge because the debtor didn’t offer adequate protection to the lender.
In a factually similar case, a New York court came to a different conclusion in In re Holstander, 507 B.R. 779 (Bankr. N.D.N.Y. 2014). In Holstander, the debtor crammed-down the value of a loan against a 2006 Chrysler to a secured value of $12,000. However, the lender had filed its claim in the amount of $16,190. After plan confirmation, the vehicle was totaled and the insurer paid $14,190. The lender had argued that the insurance proceeds weren’t part of the estate because they were payable directly to the lender. As such, the lender should be entitled to the full amount. By contrast, the debtor argued that the insurance proceeds were property of the estate and that the lender should be limited to recover only the amount of its claim. Ultimately, the court agreed with the debtor and held that the proceeds were part of the estate and that the lender was bound by the terms of the confirmed plan. Thus, the lender only received the confirmed value of $12,000.00.
In reaching this conclusion, the court stated that the question of whether insurance proceeds are property of the estate is a complex one that depends upon the nature or type of insurance, the timing of the casualty loss, and the policy terms. Further, the court propounded that the post-confirmation relationship between the debtor and creditors requires creditors to forgo certain rights in exchange for the debtor’s promise to make payments under the plan. By withdrawing its objection to confirmation, the creditor accepted the proposed treatment and became bound by the confirmed value of $12,000.
As a result, vehicle lenders should proceed cautiously when evaluating their rights to insurance proceeds on totaled vehicles in Chapter 13 cases. Lenders should always look to the language of the confirmed plan and determine if the property had vested in the debtor or the estate upon confirmation. If vested in the estate, then the insurance proceeds are likely property of the debtor’s estate and will be distributed by the Chapter 13 trustee. In such circumstances, the lender shouldn’t apply proceeds without a bankruptcy court order. By contrast, if the vehicle had vested in the borrower upon confirmation, lenders likely retain an interest in the proceeds against that of the estate.Like This Post