SW Legal studies in Business

Negative Equity in Car Trade Is Part of One Financial Obligation for New Car Buy
Description

New York high court answered a question from federal courts to clarify the rule about negative equity in used cars—where the trade-in value is less than the outstanding loan. When that equity is rolled into a loan for a new vehicle, it cannot later be separated. There is only one obligation.

Topic Negotiable Instruments and Credit
Key Words

Purchase Money Security Interest; Negative Equity

C A S E   S U M M A R Y
Facts

Buyers of a new car often engage in transactions in which the seller of the car retains an interest in the good sold (the car) to secure payment of all or part of its price. This interest is a “purchase-money security interest” or PMSI. Sometimes, when the car buyer later trades in an old car, the value of the debt the buyer owes on the old car exceeds the car’s value. This is called negative equity. That equity is often rolled into the sales contract for a new car. That is, the loan on a new car includes an amount due on the new car, plus the amount of negative equity from the old car that was traded in. It was unclear under New York law if the negative equity was part of the PMSI in the new car agreement. That is, in the event of default by the borrower (the buyer of the new car), can the claim by the creditor against the debtor be split into two parts—the amount owed on the new car and the amount owed on the old car? The issue arose in bankruptcy cases where the debtor was allowed to retain the vehicle. Federal courts asked the New York high court to clarify the law on this point. The court did. The federal court explained the consequence.

Decision

As explained by the New York Court of Appeals, there are two ways that a purchase-money obligation may arise: 1) where the obligor—the debtor—incurs an obligation as all or part of the “price” of the collateral, or 2) where “value” is given to enable the debtor to acquire the collateral. Negative equity fits within either definition (see UCC 9-103). The financing of the negative equity is essential to the completion of the sale of the new car, so it is part of the deal. Hence, in the event of a default on the purchase-money agreement, the portion of the loan attributed to the value of the new car may not be separated from the negative equity that was rolled into the new loan.

Citation In Re Peaslee, ---F.3d--- (2009 WL 3233823, 2nd Cir., 2009)

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