What happens to cars in bankruptcy? Or cars with notes? After all, almost everyone filing bankruptcy has a car and it is often one of the larger assets a debtor owns. The answer depends largely on how much equity the debtor has in the vehicle.

Cars in bankruptcy that are Paid Off

Technically, cars in bankruptcy that are paid off become assets of the Bankruptcy Estate and, as such can be sold by the Bankruptcy Trustee and the proceeds used to repay the debtors’ creditors. However, no Trustee will sell cars in bankruptcy worth $7,500 or less (as valued by the Kelly Blue Book Private Party estimates). That’s because the State of California realizes most of us live in parts of the state that require a car to be able to get to work and otherwise function. 

A car worth more than $7,500 can also be kept by the person filing chapter 7 bankruptcy if they claim the car’s value under the Wildcard Exemption. California Bankruptcy law allows everyone going through chapter 7 BK to claim one of two exemptions: the Wildcard Exemption, worth up to $32,000 in the value of any assets the debtor chooses, or the “Homestead” exemption, worth approximately $750,000 in equity in a primary residence/house. 

If a debtor owns a car worth more $7,500 and takes the Homestead Exemption, it’s impossible to predict what a Bankruptcy Trustee will do because it’s up to the individual Trustee, but there’s generally one of two possibilities. First, I have seen BK Trustees ignore a car with significant value, allowing debtors to maintain possession. For example, a client of mine years ago owned a Dodge Viper worth $35,000 which the Trustee on their case simply let my client keep.

What? Why?

It’s an enormous administrative hassle for a Trustee to sell a car: it takes time, administrative follow-through (such as in finding and monitoring an auctioneer to sell the car), and sometimes even a lawyer to seize the car legally. Implication? The costs of seizing and selling a car mean that most Trustees don’t take cars in bankruptcy that aren’t worth significantly more than $7,500.

However, some Trustees do either take the car, or otherwise extract value for creditors. Most often what I’ve seen is a Trustee demand the person filing bankruptcy pay them the difference between the $7,500 vehicle exemption and the actual value of the car, in exchange for allowing the debtor to keep their car after the bankruptcy is concluded. How can someone so broke they’re filing for bankruptcy come up with the funds?

Most of my clients have a friend or relative lend or give them the money. The less common method for the Trustee to take the car is to literally demand title be signed over to the Trustee who then hires automobile auction company to sell the vehicle. This is the less common alternative for administrative hassle and costs it imposed discussed above. For the record, I’ve only seen this when the equity in a car is at least slightly over $10,000.

Cars in bankruptcy With Loans that Aren’t Paid Off

Counterintuitively, it can be easier to keep leased cars in bankruptcy or ones that still have notes on them, than the same car that’s paid off. Consider the example of a recent model Mercedes-Benz GLA230. I had a bankruptcy client who leased this car and thus he had no equity in it. He was able to keep the car because he didn’t legally own the car – Mercedes did.

If he had owned that car, then it would have been as asset that was transferred to the Trustee in bankruptcy (keep in mind that, in bankruptcy, legal ownership of everything the debtor owes and owns is transferred to the Trustee while the bankruptcy process is and until it is legally concluded when the assets the debtor are entitled to are returned and their debts erased). In the case of this GLA230, the Trustee likely would have sold it, giving my client the $7,500 he was entitled to have in the value of a car, and the Trustee would have used the remainder of the proceeds (after administrative costs) to repay the debtor’s creditors on a pro rata basis.

Could this be stopped?

While losing the GLA in the bankruptcy is arguably unfair, the more relevant issue this hypothetical example raises is the importance of pre-bankruptcy planning to minimize asset loss for a client. For example, I would have advised a client who owned a $50,000 car that was vulnerable to seizure by a Trustee, and recommended the client sell the vehicle themselves and pay off their most important creditors.

For example, if the client owed recent taxes, I would advise them to pay off the IRS with the proceeds, since only tax debt three years or older can be discharged in bankruptcy. However, this hypothetical client would also need to wait 90 days from the time of selling the Mercedes to file bankruptcy, otherwise the Trustee can legally demand that $50,000 back from the debtor and/or the IRS (debtors aren’t allowed to make payments of more than $600 to any creditor in the 90 days prior to filing bankruptcy without violating the “preference” rule – whereby the debtor is “preferring” some creditors with repayment to others).

How Are Car Loans Treated in Bankruptcy?

What about the case of a Hyundai Ionic 5 worth $50,000 that a debtor still owes $30,000 on? If the debtor doesn’t own his home, then he will use the Wildcard exemption to keep the $20,000 in car equity that he owns. Second, the lender will receive notice of the debtor’s bankruptcy as soon as he files. But the lender is legally obligated to keep the car note in force so long as the debtor continues to make timely, complete and uninterrupted payments.

Moreover, car lenders may not threaten to repossess a debtor’s cars in bankruptcy or require legal agreements “reaffirming” the debtor’s obligations – but this is very recent law, passed only a year ago, on January 1, 2023. Indeed, many car lenders seem not to know about or understand the effects of California Code of Civil Procedure § 2983.3. invalidating ipso facto clauses in bankruptcy. I’ve been needing to send lots of letters explaining to car lenders  how Reaffirmation Agreements have changed.

Laws have changed!

Prior to 2023, car lenders required people in bankruptcy to sign a Reaffirmation Agreement, a legal document, requiring the debtor to re-obligate themselves to the car loan, or else the car will be repossessed. Since bankruptcy generally results in the debts of the debtor being erased, car lenders are understandably nervous when their customers file bankruptcy because it puts repayment of the car loan in jeopardy of being wiped out by the bankruptcy.

The standard practice was for car lenders to require their customers in bankruptcy to sign a Reaffirmation Agreement, which the Bankruptcy Court would approve. But this is no longer the law, even if many car lenders insist it is, as I have experienced.

What to Do if Car Loan Pressures You to Sign Reaffirmation Agreement

What should a debtor do if their car lender is pressuring them to sign an unnecessary Reaffirmation Agreement? After all, in my experience, few car lenders seem to understand they can no longer compel borrowers to sign these agreements, nor are the Bankruptcy Courts getting involved in approving them. I recommend sending a Reaffirmation Reply Redacted on behalf of a client. The letter does two things: (1) it advises the car lender of the new laws, and (2) cooperatively offers to have my client enter into a reaffirmation agreement, but only if the lender is going to offer better terms on the car loan. 

Got Questions about Cars in Bankruptcy? Got Questions about the Bankruptcy process in general? Call me – my team and I love educating people on how bankruptcy works and how it would work with your specific debts and assets. 

January 18, 2024

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