If you are contemplating buying a car before filing for bankruptcy in Colorado, here is fair warning of some pitfalls that may arise.
In Colorado, anyone looking to claim a secured interest in a motor vehicle (such as a car dealer or family member who sells you a car) must “perfect” their lien against the vehicle by filing a record of their security interest with the Department of Motor Vehicles in the county where the property is located. This rule is intended to put everyone else on notice that there is a lien on the vehicle.
In practice, car dealerships and family members who sell you a car do not always “perfect” their security interest in a timely manner. Many of them wait to file their security interest with the DMV. This can create big problems for both buyer and seller if the buyer files bankruptcy. These problems arise in two ways.
In the first situation, the seller of the vehicle does not record the lien at all. Because there is no recorded lien, the lien is called “unperfected.” In this situation, the trustee can use their “strong-arm power” under bankruptcy code section 544 to avoid (or cancel/reverse) the lien and then use Section 551 to preserve the property for the bankruptcy estate. What that means is that the trustee uses their power to ignore the lien and then, because there is no security interest in the car anymore, the car itself becomes a part of the bankruptcy estate and can be sold to pay creditors.
In the second situation, the seller records the security interest more than 30 days after the car was purchased and within 90 days of the bankruptcy case being filed. Here, you have a valid security interest (as long as no other person who claims to have a security interest files their interest in the meantime, Colorado is a “first in time, first in line” state as far as security interests in property go—but that’s a whole ‘nother ball of wax). However, you also have something called a “preference payment” under bankruptcy law.
A preference payment is a payment made to a creditor of more than $600 in the 90 days before bankruptcy. These can be cash payments or providing a security interest in one of your assets. Regardless of the type of payment, preference payments can also be avoided (or canceled/reversed) by the trustee. This is because when you file bankruptcy, all your creditors are supposed to share equally in the property that may be liquidated to pay their claims. If you were able to pay off one creditor to the exclusion of others, that just wouldn’t be fair. Your unsecured creditors are supposed to all get an equal piece of the pie. So, if the security interest gets recorded during the 90 days before the buyer files bankruptcy, it can also disappear, allowing the trustee to claim the car as property of the estate.
There are some defenses to preference payments. One of the defenses is called “contemporaneous value”, meaning that you paid for something and got something at the same time. This should be the case when you buy a car, right? BUT, if the seller waits more than 30 days to record that security interest, they may lose the argument that the value exchange was contemporaneous, or “at the same time”. Generally, a 30-day period is found to be contemporaneous, meaning that perfection of a security interest within 30 days of the sale date for the vehicle avoids any problems even if the perfection occurs within 90 days of the buyer filing for bankruptcy. However, if the seller waits longer than 30 days and either perfects the security interest within the 90 days prior to the buyer filing bankruptcy or does not perfect at all before the buyer files bankruptcy, then problems arise.
The bottom line in both of these scenarios is not good for buyer or seller. Once the trustee successfully avoids the lien, the automobile in question is claimed as part of the bankruptcy estate. The trustee then wants the value of the property, or the property itself. Since trustees are under pressure to close cases in a timely manner, they are not usually open to allowing bankruptcy filers (i.e., the buyer of the car) to pay the car off over time. Rather, they want a lump-sum payment for the value of the lien (i.e., fair market value less any equity the buyer may have had in the vehicle on the bankruptcy filing date). Trustee mileage may vary, but odds are the buyer of the vehicle will need to either pay up in full within a few months, or lose the car.
Additionally, the seller of the car loses big time. They no longer have a security interest in the vehicle, and the contract you signed with them is wiped out by the bankruptcy (unless they bring a claim against the buyer for fraud, such as buying the car knowing they were going to file bankruptcy and lying to the seller about their intentions. A whole ‘nother ball of wax for sure!). So the seller is out the property AND the right to receive your payments for the property.
No one ends up happy in this situation except the trustee. (And no, the buyer can’t just claim the car exempt once it comes back into the bankruptcy estate. The exemption is determined at the time of filing, when the security interest was presumed to exist. So unless the buyer had equity in the car on the filing date, he or she gets nothing.)
WHAT TO DO ABOUT THIS?
For sellers of vehicles, there is a simple solution. Always perfect your security interest within 30 days.
For buyers of vehicles within 6 to 9 months of filing bankruptcy, contact the seller prior to filing bankruptcy to get the date of perfection (that is, the date they filed the lien with the DMV). If the lien was filed by the seller within 30 days of the sale, the buyer can proceed with filing bankruptcy without this risk. If not, the buyer should make sure at least 90 days have passed since the lien was perfected before filing for bankruptcy.
This convoluted subject really highlights the pitfalls of bankruptcy. The bankruptcy laws are deceptively complex and filing for bankruptcy without having competent legal advice can mean the loss of property you would have otherwise been able to keep. Having a bankruptcy attorney you trust is essential for spotting these pitfalls and allowing you to file your case with peace of mind.