A “lease” of furniture or other consumer goods may actually be a disguised purchase. If so, through “cramdown” you can pay much less on it.
Our last blog post was about your bankruptcy options on leases of personal property—such as furniture or electronics. Your basic options are either to “accept” the lease or else “reject” it. When “accepting” the lease you keep possession of the property and must accept ALL of the lease’s terms and obligations. When “rejecting” the lease, you surrender the property and ALL of the remaining lease debt is discharged—legally written off. It’s all or nothing.
But what if that lease is really just a disguised purchase over time, with the “leased” property as collateral? If so, that may give you some major advantages. There can be a big difference in the bankruptcy consequences leasing something instead of buying it on time.
An Example—Assuming a Furniture Lease
Let’s say that a year ago, after a period of unemployment, you got a new job that required you to move to a new area. Your family rented an unfurnished home and then rented a bunch of furniture for it. You got two sets of bedroom furniture, as well as for the family room and dining room.
Your credit record was terrible so you used a “rent-to-own” contract, having been told you “didn’t need credit.” You pay $350 per month for furniture which you heard would have cost about $7,000 to buy new. Under the terms of the contract, after paying 36 monthly payments you would own the furniture. But until then you were renting it.
Your income from the new job has not turned out to be as high as you’d hoped. Plus huge debts from when you were not employed are putting unbearable financial pressure on you. So you talk with a bankruptcy lawyer about your options.
You learn that if you file bankruptcy and the rent-to-buy contract is treated as a lease, your options are limited. You can “assume” the lease by continuing to pay the $350 monthly payments and keep the furniture. Or you can “reject” the lease, give back the furniture, and any resulting debt would be discharged in bankruptcy. That would leave your family with an empty house so that’s not really an option.
But by this time the furniture has depreciated to being worth no more than about $3,000. Furniture depreciates very quickly. Paying $350 for the remaining 24 months would mean you’d be paying $8,400 more on furniture now worth barely a third of that. So you are very hesitant to “assume” such a bad deal.
If the “Rent-to-Own” Is Treated as a Secured Purchase
In contrast, if the contract is treated as a purchase over time, you would likely pay much less for the furniture. If you filed a Chapter 13 “adjustment of debts” you could do a “cramdown” of that obligation. (You qualify to do this on personal property other than a motor vehicle, as long as at least one year has passed since entering into the transaction. See Section 1325(a)(final paragraph after subsection (9).)
Under “cramdown,” the secured creditor’s debt is only treated as secured to the extent of the value of the collateral. In our situation, the $8,400 remaining debt is secured only to the extent of $3,000. That is the portion that you would have to pay for sure to keep the furniture. The remaining $5,400 would be treated as unsecured.
You would pay the $3,000 secured portion through your Chapter 13 payment plan. You could reduce the $350 monthly payments usually to any amount that would pay the $3,000 plus interest within the 3-to-5-year length of the case. So the monthly payment could be $100 per month, or maybe even less.
The remaining $5,400 unsecured portion would almost never be paid in full. You may not have to pay any of it. It is lumped in with the rest of your “general unsecured” debts. In most Chapter 13 cases, you wouldn’t pay any more into your plan because of that $5,400 unsecured debt. That’s because in these case you pay a certain amount towards the pool of all of your “general unsecured” debts. That amount is based on your “disposable income” during the period of your plan, minus other secured and “priority” debts that you must pay first.
So, for practical purposes “cramdown” usually significantly reduces your monthly payments and the total amount you pay.
Distinguishing Personal Property Leases from Secured Purchases
Because of the potentially huge difference in the treatment of leases and secured purchases, disputes arise about whether a transaction is a true lease or a disguised secured purchase. Our next blog post will be about the factors that the bankruptcy court looks at to decide.