The treatment of secured debts in a Chapter 13 is relatively straight forward. By its nature, a Chapter 13 will generally allow you to reorganize your debts, especially secured debts, under the protection of the bankruptcy stay. This will allow you, in the case of your home, to pay back your mortgage arrearages over the life of your Chapter 13 plan or, in the case of a car, allow you, under the correct circumstances, to recalculate the outstanding balance on the loan and/or the interest rate you must pay. One thing both a home and car loan have in common is that they are clearly secured loans in the most traditional sense. A question arises when you are dealing with a very common loan among people who face financial difficulty. The rent-to-own agreement offered by companies like Rent-a-Center or Aaron's. How are those agreements treated in a Chapter 13 plan?
To answer that question it has to be determined if the agreement is going to be governed by Section 506 of the Bankruptcy Code or Section 365. If the agreement is governed by Section 365 it will be considered an unexpired lease and you will either need to assume or reject the lease in your Chapter 13 plan. In other words, if it is a true lease under Section 365, you either have to keep paying under the original terms or give the goods back. If it is governed by Section 506, it will be treated as a secured loan that you can reorganize under your plan. This usually means changing the amount due to the current value of the goods at the time of filing and reducing any interest rate applicable to the loan to around 4.5%.
This discussion is often referred to as true leases verses disguised security agreements. The determination of what type of agreement you have is usually governed by state law. It should come as no surprise that over the past several years organizations like Aaron's and Rent-a-Center of lobbied state governments to amend their statutes to make it very hard to find one of their agreements to be a disguised security agreement. To some extent Maryland is no different. The determination of a true lease or disguised security agreement in Maryland is governed by Section 1-203 of the Commercial Law Article of the Maryland Annotated Code. This code provision sets out several factors that will weigh in the determination of a lease or a secured transaction.
Code provisions, like Section 1-203, weigh heavily in favor of finding typical rent-to-own transactions to be true leases. State laws like Section 1-203 are also generally not interested in the subjective intent of the parties to the agreement but focus more on the economic factors and objective factors in making a determination. While that may be the case, if the effort to classify these rent-to-own agreements as true leases will cost an organization like Aaron's more than what they may loss if the agreement is classified as a secured transaction, more often than not, they will not object. In any case, if you have a Chapter 13 that may implicate these types of agreements it is highly advisable to retain competent counsel to assist with your case.
In my next post I will discuss the mechanics of the subordinate mortgage lien strip in a Chapter 13.