I got a call the other day from a person asking if filing for bankruptcy would allow me to return a car that had been repossessed. Although my answer probably didn’t satisfy the caller (depends on the attorney’s usual response), this is what is required in California (at least how the courts have viewed the law).

Bottom In most vehicle contracts, the lender retains the right to repossess a vehicle if the borrower defaults on scheduled payments. With many contracts, this recovery can be done outside of any court proceedings. However, once an individual files for bankruptcy, many of the rules change. On the one hand, an automatic suspension is implemented. This stay prevents most actions against the debtor (individual filing for bankruptcy). Specifically, the automatic stay strictly prohibits any lawsuit or recovery against a debtor who is delinquent in car loan payments. Any garnishment after a bankruptcy petition has been filed constitutes a violation of the automatic stay, with the garnishment null and void. In that case, the lender would be immediately obligated to return the vehicle to the debtor.

Effect of Bankruptcy on Pre-petition Recovery Bankruptcy Code Section 542 requires that entities in possession of “bankruptcy estate assets” generally must surrender the assets to the trustee (in Chapter 7) or the debtor (in Chapter 13). This big sticking point for this turnover requirement is determining what “estate ownership” is. Section 541 of the Bankruptcy Code defines estate ownership. This definition includes “all legal or equitable interests of the debtor in possession at the commencement of the case.” Basically, this definition states that whatever rights the debtor has at the beginning of the case continue in bankruptcy. As for the vehicle that has been repossessed, the court has to find out what rights a debtor had when the bankruptcy case was filed. These rights are determined by state law (California state law). Under California Civil Code (section 2983.2), a debtor has the right to trade in a repossessed vehicle until the date the car is sold by the repossessed lender. Two recent cases have come to different conclusions as to whether surrender of the vehicle is required when filing for bankruptcy.

First, in a case from the Southern District of California (In re: Fitch, 1998), the bankruptcy court held that while a repossessed car is owned by the estate, the right to own the car transferred to the lender prior to the filing of the bankruptcy petition. The court interpreted the statutes to mean that the automatic stay freezes the positions of the debtor and the creditors. Thus, the lender was entitled to retain possession. The court stated that a vehicle could be returned to a debtor if the debtor provides adequate protection. In most cases, adequate protection means establishing proof of insurance and proof that the debtor will be able to make regular car payments. In the Northern District of California (In re: Cortez, 2010), the Bankruptcy Court interpreted the Bankruptcy Code, and specifically the section on automatic stay, to mean that a “knowing retention of estate property violates … the automatic stay.” Because a debtor has a right to redeem until the date of a sale by the lender, the vehicle remains part of the estate and is subject to rotation. In this case, the debtor provided adequate protection to the secured creditor. However, the court seemed to say that it was not necessary for the rotation.

To do? If your car has been repossessed and you want to make sure you retain ownership, bankruptcy may be a solution if you can’t pay off the balance before the lender’s sale. However, while the Northern District seemed to assert that adequate collateral is not necessary for rotation, it will ultimately be necessary to prevent a lender’s motion for automatic stay relief. Be prepared to show (a) insurance, (b) regular and sufficient income, and (c) ability to pay for the vehicle. If you have any questions about the matter, please contact the Henshaw Law Office.