Patrick O'Malley

Cramdown & Lien Stripping In Bankruptcy

Cramdown. Ouch, that sounds painful. And it is painful, for creditors. Cramdowns are one of the most powerful tools a bankruptcy filer has at his disposal.

What is a cram down?

In a cramdown, the court agrees with you and allows you to reduce the amount of the debt owed to the creditor, and this is true even though the debt is secured by an asset. An additional important feature of cramdowns is the possibility of reducing the interest rate on the debt.

Limitations on cramdowns

Being such a powerful tool, it stands to reason that the bankruptcy code places a number of significant limitations on how and when cramdowns can be used. Most importantly, cramdowns cannot be used for primary residences in most circumstances. Cramdowns can be used for personal property. But only if the personal property (including cars) was not purchased recently—what constitutes recent depends on the type of personal property. If the time limit has passed then the cramdown is allowed. Since a Chapter 7 case involves selling off most assets, cramdowns are never a part of Chapter 7. Instead, they feature heavily in Chapter 11 cases, and to a lesser degree, in Chapter 13 cases.

Example of a cramdown

Fred the filer filed for Chapter 13 personal bankruptcy. His secured debts include a primary residence, other real estate, an RV, an automobile, and a loan that is secured by various other personal property. For simplicity in illustrating cramdowns, all these assets are ‘underwater’ which means they are all now worth less than the amount of debt that is currently owed on them. The primary residence is not eligible for cramdown because it does not meet any of the narrow exceptions. Congress decided that the public benefit of keeping mortgage lenders safe from cramdowns—and presumably keeping costs down for all borrowers—outweighed the personal benefit to a bankruptcy filer.

The other real estate is eligible for a cramdown. If that real estate is worth $101,000 and the current debt is $200,000, then the creditor’s security is now crammed-down to $101,000. The other $99,000 now becomes unsecured debt, just like credit card debt is unsecured. One important caveat, the debtor must fully pay off the $101,000 in 3-5 years as part of the Chapter 13 plan. As a practical matter, this can be an insurmountable hurdle. If so, it’s likely Fred will offer to give the property to the creditor and discharge the $99,000 as an unsecured debt. The RV is eligible for a cramdown, similar to real estate. The automobile is also eligible for a cramdown. The only limitation is that the car must have been purchased at least 2 1/2 years earlier. The personal property is eligible, as long as it was purchased at least a year earlier. When any of these cramdowns are allowed, the interest rate can be lowered and the repayment duration can be stretched out.

For purposes of illustration, a Chapter 13 personal bankruptcy example was used in order to show how cramdowns interplay with personal residences, i.e. they don’t. Apart from this specific instance, cramdowns play out conceptually the same in business and personal bankruptcies, both in Chapter 11 and 13.

The above discussion is a simplification for purposes of illustration. A great deal of strategy, finesse, and nuance is brought to bear in designing a cramdown that will win court approval and achieve your goals.

Lien Stripping

Lien stripping is the same process as a cramdown. The only difference is the amount of security remaining after the downward adjustment. When a lien is stripped, it means there was zero value in the asset for the creditor to attach a lien to. So their entire lien is ‘stripped off’ the asset. Their former lien now becomes an unsecured debt. As such, it will typically receive pennies on the dollar in the repayment plan.

Contact us for help

Business Bankruptcy Solutions helps Coloradoans lower their debts, renegotiate contracts and save their businesses. Call (720) 674-7311 or email now to schedule a free consultation. We will discuss the problems facing both your business and personal finances and the tools we can use to achieve your goals. We draw upon decades of legal and business experience to provide you with actionable solutions. With BBS on board, we’ll help you weather this storm.