In the

United States Court of Appeals

For the Seventh Circuit ____________

No. 07-1483

IN THE MATTER OF:

CRAIG WRIGHT and LACHONE P. GILES-WRIGHT,

Debtors-Appellants.

SANTANDER CONSUMER USA INC.,

Creditor-Appellee.

____________

Appeal from the United States Bankruptcy Court

for the Northern District of Illinois, Eastern Division.

No. 06 B 13363—A. Benjamin Goldgar, Bankruptcy Judge.

____________

ARGUED JUNE 5, 2007—DECIDED JULY 3, 2007

____________

Before EASTERBROOK, Chief Judge, and MANION and

WOOD, Circuit Judges.

EASTERBROOK, Chief Judge. Bankruptcy judges across

the nation have divided over the effect of the unnumbered

hanging paragraph that the Bankruptcy Abuse Prevention

and Consumer Protection Act of 2005 added to §1325(a) of

the Bankruptcy Code, 11 U.S.C. §1325(a). Section 1325,

part of Chapter 13, specifies the circumstances under

which a consumer’s plan of repayment can be confirmed.

The hanging paragraph says that, for the purpose of a

Chapter 13 plan, §506 of the Code, 11 U.S.C. §506, does

not apply to certain secured loans.
2 No. 07-1483

Section 506(a) divides loans into secured and unsecured

portions; the unsecured portion is the amount by which

the debt exceeds the current value of the collateral. In a

Chapter 13 bankruptcy, consumers may retain the collateral (despite contractual provisions entitling creditors

to repossess) by making monthly payments that the

judge deems equal to the market value of the asset, with

a rate of interest that the judge will set (rather than the

contractual rate). See Associates Commercial Corp. v.

Rash, 520 U.S. 953 (1997); Till v. SCS Credit Corp., 541

U.S. 465 (2004). This procedure is known as a

“cramdown”—the court crams down the creditor’s throat

the substitution of money for the collateral, a situation

that creditors usually oppose because the court may

underestimate the collateral’s market value and the

appropriate interest rate, and the debtor may fail to

make all promised payments, so that the payment

stream falls short of the collateral’s full value. (The effect

is asymmetric: if a judge overestimates the collateral’s

value or the interest rate, the debtor will surrender the

asset and the creditor will realize no more than the

market price. When the judge errs in the debtor’s favor,

however, the debtor keeps the asset and pays at the

reduced rate. Creditors systematically lose from this

asymmetry—and in the long run solvent borrowers must

pay extra to make up for creditors’ anticipated loss in

bankruptcy.)

The question we must decide is what happens when, as

a result of the hanging paragraph, §506 vanishes from

the picture. The majority view among bankruptcy judges

is that, with §506(a) gone, creditors cannot divide their

loans into secured and unsecured components. Because

§1325(a)(5)(C) allows a debtor to surrender the collateral to the lender, it follows (on this view) that surrender fully satisfies the borrower’s obligations. If this

is so, then many secured loans have been rendered nonre-
No. 07-1483 3

course, no matter what the contract provides. See, e.g., In

re Payne, 347 B.R. 278 (Bankr. S.D. Ohio 2006); In re

Ezell, 338 B.R. 330 (Bankr. E.D. Tenn. 2006); In re Kenney,

2007 Bankr. LEXIS 1646 at *16-17 (Bankr. E.D. Va. May

11, 2007) (collecting cases). The minority view is that

Article 9 of the Uniform Commercial Code plus the law of

contracts entitle the creditor to an unsecured deficiency

judgment after surrender of the collateral, unless the

contract itself provides that the loan is without recourse

against the borrower. See, e.g., In re Particka, 355 B.R.

616 (Bankr. E.D. Mich. 2006); In re Zehrung, 351 B.R. 675

(W.D. Wis. 2006). That unsecured balance must be

treated the same as other unsecured debts under the

Chapter 13 plan.

Craig Wright and LaChone P. Giles-Wright, debtors

in this proceeding, owe more on their purchase-money

automobile loan than the car is worth. Because the purchase occurred within 910 days of the bankruptcy’s

commencement, the hanging paragraph in §1325(a)(5)

applies. This paragraph reads:

For purposes of paragraph (5), section 506 shall

not apply to a claim described in that paragraph if

the creditor has a purchase money security interest securing the debt that is the subject of the

claim, the debt was incurred within the 910-day

[sic] preceding the date of the filing of the petition,

and the collateral for that debt consists of a motor

vehicle (as defined in section 30102 of title 49)

acquired for the personal use of the debtor, or if

collateral for that debt consists of any other thing

of value, if the debt was incurred during the 1-year

period preceding that filing.

Debtors proposed a plan that would surrender the car to

the creditor and pay nothing on account of the difference

between the loan’s balance and the collateral’s market

value. After taking the minority position on the effect of
4 No. 07-1483

bypassing §506, the bankruptcy judge declined to approve

the Chapter 13 plan, because debtors did not propose to

pay any portion of the shortfall.

Normally the next step would be an appeal to the district

court, followed by an appeal to this court once a final

decision had been rendered. But the 2005 Act amends

28 U.S.C. §158 to allow a direct appeal from a bankruptcy

court to the court of appeals, bypassing the expense and

delay of litigation before a district judge. Section

158(d)(2)(A) now provides:

The appropriate court of appeals shall have jurisdiction of appeals described in the first sentence

of subsection (a) if the bankruptcy court, the

district court, or the bankruptcy appellate panel

involved, acting on its own motion or on the request of a party to the judgment, order, or decree

described in such first sentence, or all the appellants and appellees (if any) acting jointly, certify

that—

(i) the judgment, order, or decree involves a

question of law as to which there is no controlling decision of the court of appeals for the

circuit or of the Supreme Court of the United

States, or involves a matter of public importance;

(ii) the judgment, order, or decree involves a

question of law requiring resolution of conflicting decisions; or

(iii) an immediate appeal from the judgment,

order, or decree may materially advance the

progress of the case or proceeding in which the

appeal is taken; and if the court of appeals

authorizes the direct appeal of the judgment,

order, or decree.
No. 07-1483 5

The bankruptcy judge certified that this litigation satisfies both subparagraphs (i) and (ii). A motions panel of

this court accepted the appeal because the issue not only

has divided the bankruptcy courts but also arises in a

large fraction of all consumer bankruptcy proceedings. A

clear answer is needed—yet this issue appears to be

“stuck” in the bankruptcy courts. No court of appeals

has addressed the subject, and few district judges have

done so. Lower litigation costs for thousands of debtors and

creditors may be achieved by expediting appellate consideration of this case.

Like the bankruptcy court, we think that, by knocking

out §506, the hanging paragraph leaves the parties to

their contractual entitlements. True enough, §506(a)

divides claims into secured and unsecured components.

(Section 506 does other things as well, see Dewsnup v.

Timm, 502 U.S. 410 (1992), but these have no bearing on

the question at hand.) Yet it is a mistake to assume, as the

majority of bankruptcy courts have done, that §506 is

the only source of authority for a deficiency judgment when

the collateral is insufficient. The Supreme Court held in

Butner v. United States, 440 U.S. 48 (1979), that state law

determines rights and obligations when the Code does not

supply a federal rule. See also, e.g., Travelers Casualty &

Surety Co. v. Pacific Gas & Electric Co., 127 S. Ct. 1199

(2007); Raleigh v. Illinois Dep’t of Revenue, 530 U.S. 15

(2000).

The contract between the Wrights and their lender is

explicit: If the debt is not paid, the collateral may be seized

and sold. Creditor “must account to Buyer for any surplus.

Buyer shall be liable for any deficiency.” In other words,

the contract creates an ordinary secured loan with recourse against the borrower. Just in case there were

doubt, the contract provides that the parties enjoy all of

their rights under the Uniform Commercial Code. Section
6 No. 07-1483

9-615(d)(2) of the UCC, enacted in Illinois as 810 ILCS 5/9-

615(d)(2), provides that the obligor must satisfy any

deficiency if the collateral’s value is insufficient to

cover the amount due.

If the Wrights had surrendered their car the day before

filing for bankruptcy, the creditor would have been entitled to treat any shortfall in the collateral’s value as an

unsecured debt. It is hard to see why the result should be

different if the debtors surrender the collateral the day

after filing for bankruptcy when, given the hanging

paragraph, no operative section of the Bankruptcy Code

contains any contrary rule. Section 306(b) of the 2005 Act,

Pub. L. 109-8, 119 Stat. 23, 80 (Apr. 20, 2005), which

enacted the hanging paragraph, is captioned “Restoring

the Foundation for Secured Credit”. This implies replacing a contract-defeating provision such as §506 (which

allows judges rather than the market to value the collateral and set an interest rate, and may prevent creditors

from repossessing) with the agreement freely negotiated

between debtor and creditor. Debtors do not offer any

argument that “the Foundation for Secured Credit” could

be “restored” by making all purchase-money secured

loans non-recourse; they do not argue that non-recourse

lending is common in consumer transactions, and it is

hard to imagine that Congress took such an indirect

means of making non-recourse lending compulsory.

Appearing as amicus curiae, the National Association of

Consumer Bankruptcy Attorneys makes the bold argument that loans covered by the hanging paragraph cannot

be treated as secured in any respect. Only §506 provides

for an “allowed secured claim,” amicus insists, so the

entire debt must be unsecured. This also would imply that

a lender is not entitled to any post-petition interest.

Amicus recognizes that §502 rather than §506 determines

whether a claim should be “allowed” but insists that only

§506 permits an “allowed” claim to be a “secured” one.
No. 07-1483 7

This line of argument makes the same basic mistake as

the debtors’ position: it supposes that contracts and

state law are irrelevant unless specifically implemented

by the Bankruptcy Code. Butner holds that the presumption runs the other way: rights under state law count in

bankruptcy unless the Code says otherwise. Creditors don’t

need §506 to create, allow, or recognize security interests,

which rest on contracts (and the UCC) rather than federal

law. Section 502 tells bankruptcy courts to allow claims

that stem from contractual debts; nothing in §502

disfavors or curtails secured claims. Limitations, if any,

depend on §506, which the hanging paragraph makes

inapplicable to purchase-money interests in personal motor

vehicles granted during the 910 days preceding bankruptcy

(and in other assets during the year before bankruptcy).

Both the debtors and the amicus curiae observe that

many decisions, of which United States v. Ron Pair

Enterprises, Inc., 489 U.S. 235, 238-39 (1989), is a good

example, state that §506 governs the treatment of secured

claims in bankruptcy. No one doubts this, but the question

at hand is what happens when §506 does not apply. The

fallback under Butner is the parties’ contract (to the extent the deal is enforceable under state law), rather than

non-recourse secured debt (the Wrights’ position) or no

security interest (the amicus curiae’s position). And there

is no debate about how the parties’ contract works: the

secured lender is entitled to an (unsecured) deficiency

judgment for the difference between the value of the

collateral and the balance on the loan.

By surrendering the car, debtors gave their creditor the

full market value of the collateral. Any shortfall must be

treated as an unsecured debt. It need not be paid in

full, any more than the Wrights’ other unsecured debts,

but it can’t be written off in toto while other unsecured

creditors are paid some fraction of their entitlements.

AFFIRMED
8 No. 07-1483

A true Copy:

Teste: 

 ________________________________

Clerk of the United States Court of

Appeals for the Seventh Circuit 

USCA-02-C-0072—7-3-07