What Is A “Purchase Money Security Interest”?

Asset-based lenders with deals in Indiana need to be familiar with Indiana’s definition and application of a “purchase money security interest”.  Fortunately, a recent case from the U. S. Bankruptcy Court for the Southern District of Indiana, In Re:  Myers, 2008 Bankr. LEXIS 2172 (Myers.pdf), helps answer the question of what is a purchase money security interest.

Definition.  The Bankruptcy Code does not define “purchase money security interest”.  The Myers Court thus looked to state law “to fill the void,” including Indiana’s version of the UCC.  Specifically, Ind. Code § 26-1-9.1-103 outlines in detail the definition.  A purchase money security interest “in goods” is defined in section (b):

A security interest in goods is a purchase-money security interest:
(1)  to the extent that the goods are purchase-money collateral with respect to that security interest;
(2) if the security interest is in inventory that is or was purchase-money collateral, also to the extent that the security interest secures a purchase-money obligation incurred with respect to other inventory in which the secured party holds or held a purchase-money security interest; and
(3) also to the extent that the security interest secures a purchase-money obligation incurred with respect to software in which the secured party hold or held a purchase-money security interest.

According to I.C. § 26-1-9.1-103(a), “purchase money collateral” means “goods or software that secures a purchase money obligation incurred with respect to that collateral.”  That statute also provides the definition of “purchase money obligation”, which means “an obligation of an obligor incurred as all or part of the price of the collateral or for value given to enable the debtor to acquire rights in, or the use of the collateral if the value is in fact so used.”  The Court summed things up:

Thus, if the debt created by the money loaned or the credit extended was (1) incurred as all or part of the price of the collateral or (2) for value given by the creditor to the debtor to enable the debtor to acquire rights in or the use of the collateral, the debt so incurred is a “purchase money obligation”; the collateral which was purchased by the debtor and in which the creditor takes a security interest is “purchase money collateral”; and the security interest obtained in the collateral by the creditor is a “purchase money security interest”.

PMSI in action.  The Myers case addressed to what extent a lender had a purchase money security interest in a vehicle.  As part of the subject transaction, negative equity in the debtor’s trade-in was rolled into the loan, so the loan amount far exceeded the price of the vehicle.  (“Negative equity” meant the difference between the value of the trade-in and the amount still owed on it.)  The issue in Myers surrounded whether the creditor’s purchase money security interest extended to the negative equity portion of the loan, which begged the question of whether the negative equity loan was a “purchase money obligation”.  To qualify, the loan must have been either “(1) incurred as all or part of the price of the vehicle or (2) was value given by [creditor] to enable the debtor to acquire rights in [ownership] or the use of the vehicle.” 

After looking at a number of technical, legal bases, the Court concluded:

For the Debtor here to acquire ownership rights in the Vehicle, she needed financing and, under this transaction, she could not get financing without including her trade in . . ..  For her to include the trade in, she had to pay off the debt owed on it, and for her to pay the debt owed on the [trade in], she had to borrow enough funds to cover the trade in debt as well as the price of the Vehicle.  . . .  [T]his Court finds that it is difficult to see how the funds used to pay the negative equity here could not be viewed as an expense incurred in connection with acquiring rights in the Vehicle, and moreover believes the negative equity financing here is “precisely the type” of such expense.

Because the creditor’s purchase money security interest covered the money used to finance the negative equity, the court held the entire loan to be secured. 

Even though the Myers decision involved a consumer transaction, the case could apply to Indiana commercial transactions.  At a minimum, the opinion helps illustrate what a purchase money security interest is.