In finance, a cramdown refers to the imposition of a bankruptcy restructuring plan by a court despite complaints by certain lenders. Simply put, it is when the court grants a bankruptcy reorganization plan without showing concern for how it may affect creditors. A cramdown is typically part of a Chapter 13 bankruptcy filing and it includes the borrower modifying the terms and conditions of a contract with a lender by seeking help from the court. If a cramdown is authorized, the value of a debt or a loan is reduced to reflect the real market value of collateral used in securing such a loan. While cramdowns are used in different secured debts like the acquisition of vehicles or commercial assets, it is prohibited on mortgage for primary residences.
A Little More on What is a Cramdown
When a debtor takes up a valid plea to court, the court is given the power to decide if a cramdown is permitted or not. According to Section 1129(b) of the Bankruptcy Code, a cramdown provision gives a bankruptcy court the right to disregard pleas and objections of a secured lender and approve a borrower’s restructuring plan provided that it is fair and genuine. Also referred to as a “cram-down deal,” this system forcefully makes the lender to settle for less than what was in the original agreement; thus the term “cramdown” (to forcefully make lenders accept loan changes even without their consent). In a case where the debtor is a personal entity, the or she can file a loan renegotiation via the Chapter 13 restructuring plan by using a cramdown, or can lose everything via a Chapter 7 filling, thus giving secured lenders more money than what was originally agreed.
In a cramdown, there are two types of creditors usually acting as the defendant in court; the secured lenders and the unsecured creditors. Usually, secured lenders are the ones with most of the objections in the court, while the unsecured creditors usually find it more rewarding not to argue. They simply require the court to make them an assurance that the debtor can meet up with the restructuring plan obligations rather than trying to debate whether the plan is fair and genuine enough. Secured creditors, however, mostly have no chance in cramdowns, as they’ll have to accept whatever the court says.
For personal entities, cramdowns can be applied to private properties, especially vehicles. Although there is a condition that the minimum duration will have elapsed depending on the asset, in which case, that of vehicle is 910 days, which other properties and assets usually have a minimum duration of one year. If the debtor seeks a cramdown before the minimum period has elapsed, it won’t be granted by the court, and the debtor will still owe the originally agreed sum of the loan.
For mortgage on non-primary residential properties, the debtor is usually expected to repay the loan within 3-5 years after the cramdown has been implemented. Most debtors, however, fall into problems as they’ll be unable to pay off this loan within such a short timeframe.
Origin of Cramdowns
Initially, cramdowns were used by personal entities in the Chapter 13 personal bankruptcies, but it later gained popularity and spread to the Chapter 11 corporate bankruptcies as debtors were looking for ways to reduce their debts. In 1994, the court prohibited the utilization of cramdowns on mortgages for primary residential properties in Chapter 11 using the Bankruptcy Reform Act. However in 2008, during the financial crisis, borrowers deemed that the restrictions on subprime mortgages should be lifted to help the pay a lesser than agreed price for their property. The cirrus however declined this action, stating that it would negatively impact the United States financial system since most banks which act as secured creditors could go out of business, thus making the interest rate on newer mortgages ridiculously high and unaffordable to the average citizen.