Does the automatic stay prevent automatic transfer of ownership of

Does the automatic stay prevent automatic transfer of ownership of

pawned property once the redemption period expires? For the uninitiated, the pawnbroking business has some surprising features. Annual interest rates of over 100% are normal.

Once the redemption period required by law passes, a default can automatically transfer ownership of the pledged property, potentially resulting in a windfall for the pawnbroker if there is a significant discrepancy between the value of the pledged property and the amount of the pawn loan.

To be sure, pawnbrokers serve an important (and growing) function in the United States and, especially Puerto Rico. For many, they are the sole source of short-term or emergency financing, especially after the consolidation of the local banking sector and the beating that credit unions took as a result of the default and subsequent restructuring of Puerto Rico’s public debt.

Given the credit profile of the borrowers they serve, pawnbrokers frequently assume massive risk when issuing a loan; hence the astronomical interest rates. Moreover, since pawn loans are usually for small amounts, a simple and economical process for monetizing the pledged property is essential; a judicial foreclosure or even an Article 9 UCC sale is simply too complicated and costly for the amounts involved.

The intersection between Puerto Rico’s regulation of the pawnbroking business and the bankruptcy code had not been addressed by our bankruptcy court, until now.

Under Puerto Rico’s Pawnbroking Business and Operation Regulatory Act, Act No. 23-2011 after the thirty-day redemption period passes without the borrower paying the amounts due, ownership in the pledged property may automatically transfer to the pawn broker, unless agreed otherwise by the parties.

Far from raising a barrier against the effects of Act 23-2011, the bankruptcy code seems to complement it, at least under certain circumstances. Specifically, section 541(b)(8) says that pledged property is not considered property of the estate if the following conditions are met:

• the pawned property is in possession of the pawn broker;
• the loan is nonrecourse, and
• redemption rights are not exercised in a timely manner.

Tying into this last condition, section 108 extends the redemption period to 60 days after a voluntary petition is filed. Now what happens if the borrower files for bankruptcy before the redemption period expires? Does it continue to run?

Is it frozen by the automatic stay? Does it make a difference if the borrower files for bankruptcy before or after the pawn loan matures? In a recent case, Judge Lamoutte answered some, but not all of these questions.

The controversy came before the court in an objection to a chapter 13 plan confirmation by a pawnbroker, La Familia Pawn. La Familia argued that the debtor’s plan improperly provided for the debtor to keep the pledged property—a car—ownership of which would automatically transfer from the debtor to La Familia upon the former’s failure to pay the amounts due before the expiration of the redemption period.

On the other hand, the debtor argued that she brought into the estate “unfettered title, possession, and ownership of the vehicle, not just a limited right of redemption.” As a result, according to the debtor, the automatic stay prevent the automatic transfer of ownership upon failure to redeem the vehicle as provided under Act 23-2011. Moreover, the debtor argued that La Familia’s rights, as a secured creditor, could be modified (as provided under the plan) pursuant to section 1322(b)(2).

The bankruptcy court agreed with La Familia. It concluded that “that [the automatic stay] does not freeze an unexpired state-law redemption period. Thus, […] [u]pon debtor’s failure to timely redeem the pledged property, La Familia Pawn [became] the owner of the Vehicle […].” Several observations:

• the court’s conclusion says that the debtor filed for bankruptcy

“after the loan’s extended maturity period[.]” This seems to be incorrect. The debtor filed for bankruptcy on January 24, 2023 while the loan’s extended maturity date was February 18, 2023.

• This may or may not make a difference, depending on which case from

the 11^(th) Circuit Judge Lamoutte decides to follow. In In re Northington (11th Cir. 2017), the Eleventh Circuit held that “the Bankruptcy Code did not forestall the ‘automatic[]’ operation of Georgia's pawn statute, that the car dropped out of the bankruptcy estate (and vested in the pawnbroker) when the prescribed redemption period lapsed, and, accordingly, that with respect to the car, Section 1322(b)(2) had no field of operation. Simply put, following the expiration of the grace period, the pawnbroker didn't have a mere ‘claim’ on the debtor's car—it had the car itself.” 876 F.3d at 1306.

However, in that case, the debtor filed after the loan matured, and the redemption period was already running.

• In contrast, the debtor in In re Womack (11^(th) Cir.

2021)(unpublished) filed before the loan matured. That panel focused on that difference to reach a different result. However, in so doing, the panel also expressed a fundamentally different view of the effect of the automatic stay by concluding that “the automatic stay, […] froze the interest of [pawnbroker] as a lienholder with a secured interest in Womack's vehicle[…].”

• In this case, Judge Lamoutte’s reasoning seems to agree with

Northington (“This court finds that Section 362(a) does not freeze an unexpired state-law redemption period.”).

• However, the conclusion seems to suggest that it was based on the same facts as in Northington (“the debtor filed […] after the loan’s extended maturity period”), when in fact the circumstances were closer to those in Womack (i.e., the loan had not matured on the date of filing).
• Unless the debtor seeks reconsideration based on what appears to be a manifest error of fact, it will remain an open question whether it makes a difference to file before or after a pawn loan matures.
• Although not expressly addressed, the court seems to have assumed that the pawnbroker had “constructive” possession of the vehicle (to comply with §541(b)(8)) pursuant to article 1000 of the Civil Code (31P.R. Laws. Ann. §8691).
• Lastly, since the value of the vehicle exceeded the amount due, the court had not occasion to consider the issue raised by a pawnbroker’s filing of a proof of claim which includes a deficiency amount (which could go against §541(b)(8)’s requirement that the loan be non-recourse, as well as violate Act 23-2011).