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In re Short - 170 B.R. 128 (Bankr. S.D. Ill. 1994)

Rule:

The second line of cases, rejecting the "all or nothing" approach of the transformation rule, holds that a lien may be partially purchase-money and partially nonpurchase-money and that the purchase money aspect of a lien is not automatically destroyed by refinancing or consolidation with other debt.

Facts:

Debtors had entered into a retail installment contract with Anderson Warehouse Furniture for the purchase of bedroom furniture. Under the contract, no interest was charged for one year and no payments were due until June 20, 1993, at which time the entire balance of $2,880.00 became due. The contract, which granted a security interest in the bedroom furniture purchased by the debtors, was assigned to American on the  date it was signed. The debtors made no payments under this contract. On July 16, 1993, the debtors executed a note with American in which they consolidated the June 20 contract obligation with another note to American for $3,642.33 dated June 22, 1992. The July 16 note in the amount of $7,337.30 provided funds to pay off the June 20 and June 22 notes, with the remaining balance applied to pay credit life and disability insurance premiums. The July 16 note, providing for an interest rate of 21.90%, was to be paid in monthly installments, with the final payment due in July 1997. A disclosure statement accompanying the note described the collateral for the July 16 note as a "continued purchase money interest" in the debtors' bedroom furniture and, on a separate line, listed numerous other recreational and household items owned by the debtors. There was no indication that these latter items served as collateral for the June 22 note or that American had a purchase money security interest in them.

Issue:

Was “purchase money security interest” extinguished when the original purchase money loan was refinanced?

Answer:

No

Conclusion:

The debtors had made no payments on the original purchase money loan of June 20 at the time they agreed to consolidate this obligation with another, nonpurchase money note of June 22. Since the entire purchase price of the collateral remained unpaid, it is unlikely the parties intended to extinguish the debtors' obligation under the first note or to change its character. Rather, the purchase money note of June 20, a no-interest note with one annual payment, was essentially "extended" by the consolidation note of July 16 to allow for monthly payments at a commensurately high interest rate. The parties' intent to continue the purchase money character of American's lien following consolidation was specifically stated in the documentation for the July 16 note, in which the security was described as a "continued purchase money interest" in the debtors' bedroom furniture. 

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