I suppose we should understand by now that judges are human and they make mistakes. However, a judge in the bankruptcy court for the Western District of Texas recently made a doozey in a recent case that is causing a big stir in the vehicle financing industry throughout Texas.

The case seemed simple enough. Clark Contracting Services, a San Antonio construction company, bought six big, specialized trucks that happened to need certificates of title under the Texas titling law. CIT Equipment Financing financed Clark’s purchase with the trucks serving as collateral subject to lien in favor of CIT. Accordingly, CIT was listed as the lien holder on the six certificates of title.

About a year later, Wells Fargo Equipment Finance bought the financing contracts from CIT. As part of the deal, Wells took an assignment of CIT’s lien in the trucks, but it didn’t re-title the vehicles to replace CIT as the listed lien holder. About a year after that, Clark filed for Chapter 11 bankruptcy.

In the bankruptcy, Clark asked the court to void Wells Fargo’s lien on the trucks. Clark argued that the Texas titling law required Wells Fargo to re-title after the lien was assigned to it. The bankruptcy judge agreed with Clark Equipment and that left Wells Fargo with no collateral and an unsecured claim in the bankruptcy proceeding. Not what Wells had in mind when it got involved in the deal.

So Wells Fargo loses six specialized construction vehicles — why should you care about that? Turns out that the decision, if upheld, exposes the holders of millions of ordinary Texas motor vehicle financing contracts to big losses if the customers who owe the money under the contracts file for bankruptcy protection.

Why, you ask? Because the decision has serious, negative implications for a common process in the vehicle financing industry known as "securitization," a critically important source for the funds finance companies and banks need to buy more financing contracts from dealers. Loan originators bundle up existing contracts and sell the bundles to something called a securitization trust. The trust then sells securities to investors that represent ownership of a piece of the payment streams due under the bundles of contracts the trust bought.

As part of the process, the securitization trust takes an assignment of the lien in the vehicles that serve as collateral for the individual contracts. In Texas and elsewhere, it is common practice not to re-title the vehicles to show the securitization trust as lienholder. First, it would be hugely expensive to re-title thousands of vehicles as part of the process. Second, listing the securitization trust on the title would likely confuse the customers who owe the money under these contracts because the finance company or bank usually continues to service the contracts in its own name after they are securitized.

Of course, if state law required re-titling, that step — and expense — would be included in the process. But nobody thought Texas law required the securitization trust to re-title. Now, the judge in this case says that it does. If he’s right, securitization trusts holding millions of these “securitized” Texas contracts could have their liens voided if the customers who owe the money under the contracts file for bankruptcy protection.

Fortunately, most people familiar with this area of the law are pretty confident that the judge is wrong and will probably be overturned on appeal. In addition, as I write this article, Texas is on the verge of changing its titling law to undo the judge’s decision. Unfortunately, until these things happen, the risk and uncertainty caused by this decision will probably hamper efforts to raise money through securitizations in a market where money is already tight.

EDITOR'S NOTE: Legislation overturning the ruling in this case was passed by both houses of the Texas legislature in late May. Texas Gov. Rick Perry has until June 21 to sign or veto the bill; Perry has given no indication he will send it back to the legislature.

Tom Buiteweg is a partner in the Michigan office of Hudson Cook LLP. His practice focuses on helping dealers, finance sources and manufacturers establish and maintain national consumer automobile finance and leasing programs, mortgage and other credit programs. He can be reached at tbuiteweg@special-finance.com.