Student Loans and Chapter 13 Bankruptcy

On March 23, 2010, the U.S. Supreme Court issued its decision in United Student Aid Funds v. Espinosa, No. 08-1134 (2010), which affirmed the 9th Circuit’s holding that a Chapter 13 Bankruptcy debtor can obtain a discharge of a student loan by including it in a Chapter 13 plan.  The loan can be discharged if the creditor fails to object after notice and opportunity to do so, and the bankruptcy court enters an order confirming the Chapter 13 plan.

In a typical bankruptcy, whether Chapter 7 Bankruptcy or Chapter 13 Bankruptcy, a student loan is not discharged unless the bankruptcy court makes a determination that the student loan would be an undue hardship on the debtor. Under Bankruptcy Rules, the court is required to make such a determination in an adversary proceeding, which is a lawsuit within the bankruptcy case.  In United Student Aid Funds, the debtor did not bring an adversary proceeding.  Rather, the debtor put in his plan that only the principal amount of the student loan would be paid through the plan, but that accrued interest would be discharged.  The student loan lender did receive a copy of the plan, and even filed a Proof of Claim.  However, the lender did not object to confirmation of the Chapter 13 plan.

Subsequently, the bankruptcy court entered an order confirming the plan as proposed.  After confirmation, the Chapter 13 trustee sent a notice to the lender, saying that the Proof of Claim amount differed from the amount stated in the Chapter 13 plan, and that if the lender disputes the amount in the plan, it should notify the trustee within 30 days.  After the debtor completed his plan payment, several years later, the student loan lender tried to collect the remaining amount due.

The debtor filed a motion seeking enforcement of his bankruptcy discharge.  The lender filed a motion seeking to declare the order confirming the Chapter 13 plan void.  Ultimately, this was the issue that the Supreme Court resolved. That is, the student loan lender argued that the bankruptcy court order confirming the Chapter 13 plan void because the lender was denied due process regarding the required statutory finding of undue hardship, which did not happen in this case.

The Supreme Court, in looking only at Bankruptcy Rule 60(b)(4), which permits a court to relieve a party for a final order or judgment, found that the lender was not denied due process, since the lender did receive the plan, filed a claim, and received the notice from the chapter 13 trustee.  The Court agreed that the confirmation of the plan without an undue hardship determination was legal error, however, the legal error does not void the order.  The Court noted that Rule 60(b)(4) strikes a balance between the need for finality of judgments, and the right of parties to have a full and fair opportunity to raise issues and the lender had ample notice and opportunity to contest the debtor’s actions.

What is to be learned from United Student Aid Funds?  Bankruptcy lawyers are well aware of the fact that lenders can make errors in dealing with both Chapter 7 Bankruptcies and Chapter 13 Bankruptcies.  However, in most chapter 13 bankruptcies, here in Rochester, New York, and elsewhere, the student loans are paid pro rata through the plan.  Thus, the bankruptcy lawyers are unlikely to follow the debtor’s approach to the student loans in United Student Aid Funds, since it is likely to be rejected by the bankruptcy court.  It appears that the bankruptcy court in that case ignored its obligation to make sure that the debtor followed the Bankruptcy Code in his Chapter 13 Bankruptcy.  At the same time , there is little harm in trying to discharge some or all of the student loan debt, since if the above approach is followed, and the bankruptcy court or the bankruptcy trustee object, the plan can be amended to comply with the law, but if the bankruptcy court rubberstamps the plan and the lender fails to object in a timely manner, the debtor may get a discharge.

If you contemplating filing Chapter 7 Bankruptcy or Chapter 13 Bankruptcy, or are dealing with debt problems in Western New York, including Rochester, Canandaigua, Brighton, Pittsford, Penfield, Perinton, Fairport, Webster, Victor, Farmington, Greece, Gates, Hilton, Parma, Brockport, Spencerport, LeRoy, Chili, Churchville, Monroe County, Ontario County, Wayne County, Orleans County, Livingston County, and being harassed by bill collectors, and would like to know more about how bankruptcy may be able to help you, contact me today by phone or email to schedule a FREE initial consultation with a Rochester, NY, bankruptcy lawyer.