Bankruptcy Newsletter

Discharging Student Loan Debt Without Undue Hardship Finding   The United States
Supreme Court has granted certiorari in United Student Aid Funds, Inc. v. Espinosa, a case in which the Ninth Circuit Court of Appeals held that a debtor could discharge student loan debt by including it in a Chapter 13 plan, without complying with the heightened notice requirements embodied in the Bankruptcy Code and the bankruptcy rules and without initiating an adversary proceeding in which the debtor would be required to show undue hardship.

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The United States Supreme Court has granted certiorari in United Student Aid Funds, Inc. v. Espinosa (Docket No. 08-1134), 2009 WL 646192, a case in which the Ninth Circuit Court of Appeals held that a debtor could discharge student loan debt by including it in a Chapter 13 plan, without complying with the heightened notice requirements embodied in the Bankruptcy Code and the bankruptcy rules and without initiating an adversary proceeding in which the debtor would be required to show undue hardship. In this decision, Espinosa v. United Student Aid Funds, Inc., 545 F.3d 1113 (C.A.9-Ariz. 2008), op. amended and superseded, 553 F.3d 1193 (C.A.9-Ariz. 2008), the Ninth Circuit further held that the student loan creditor's due process rights were not violated because the creditor received actual notice of the debtor's Chapter 13 case and proposed plan.

In the case before the Ninth Circuit, the student loan creditor had argued that, under 11 U.S.C.A. § 523(a)(8), student loans cannot be discharged under Chapter 13 unless the debtor shows undue hardship, and, pursuant to Bankruptcy Rule 7001(6), such a showing must be made in an adversary proceeding. The debtor, however, did not initiate an adversary proceeding, and, instead, listed the student loan debt in his Chapter 13 plan, which the bankruptcy court confirmed. The Chapter 13 trustee mailed to the student loan creditor a notice advising that the amount of the claim filed differed from the amount listed for payment in the plan. The notice included a warning that the claim would be treated as indicated in the plan unless the trustee received, within 30 days of the mailing of the notice, a written request for different treatment of the claim. The creditor did not object to the Chapter 13 plan or make a written request for different treatment of its claim. The debtor successfully completed the plan, and the bankruptcy court granted him a discharge. Three years later, when the creditor began intercepting the debtor's income tax refunds to satisfy the unpaid portion of the student loan, the debtor petitioned the bankruptcy court for an order holding the creditor in contempt, and the creditor brought a cross-motion for relief from the bankruptcy court's order confirming the plan, on the ground that the order had been entered in violation of the creditor's rights.  The Arizona bankruptcy court found that the creditor had violated the discharge injunction, and denied the creditor's cross-motion for relief from the order confirming the plan. The creditor appealed, and the district court reversed. The debtor appealed. On appeal, the student loan creditor made both a statutory and a constitutional argument for setting aside the confirmed plan, based upon the debtor's failure to obtain a determination of undue hardship.

The Ninth Circuit, in ruling in favor of the debtor, stated that on the non-constitutional issue it was bound by its prior decision in In re Pardee, 193 F.3d 1083 (C.A.9-Ariz. 1999), with which it said the Second and Tenth Circuits had disagreed. The Ninth Circuit's opinion characterized the Pardee decision as firmly rejecting a student loan creditor's argument that a debtor's Chapter 13 plan was not final under 11 U.S.C.A. § 1327(a) because the creditor had not been given the benefit of the additional procedures in the Code and rules applicable to the discharge of student loans. The court further characterized Pardee as essentially holding that a discharge was a final judgment that could not be set aside or ignored because a party suddenly claimed, years later, that the trial court committed an error.

The Ninth Circuit indicated that the provision giving student loan creditors a right to special procedures was pertinent when a case was pending before the bankruptcy court. If a debtor proposed the discharge of student loan debt without following these procedures, the Ninth Circuit explained, the creditor could object to the debtor's plan until a showing of undue hardship was made in an adversary proceeding. The Court of Appeals noted, however, that there were many reasons a student loan creditor might not object to a Chapter 13 plan that proposed to discharge a student debt loan without invoking the special procedures applicable to such a debt. When a student loan creditor is served with notice of the proposed plan, the court pointed out, it has a full and fair opportunity to insist on following the special procedures by objecting to the plan on the ground that there was no finding of undue hardship. Rights can be waived or forfeited if not raised in a timely fashion, the Ninth Circuit observed, and waiver or forfeiture does not mean that these rights are ignored, nor that a judgment entered after a party has failed to assert its rights conflicts with the statutory scheme or is somehow invalid.

The Bankruptcy Code's finality provision comes into play later in the process, after the bankruptcy proceedings have come to an end, the Ninth Circuit stated. A bankruptcy discharge order is a final judgment, and even without the special protection of § 1327(a), a final judgment cannot be ignored or set aside just because it was the result of an error. Errors committed during the course of litigation must be corrected by way of a timely appeal, and after a judgment has been finalized and the time for appeal has run, the judgment can be reconsidered only in the limited circumstances provided by the rule governing motions for relief from judgment, Rule 60(b) of the Federal Rules of Civil Procedure. The Ninth Circuit said that the decisions of the Second and Tenth Circuits disagreeing with Pardee paid "scant attention" to Rule 60(b) and "elided" the requirements of Rule 60(b) by treating the matter as a question of res judicata. However, a discharge injunction does not operate by way of res judicata. Instead, it is an equitable remedy precluding a creditor, on pain of contempt, from taking any action to enforce the discharged debt.

Even if res judicata were the relevant doctrine, the Ninth Circuit said that the decisions of the Second and Tenth Circuits offered no persuasive reasons why the discharge order in the case before it should be denied preclusive effect. The creditor, after receiving proper notice of the proposed Chapter 13 plan, did not object. Rather, the creditor "accepted the payments made by the debtor during the plan's life and then acted as if the whole thing never happened," the Ninth Circuit said. The only thing the creditor had not been told in the notice was that it could insist on an adversary proceeding and a judicial determination of undue hardship. But this was "less a matter of notice and more of a tutorial as to what rights the creditor has under the Bankruptcy Code—a long-form Miranda warning for bankers," which is not the standard for adequate notice, the Ninth Circuit stated.

With respect to the due process issue, citing Mullane v. Central Hanover Bank & Trust Co., 339 U.S. 306, 70 S.Ct. 652, 94 L.Ed. 865 (1950), the Ninth Circuit noted that the standard for what amounts to constitutionally adequate notice is fairly low: it is notice reasonably calculated, under all the circumstances, to apprise interested parties of the pendency of the action and to afford them an opportunity to present their objections. The reasoning of the Ninth Circuit in In re Gregory, 805 F.2d 1118 (C.A.9-Cal. 1983), as the law of the circuit, was entirely consistent with Mullane, the Court of Appeals opined. The Gregory decision, with which, the Ninth Circuit noted, the Fourth, Sixth, and Seventh Circuits had disagreed, stated that when the holder of a large, unsecured claim receives any notice from the bankruptcy court that its debtor has initiated bankruptcy proceedings, it is under constructive or inquiry notice that its claim may be affected, and it ignores the proceedings to which the notice refers at its peril.

In the case before the Ninth Circuit, the creditor received actual notice of the Chapter 13 case, as evidenced by the documents in the record and the creditor's conduct in presenting a proof of claim. Since due process does not require actual notice, it followed a fortiori that actual notice satisfies due process, the Ninth Circuit stated.

The Ninth Circuit said that to the extent it could understand the reasoning of the Fourth, Sixth, and Seventh Circuits in disagreeing with Gregory, those courts apparently believed that a creditor entitled to heightened notice by statute was also entitled to such heightened notice as a matter of due process. The Ninth Circuit said that it was "both wrong and dangerous" to hold that the standard for constitutionally adequate notice can be changed by legislation. Furthermore, even if Congress could have affected the constitutional standard, it did not do so, and instead made it clear that a creditor, to be bound by the terms of a Chapter 13 plan, need only get ordinary notice of the plan. "That Congress provided heightened notice requirements for an adversary proceeding, which didn't take place here, is of no consequence," the Ninth Circuit stated.

In petitioning for a writ of certiorari, the student loan creditor contended that the Ninth Circuit's decision conflicted with the principles recognized by the Supreme Court in Tennessee Student Assistance Corp. v. Hood, 541 U.S. 440, 124 S.Ct. 1905, 158 L.Ed.2d 764 (2004). It also emphasized the existence of a circuit split on the issue.

The obligation imposed by the bankruptcy rule requiring any attorney representing a debtor to file a statement of compensation paid or agreed to be paid attaches when a lawyer receives payment from a debtor for the provision of services in connection with a bankruptcy. It is in no way limited to attorneys who are counsel of record. Thus, an attorney who received payments from debtors in connection with their bankruptcy proceedings had an unconditional duty to disclose the full amounts paid, notwithstanding his contention that he was not under an affirmative duty to file a supplemental disclosure statement because he was not the attorney of record for the debtors. In re Cowan, 2009 WL 736011 (E.D.Tenn., Judge Collier).

The provision of a Chapter 11 plan that delayed a judgment creditor's enforcement of its rights against the owners of the debtor-limited liability company for approximately two and one-half years was fair and equitable, as required for the confirmation of the plan despite its rejection by the creditor class to which the judgment creditor belonged. The debtor's owners were to contribute $400,000 to the debtor to effectuate the plan, which was essential to the plan's success and the resulting full payment of all creditors. The judgment creditor's enforcement of its judgment against the owners, however, would impair the owners' ability to make that contribution, thereby jeopardizing the plan's likelihood of success and making it likely that there would be no recovery by the unsecured creditors. In re Regatta Bay, LLC, 2009 WL 1609388 (Bkrtcy.D.Ariz., Judge Haines).

The time for a Chapter 11 debtor-optionee to exercise an option that had not yet expired as of the commencement of its bankruptcy case was extended for a period of 60 days after the order for relief, pursuant to 11 U.S.C.A. § 108(b)(2), a Bankruptcy Code provision specifying that when the debtor files for bankruptcy just prior to the expiration of any period fixed by applicable nonbankruptcy law or agreement for the filing of any pleading, demand, notice, or proof of claim or loss, the curing of any default, or the performance of any other similar act, that period shall be extended for 60 days after the order for relief. The exercise of the option was in the nature of "any other similar act," as used in the Code provision. Significantly, the optionor had not asserted that the petition, which was filed a mere 39 minutes before the option was set to expire, was filed solely for the purpose of extending the option date by a debtor that was not in any financial distress. In re Empire Equities Capital Corp., 2009 WL 1544394 (Bkrtcy.S.D.N.Y., Judge Gropper).