Supreme Court to Tackle Student Loan Discharges

The U.S. Supreme Court will review whether a debtor can simply discharge his student loan through a declaration in his Chapter 13 plan rather than proving undue hardship in an adversary proceeding as required by the Bankruptcy Code.

In particular, the high court will decide if lender United Student Aid Funds Inc. waived its right to contest the discharge of Francisco Espinosa's student loan because it failed to file an objection until more than three years after the discharge was granted.

Last October the 9th U.S. Circuit Court of Appeals held that United did not file a timely objection after receiving proper notice of Espinosa's Chapter 13 plan and knew the amount to be paid on the student loan was less than the amount the lender claimed.

Thus, the appeals panel said United waived its right to insist on an adversary proceeding over the student loan.

The company asked the Supreme Court to review the decision, arguing that the 9th Circuit improperly allowed Espinosa to circumvent a provision of the Bankruptcy Code that allows debtors to discharge student loans only by proving in an adversary proceeding that payment of the loan will cause an undue hardship.

United argued that the discharge of the loan through the Chapter 13 plan violated its right to due process.

Espinosa filed a Chapter 13 bankruptcy petition in the U.S. Bankruptcy Court for the District of Arizona. His repayment plan proposed to pay United $13,250 owed for student loans. United filed a proof of claim asserting that Espinosa owed $17,800 on the loans.

The Bankruptcy Court confirmed the plan, and the trustee administering the case notified United that the claim would be treated as listed in the plan unless the company filed a written objection. United did not object.

Following the successful completion of the repayment plan, the Bankruptcy Court granted Espinosa a discharge.

Three years later United allegedly began intercepting Espinosa's income tax refunds and applying the funds to the unpaid portion of the student loans.

Espinosa filed a petition in the Bankruptcy Court to hold United in contempt for violating the discharge injunction, and the company responded with a motion seeking relief from the order confirming the Chapter 13 plan.

The lender argued that since Espinosa never filed an adversary proceeding over the student loan debt, the confirmation of the plan providing for less than full payment of its claim violated its due-process rights.

The Bankruptcy Court ruled that United violated the discharge injunction and ordered it to cease all collection activity against Espinosa.

United appealed to the U.S. District Court for the District of Arizona, which reversed the decision.

Espinosa then appealed to the 9th Circuit, which found the discharge valid.

In its petition for certiorari to the Supreme Court United pointed out that the 9th Circuit is the only one of six federal appeals courts to find such a discharge enforceable. Five others have reached the opposite conclusion on indistinguishable facts.

"The decision below is not merely erroneous, it is intolerable given the necessity of national uniformity in bankruptcy law," United said.

The lender argued that even if it had actual knowledge that the Chapter 13 plan called for the discharge of the loan, it was "entitled to notice in the manner specified by law," that is, through an adversary proceeding.

Espinosa countered that "this is a waiver case, not a due-process case."

"The [9th Circuit's] opinion in this case correctly avoided stretching the due-process clause into a tool by which litigants can either make up for their mistakes or change tactics years after a judgment has become final and been performed," he said in his opposition brief.

The 9th Circuit correctly found that United received due process and waived its right to contest the discharge, Espinosa said.

The Supreme Court will take up the matter in its next session.

To comment, ask questions or contribute articles, contact West.Andrews.Editor@ThomsonReuters.com.

Charles W. Wirken, Madeleine C. Wanslee and Sean P. O'Brien of Gust Rosenfeld in Phoenix represent United. James L. Robinson Jr. of Robinson & Rylander and Michael J. Meehan of Munger Chadwick, both in Tucson, Ariz., represent Espinosa.