Supreme Court to Decide Case Involving Discharge of Student Loans

December 23, 2009 /24-7PressRelease/ -- Supreme Court to Decide Case Involving Discharge of Student Loans

On December 1, the U.S. Supreme Court heard oral arguments in United Student Aid Funds v. Espinosa, a bankruptcy case concerning the discharge of student loan debt in a Chapter 13 bankruptcy. The Court's decision in this case could potentially affect the procedural requirements for debtors seeking to discharge some or all of their student loan debt through bankruptcy.

Proving Undue Hardship

In bankruptcy, certain types of debt cannot be discharged, such as past due child support, criminal fines and penalties and unpaid taxes. Although it can be discharged in limited circumstances, student loan debt may as well be included in this list. To have student loan debt discharged, an individual meet an incredibly onerous burden of proof; the debtor must be able to prove undue hardship. The vast majority of student loan borrowers will never be able to meet this standard.

As a procedural matter, federal bankruptcy laws require that before discharging the debt, the bankruptcy court make a determination of the debtor's undue hardship in an adversary proceeding. The creditor, or loan holder, of the student loan debt must receive sufficient notice of the proposed discharge and adversary proceeding.

United Student Aid Funds v. Espinosa

In United Student Aid Funds v. Espinosa, debtor Francisco J. Espinosa filed for a Chapter 13 bankruptcy in 1992 on four federally guaranteed student loans. The total amount of the student loans, including principal and interest, was $17,832.15. Espinosa, however, submitted a bankruptcy plan to the court seeking repayment of only the principal balance on the loan, or $13,250.00.

The bankruptcy court approved Espinosa's proposed plan for repayment of the principal only without holding an adversarial proceeding or making a finding of undue hardship. Espinosa then paid off the principal amount according to the plan and the court entered a final discharge order against Espinosa's creditors, which prohibited them from seeking repayment of any unpaid debts.

United Student Aid Funds (USAF), which serviced the student loans Espinosa discharged during bankruptcy, tried to collect payment of the remaining interest owed on the loans after the bankruptcy court entered its final discharge order. In turn, Espinosa sought an order from the bankruptcy court preventing USAF and other creditors from trying to collect the debts discharged in the bankruptcy.

The bankruptcy court affirmed its earlier order and again prohibited USAF and other creditors from attempting to collect the discharged debts. On appeal, the district court reversed the bankruptcy court's decision and ordered the bankruptcy court to hold an adversary proceeding to determine whether the debtor had demonstrated undue hardship.

The Ninth Circuit Court of Appeals reversed the district court's decision, holding that the discharge of the debt was final and that USAF had received proper notice of the student loans discharged during Espinosa's bankruptcy. USAF then filed cert with the US Supreme Court.

USAF's Arguments before the Supreme Court

In its brief, USAF argues that prior cases have held that student loan debt cannot be discharged during bankruptcy without a finding by the bankruptcy court that the debtor meets the requirements for undue hardship. Further, federal bankruptcy law and rules of procedure require that this finding happen during an adversary proceeding--neither of which happened in the current case.

USAF argues that since the bankruptcy court's confirmation of Espinosa's bankruptcy plan violated the relevant law, the court's decision is void. Accordingly, USAF argues that the order discharging Espinosa's remaining debts was not a final order and subject to review.

In addition, USAF claims that it did not receive proper notice from the bankruptcy court that it intended to include the debtor's student loans in the bankruptcy. Rather, USAF received a copy of the proposed plan from Espinosa and then a copy of the court's approved bankruptcy plan from the trustee.

Finally, USAF argues that if the Ninth Circuit's decision is allowed to stand, it could have expensive and time-consuming consequences for bankruptcy courts because it would leave open the possibility of discharging the other types of debts that Congress intended to be non-dischargeable.

Espinosa's Arguments before the Supreme Court

Espinosa argues that student loans can be discharged without a formal finding of undue hardship in an adversary proceeding.

Additionally, Espinosa argues that USAF does not have grounds to challenge a final order by the bankruptcy court six years after the discharge order and 12 years after the initial bankruptcy filing. In his brief, Espinosa notes that those involved in a bankruptcy proceeding have an important reliance interest in the finality of these orders and confirmed bankruptcy plans.

Finally, Espinosa disputes USAF's claim that it did not receive proper notice and alleges that the actual notice USAF received--first from the debtor and then from the bankruptcy trustee--more than meets the minimum constitutional notice requirements.

Conclusion

The Supreme Court will not issue its decision in this case until sometime next year. During oral arguments, the Justices seemed to agree that the bankruptcy court had violated the law by including the student loan debt in the bankruptcy. However, they also seemed to have questions over whether this error made the bankruptcy court's judgment void and whether USAF had, in fact, received proper notice of the debt discharge. The Justices also seemed concerned by the prospect of putting the burden on creditors to challenge the discharge of non-dischargeable debts in instances when the bankruptcy court does not hold an undue hardship adversary proceeding.

Article provided by Joseph C. McDaniel, P.C.
Visit us at www.josephmcdaniel.com
Bankruptcy Lawyer, Phoenix, Arizona