Debtors in 9th Circuit Can Discharge Student Loan Debt in Chapter 13 Plan

Debtors in 9th Circuit Can Discharge Student Loan Debt in Chapter 13 Plan

  
Student loan debtors who obtained partial discharge of a student loan obligation through a Chapter 13 plan, without instituting an adversary proceeding for hardship determination, are entitled to the discharge if the creditor did not timely file an objection. This decision in Espinosa v. United Student Aid Funds, 553 F.3d 1193 (9th Cir. 2008), runs contrary to recent decisions in the Third and Tenth Circuits. It provides protection against the prevalent practice among student loan creditors of reviving collection efforts on discharged debt and asserting the validity of the debt on the grounds that they were denied due process in the original bankruptcy proceeding.
 
The issue before the court involved whether the lender had violated a three year old discharge order by intercepting Espinosa’s Federal income tax refund. In ruling that it had, the court not only confirmed the original discharge but left open the possibility of sanctions and recovery of damages against the lender.
 
Student loan creditors have uniformly maintained that an adversary proceeding to determine undue hardship is necessary before a student loan can be discharged. Most of the cases at issue were initiated before, or shortly after the Higher Education Act of 1998 made federally guaranteed student loans nondischargeable except in cases of undue hardship. At that time, partial discharge of student loans through Chapter 13 plans was common and lenders rarely challenged such plans. In the past few years, assignees such as ECMC have resumed collection on these supposedly discharged “zombie loans”, and have successfully gotten them reinstated, arguing that notification procedures denied the creditor due process. A decision in the 10th Circuit, Educational Credit Management Corporation v. Mersmann 505 F. 3d 1033 (10th Cir. 2007) is representative of these resurrected loans. Espinosa explicitly repudiates Mersmann as well as a handful of lower court decisions in the 9th Circuit that relied on it.
 
Judge Alex Kozinski provided several well-reasoned arguments for allowing bankruptcy courts to modify student loans in bankruptcy without invoking the protracted litigation involved in undue hardship determination.  He also pointed out that the lender’s failure to object to the Chapter 13 plan at the time, when it had ample notice of the reduced dividend, could well have been motivated by prudent self-interest rather than oversight. That is, the expected net return under the plan may well have exceeded what could have been collected outside of bankruptcy, or the lender may have anticipated that the plan would fail.  To allow the lender to subsequently claim a procedural defect struck judge Kozinski as inequitable.
 
The amounts in dispute in Espinosa were not large, and consisted of interest and fees rather than principal. A subsequent district court case that follows it, Needelman v. Pennsylvania Higher Education Assistance Agency, 2009 U.S. Dist. Lexis 31, confirmed discharge of all but 28% of $104,275 loan obligation in a Chapter 13 bankruptcy filed in 2001.
 
This is not a major advance for debtors with student loans.  While any breach in the nearly impenetrable wall built around student loan debt would be welcome, this is more likely the case of  creditors dropping the ball than a new avenue for discharge. In any event, the Supreme Court may have the last word on this subject.  A petition for certiorari was filed March 10, 2009.
 

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