U.S. Supreme Court Upholds Discharge of Student Loan Debt

On March 23, 2010, the U.S. Supreme Court decided the case of United Student Aid Funds, Inc. v Espinosa dealing with the discharge of a government-sponsored student loan debt in the absence of a determination of undue hardship by way of an adversary proceeding. This decision may have far-reaching application to situations where creditors fail to object to chapter 13 plan provisions in a timely manner.

In Espinosa, the debtor filed a plan proposing to discharge a portion of his student loan debt, but he did not initiate an adversary proceeding as required by the Bankruptcy Rules to obtain a finding of undue hardship. The creditor did not object to the plan and the plan was duly confirmed. Seven years later United filed a motion under FRCP 60(b)(4) seeking to set aside the confirmation order as void, arguing that the plan provisions were inconsistent with the Bankruptcy Code and Rules and that its due process rights had been violated due to debtor’s failure to serve it with summons and complaint as required in an adversary proceeding. The Bankruptcy Court rejected these arguments. United appealed to the District Court which reversed, being persuaded by the due process argument. Espinosa appealed to the Ninth Circuit Court of Appeals which reversed the judgment of the District Court, concluding that the Bankruptcy Court had at worst committed a legal error (which United could have appealed) by confirming the plan without finding undue hardship in an adversary proceeding. The Court of Appeals did not find this legal error a sufficient basis to set aside the confirmation order as void under Rule 60(b). The Court noted that United received actual notice of debtor’s plan and failed to object.

The Supreme Court initially noted that the Bankruptcy Court’s order confirming the plan was a final judgment from which United did not appeal, and that a motion under Rule 60(b)(4) is not a substitute for a timely appeal. The Court stated that “Rule 60(b)(4) applies only in the rare instance where a judgment is premised either on a certain type of jurisdictional error or on a violation of due process that deprives a party of notice or the opportunity to be heard.” In this case the Bankruptcy Court’s error was not jurisdictional. Citing the well-established axiom that “Due process requires notice reasonably calculated, under all the circumstances, to apprise interested parties of the pendency of the action and afford them an opportunity to present their objections,” the Court found that United’s actual notice of the filing and contents of debtor’s plan more than satisfied its due process rights. The Court decided that the Bankruptcy Court’s failure to find undue hardship before confirming debtor’s plan was a legal error, but that the confirmation order remains enforceable and binding because United had notice of the error and failed to object or timely appeal.

Having dealt with the 60(b) issue, the Court criticized the Court of Appeals’ assertion that bankruptcy courts must confirm a plan proposing the discharge of a student loan debt without a determination of undue hardship in an adversary proceeding unless the creditor timely raises a specific objection. The Supreme Court admonished that “the Code makes plain that bankruptcy courts have the authority – indeed the obligation- to direct a debtor to conform his plan to the requirements of section1328(a)(2) and 523(a)(8).”

Notwithstanding the Court’s directive to the bankruptcy courts, creditors are best served by closely scrutinizing chapter 13 plans and raising timely objections to inappropriate provisions. To further discuss this case, or any other bankruptcy-related issues, contact Bill Logan, Fred Luper, or Debbie Ecker at 614-221-7663.