Earlier this month the U.S. Supreme Court heard arguments in a case involving the question of discharge of student loans in a Chapter 13 case. The case arose from a Chapter 13 petition filed in 1992 by Francisco Espinoza, an American Airlines baggage handler.
Mr. Espinoza’s story began in 1988. Sensing that airline baggage handling was not a great long term career, Mr. Espinoza enrolled in a technical school to learn computer drafting and design, and he financined his education with a student loan. Unfortunately, he was not able to find a job using his new education and he found himself in a financial bind when American Airlines froze wages and reduced his hours.
By 1992, Mr. Espinoza found himself living paycheck to paycheck and unable to pay down his $13,000 student loan. At that point, he contacted a lawyer and filed a Chapter 13 bankruptcy. The Chapter 13 plan prepared by Mr. Espinoza’s lawyer provided for full payment of the balance due on the student loan over the term of the plan but it did not provide for payment of $4,000 in accrued interest or for future interest.
The student loan lender was given notice of this plan provision and did not object. The bankruptcy judge to whom Mr. Espinoza’s case was assigned issued an order of “confirmation” that formally approved the plan. Mr. Espinoza dutifully sent in his trustee payments and approximately 5 years later, after payments were made per the confirmed plan, the judge issued a “discharge order” declaring debtor Espinoza free and clear of all debt.
In 2003 and 2004, Mr. Espinoza’s student loan creditor renewed its efforts to collect the student loan debt interest. The creditor contends that the Bankruptcy Code does not permit the discharge of any part of student loan debt unless the debtor files a special lawsuit in his bankruptcy case to ask for a finding of “undue hardship.” The creditor contends that a bankruptcy judge cannot discharge student loan debt or interest on a student loan debt through a confirmation order in the absence of a hardship discharge finding.
The United States government, 24 states and the student loan lending industry are supporting the student loan creditor in this case. You can read the court documents and more information about the Espinoza case by clicking on the link. The Supreme Court’s decision in this case is expected within the next few months.
I will be very surprised if the Court rules in favor of the Espinoza position. The Bankruptcy Code seems fairly clear in placing the burden of showing undue hardship on the debtor – to make a non-dischargeable debt dischargeable because the lender did not object to a provision buried in a Chapter 13 plan seems contrary to the plain language of the code. It will be interesting to see what happens.
UPDATE: in March, 2010, the Supreme Court ruled in favor of Mr. Espinoza, but on very narrow grounds. The Court noted that the bankruptcy judge erred in confirming Mr. Espinoza’s plan without first finding “undue hardship,” but also found that the student loan creditor waited too long to try to correct this error. The Court specifically suggests that its ruling in this case does not have broad applicability and thus the “plan provision” tactic should not be used by debtors to bypass the “undue hardship” laws.