Bankruptcy Experts Discuss Supreme Court’s Ruling in the Espinosa Case Affirming a Bankruptcy Court’s Authority to Discharge Student Debt Even When the Debtor Does Not Seek an “Undue Hardship” Finding Under the Bankruptcy Code
(March 24, 2010)

Issue:

The U.S. Supreme Court unanimously ruled on March 23, 2010 in the case of United Student Aid Funds v. Espinosa (08-1134), affirming a lower court ruling that a bankruptcy court has the authority to discharge a student loan debt even if the student has not sought to discharge the debt under the undue hardship found in the bankruptcy law.

The speakers include:

• Henry E. Hildebrand, III, has served as standing trustee for chapter 13 matters in the Middle District of Tennessee in Nashville since 1982 and as standing chapter 12 trustee for that district since 1986. He is chair of the Legislative and Legal Affairs Committee for the National Association of Chapter 13 Trustees (NACTT) and serves on its board of directors for its NACTT Academy for Consumer Bankruptcy Education, Inc.


• Alane A. Becket is a managing partner at Malvern, Pa.-based Becket & Lee LLP, where she specializes in representation of creditors in bankruptcy matters, primarily consumer lenders and debt purchasers.


• Rafael Pardo is an Associate Professor at Seattle University School of Law teaching in the fields of bankruptcy, commercial law, and contracts. Prof. Pardo filed an amicus brief in the Espinosa case.


• Carmen Dellutri is the managing partner and president of the Dellutri Law Group, P.A. Based out of Ft. Myers, Fla., Dellutri specializes in consumer debt reorganization.


• Prof. Juliet M. Moringiello is the ABI Resident Scholar and teaches bankruptcy law at Widener University School of Law. She served as the moderator for the media teleconference.

Background:

On March 23, 2010, the U.S. Supreme Court issued a 9-0 opinion in United Student Aid Funds v. Espinosa, in which it affirmed the Ninth Circuit’s holding (545 F.3d 1113) that a debtor may obtain discharge of a student loan by including it in a Chapter 13 plan if the creditor fails to object after notice of the proposed plan and the Bankruptcy Court confirms the plan. Under the Bankruptcy Code a student loan is non-dischargeable unless excepting such debt from discharge would impose an undue hardship on the debtor. Under Bankruptcy Rule 7001(6), bankruptcy courts are required to make the undue hardship determination in an adversary proceeding. Even under this holding, however, a debtor’s ability to discharge a student loan in the absence of an undue hardship finding is very limited. The Court emphasized that bankruptcy courts have an obligation to deny confirmation to plans that do not meet the Code’s requirements.

The debtor, Espinosa, filed for Chapter 13 in 1992. In his plan, he proposed to pay only the principal amount of his student loan due to the petitioner, United Student Aid Funds (United) and thus discharge the accrued interest. United received a copy of the plan, and in response, filed a proof of claim for the principal and interest due on the loan. The Bankruptcy Court confirmed the plan without an adversary proceeding to determine undue hardship, in contravention of the Code’s confirmation requirements. After confirmation, the Chapter 13 trustee mailed United a notice informing United that the amount claimed in its proof of claim differed from the amount listed for payment in the plan. That notice also informed United that if it wanted to dispute the treatment of its claim, it had the responsibility to notify the trustee within 30 days. United did nothing after receiving this notice. After Espinosa completed his plan, United attempted to collect the remaining debt. After Espinosa filed a motion in the Bankruptcy Court to enforce its discharge order by directing United to stop collection efforts, United filed a cross-motion under FRCP 60(b)(4) to set aside as void the order confirming the plan. This cross-motion was filed in 2003, 10 years after Espinosa’s plan was confirmed.

The question before the Court was whether the Bankruptcy Court’s order confirming the debtor’s plan was void for the purpose of Federal Rule of Civil Procedure Rule 60(b)(4). Rule 60(b) (4) permits a court to relieve a party from a final order or judgment if that order or judgment is void. United argued that the order confirming the plan was void for two reasons. First, United claimed that it was denied due process because it had not been served with a summons and complaint in an adversary proceeding to determine undue hardship. Second, United argued that the confirmation order was void because the Bankruptcy Court lacked statutory authority to confirm Espinosa’s plan absent a finding of undue hardship.

The Supreme Court held that because United had actual notice of the court’s error and failed to object to the plan or timely appeal the order confirming the plan, the order remained enforceable. United had received notice of Espinosa’s intent to discharge his student loan debt twice: when it received a copy of Espinosa’s plan after his Chapter 13 filing, and when the trustee sent notice after confirmation. The Court found that the two notices received by United satisfied United’s due process rights because due process requires notice reasonably calculated to apprise interested parties of the pending action and afford them an opportunity to present their objections.

While the Court agreed that the Bankruptcy Court’s confirmation of the plan without an undue hardship finding was legal error, the Court held that the error did not void the order. The Court stressed that a judgment is not void simply because it was erroneous and that Rule 60 (b)(4) applies only when a judgment is premised on “a certain kind of jurisdictional error” or on a “violation of due process that deprives a party of notice or the opportunity to be heard.”

The ruling preserves the finality of orders. In its opinion, the Court emphasized that Rule 60(b)(4) strikes a balance between the need for finality of judgments and the importance of ensuring that litigants have a full and fair opportunity to litigate a dispute.

The Court acknowledged United’s argument that its failure to declare the confirmation order void might encourage unscrupulous debtors to abuse the Chapter 13 process. The Court noted that debtors and their attorneys are subject to a number of penalties for engaging in improper conduct in a bankruptcy case, and that if existing sanctions are not sufficient to discourage bad faith attempts to discharge student loans, Congress should enact additional provisions.

Click here to read the Supreme Court's ruling.

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