Chapter 4 Special Issues in Cases

• Jurisdiction: United States

Chapter 4 Special Issues in Chapter 13 Cases

This chapter provides a basic introduction to chapter 13 of the Bankruptcy Code and describes the special educational loan issues that can arise in conjunction with chapter 13 cases. Like a debtor in chapter 7, a chapter 13 debtor may file an adversary proceeding under § 523(a)(8) seeking to have her student loans discharged as an undue hardship.²⁹⁸ Although adversary proceedings are governed by a uniform set of rules, the debtor's choice of chapter 13 will raise several distinct issues within that adversary proceeding. These include the points addressed by the Supreme Court in United Student Aid Funds Inc. v. Espinosa,²⁹⁹ as well as the proper time for filing the adversary complaint during the long life of the chapter 13 plan. After introducing chapter 13 bankruptcy, this chapter explores the special issues that can arise in § 523(a)(8) adversary proceedings connected to chapter 13 cases.

When a debtor chooses to file for bankruptcy under chapter 13, however, the most intricate questions relating to educational debt frequently occur in the case itself, and not in an adversary proceeding filed under § 523(a)(8). These issues concern the debtor's ability (or inability) to use the chapter 13 plan to pay or adjust his student loans, including (1) the accrual and payment of post-petition interest on student loan claims, (2) the use of separate classification under § 1322(b)(1) to provide more favorable treatment to nondischargeable student loan claims and the related use of § 1322(b)(5) to cure defaults and maintain regular payments outside the plan, (3) whether student loan payments can be considered special circumstances that justify a downward adjustment in the debtor's projected disposable income and (4) whether a debtor who devotes all his projected disposable income to a plan is free to pay student loan creditors with his remaining surplus income.

A. A Brief Introduction to Chapter 13

A debtor commences a chapter 13 bankruptcy case by filing a petition with the court, along with schedules and statements explaining the debtor's financial picture. However, instead of receiving a prompt discharge, the chapter 13 debtor must submit a plan of reorganization under which she devotes all of her "projected disposable income" to repay a percentage of unsecured debt by making monthly plan payments to the trustee over a period of three to five years.³⁰⁰ To be confirmed, the plan must also propose to distribute property equal to or greater than the amount that all unsecured claims would be paid if the debtor's estate were liquidated under chapter 7 on the effective date of the plan.³⁰¹ If the plan satisfies these two tests and is confirmed, the debtor will be permitted to retain nonexempt property that a trustee would normally liquidate in chapter 7.³⁰²

After BAPCPA, a mechanical formula similar to the chapter 7 means test is used to determine the amount of a chapter 13 debtor's "disposable income" that must be paid each month to fund the chapter 13 plan.³⁰³ The test is calculated on Official Bankruptcy Form 22C, which requires the debtor to enter his income and expenses according to certain statutory formulae and allowances. The resulting amount is the debtor's "disposable income" for purposes of the statute. For some debtors, the disposable income calculated on Form 22C may be less than the debtor's actual net income.³⁰⁴

Under the plan of reorganization, the debtor makes a single monthly payment to the chapter 13 trustee, who then distributes the payment among creditors with claims that are included in the plan.³⁰⁵ Failure to make plan payments is grounds for dismissal of the case.³⁰⁶ Unless a secured claim is modified in the plan, the debtor must remain current on payments for secured debt, such as a house or vehicle, if the debtor wishes to retain the collateral.³⁰⁷ A chapter 13 plan must also provide for the full payment of all priority claims filed in the case.³⁰⁸ Finally, a chapter 13 plan must be feasible and proposed by the debtor in good faith.³⁰⁹

At least one chapter 13 trustee is appointed in every federal district to oversee chapter 13 cases filed in the district.³¹⁰ The primary duties of a chapter 13 trustee are to receive the monthly payments made by the debtors³¹¹ and to distribute the proceeds to the debtor's creditors as provided for in the plan.³¹² The trustee ensures that the debtor commences payments under the plan, ensures that the plan meets the confirmation requirements of the Code, and may move to dismiss the case if the debtor defaults on plan payments. Some bankruptcy courts and chapter 13 trustees allow debtors to pay secured or long-term debts (debts with repayment periods that extend beyond the duration of the plan) directly to the creditor and outside the plan.³¹³

A chapter 13 debtor does not receive a discharge until payments are completed under the plan.³¹⁴ Unless a prior bankruptcy case has been dismissed within the preceding year, a chapter 13 debtor will receive the benefit of the automatic stay until she receives a discharge in the case.³¹⁵ Unlike any other chapter, the filing of a petition under chapter 13 also creates a co-debtor stay that enjoins creditors from taking action against any nonfiling individual who is liable on a consumer debt with the chapter 13 debtor.³¹⁶

Finally, chapter 13 has restrictive eligibility limits. A chapter 13 case may only be filed by an individual debtor who has regular income to fund the plan.³¹⁷ In addition, the debtor's liabilities must fall below the debt limits stated in § 109(e) of the Code. A debtor is eligible to file chapter 13 only if, as of the petition date, her noncontingent, liquidated secured debts are less than $1,184,200 and noncontingent, liquidated, unsecured debts are less than $394,725.³¹⁸

B. Undue-Hardship Determinations in Chapter 13

Bankruptcy Rule 7001(6) provides that the dischargeability of a student loan debt must be determined in an adversary proceeding governed by the rules in Part VII of the Federal Rules of Bankruptcy Procedure.³¹⁹ Although the same general procedures apply in § 523(a)(8) cases filed in connection with cases under all chapters, a few distinct issues have arisen in connection with chapter 13. The first such issue is whether the chapter 13 plan confirmation process can be used in lieu of an adversary proceeding to determine the dischargeability of a student loan debt. The second issue is whether a chapter 13 debtor is required to wait until near the end of his plan to file a complaint under § 523(a)(8).

1. Discharge by Confirmation: United Student Aid Funds Inc. v. Espinosa

The debtor in Espinosa filed a chapter 13 plan that listed his student loans as his only debts.³²⁰ The plan proposed to pay only the $13,500 principal on those debts, stating that the accrued interest would be discharged upon completion of the plan. The student loan creditor, United Student Aid Funds, Inc. (United), was given notice of the plan and subsequently filed a proof of claim for $17,832, the amount of the principal and accrued interest. United did not file an objection to the plan's proposed discharge of the interest on the debtor's student loans and did not object to the debtor's failure to file an adversary proceeding to determine undue hardship under § 523(a)(8).³²¹

One month after Espinosa's plan was confirmed, the trustee mailed United a notice that the amount of the claim filed differed from the amount proposed for payment in the plan. The notice stated that the claim would be paid as listed in the plan and requested United to notify the trustee within 30 days if it wished to dispute the plan payment. United again failed to object. Espinosa ultimately completed payments on his plan and was granted a discharge of the interest on his student loans in 1997.

Three years later, in 2000, the creditor took steps to collect the unpaid interest.³²² These efforts continued until 2003, when Espinosa filed a motion asking the bankruptcy court to enforce the discharge order entered in 1997. United responded by filing a cross-motion under Rule 60(b)(4) seeking to set aside the confirmation order as void. United argued that Espinosa's plan was inconsistent with the Bankruptcy Code's requirement that a court find undue hardship before discharging a student loan debt. United also claimed that it had been denied due process because Espinosa failed to file an adversary proceeding and serve United with a summons and complaint as required by the Bankruptcy Rules.

In a unanimous opinion, the Supreme Court held that the confirmation order was a final judgment and was not rendered void by the bankruptcy court's error in discharging a student loan obligation without a finding of undue hardship.³²³ The Court also held that the bankruptcy court's error was not jurisdictional and did not violate the creditor's due-process rights.³²⁴ Instead, the undue-hardship requirement in § 523(a)(8) is a statutory precondition to discharge that does not limit the court's jurisdiction.³²⁵ In addition, despite the absence of a summons and complaint, due process was satisfied by the creditor's actual notice of the bankruptcy case and contents of the plan.³²⁶

In reaching this holding, the Court stated that the bankruptcy court had an obligation to avoid this type of error by independently determining undue hardship in a chapter 13 case, even without the objection of or appearance by the creditor:³²⁷

Neither the Code nor the Rules prevent[s] the parties from stipulating to the underlying facts of undue hardship, and neither prevents the creditor from waiving service of a summons and complaint. But, to comply with § 523(a)(8)'s directive, the bankruptcy court must make an independent determination of undue hardship before a plan is confirmed, even if the creditor fails to object or appear in the adversary proceeding.³²⁸

Finally, the Court noted that this holding created some incentive for debtors and their attorneys to...