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News Now

Washington
Supreme Court debates when student debt is dischargeable
WASHINGTON (12/11/09)—In a case of interest to credit unions, Espinosa v. United Student Aid Funds (USAF), Inc., the U.S. Supreme Court last week heard oral arguments involving a dispute on when non-dischargeable student loan debt may be discharged in bankruptcy proceedings. Under the bankruptcy law, student loans cannot be discharged unless denying such relief would impose an “undue hardship.” However, the U.S. Courts of Appeals are sharply divided on whether debtors can discharge student loan debt through a Chapter 13 plan. The federal bankruptcy rules require that the debtor’s effort to discharge student loan debt be an “adversary proceeding,” requiring that the lender be served with a summons and complaint. In this case, the debtor in a Chapter 13 plan proposed to repay $13,000 in principal over five years but to have all accrued and post-petition interest on the student loan discharged. USAF had filed a claim for the full amount including interest. The trustee told the lender that it would be paid what was listed in the plan, and USAF did not object to the plan. The bankruptcy court confirmed the plan as submitted. The court did not make an undue hardship finding, and the debtor never initiated an adversary proceeding with the lender. The debtor completed the plan over five years and received a discharge, but three years later USAF attempted to collect the remaining amount due under the student loan contract by garnishing the debtor’s federal income tax refunds, setting off a volley of conflicting rulings. In reopening the case, the bankruptcy court ruled that USAF had violated the discharge order, and directed the lender to cease all collection activities, saying that the plan became final when it was confirmed and USAF should have objected to any procedural defect prior to confirmation. The federal district court reversed the bankruptcy court, ruling that USAF had been denied due process. The Ninth Circuit Court of Appeals reversed that decision, ruling in favor of the debtor’s discharge and directing the bankruptcy court to determine if USAF had willfully violated the discharge order. In oral argument to the Supreme Court last week, USAF attorneys argued that student loan debt cannot be discharged without a showing of undue hardship in a court proceeding, and that the bankruptcy court did not apply the statute properly. The U.S. Justice Department entered the case on the side of the lender, noting that there is an important public interest at stake here because the U.S. Department of Education is reinsuring student loans. The borrower’s attorney, while acknowledging that the bankruptcy court violated the law, said that once the plan is confirmed, it is final and creditors cannot later – perhaps years later – object. This case was one of two on bankruptcy laws taken up by the high court last week. The other involved a bankruptcy law restriction on attorneys’ advice to clients to incur more debt in anticipation of bankruptcy. (See News Now 12/8/09: Supreme Court hears case on bankruptcy attorneys’ advice restriction.)


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