Oral argument: Dec. 1, 2009
Appealed from: United States Court of Appeals for the Ninth Circuit (Dec. 10, 2008)
BANKRUPTCY, STUDENT LOANS, CHAPTER 13, DISCHARGE, RES JUDICATA, DUE PROCESS
Francisco J. Espinosa filed for Chapter 13 bankruptcy and proposed in his Chapter 13 reorganization plan that he would repay $13,250 in student loans to United Student Aid Funds (“Funds”). Although Funds claimed they were owed an additional $4,582.15, the U.S. Bankruptcy Court for the District of Arizona confirmed Espinosa's plan as proposed, and Funds did not object to the confirmed plan. Espinosa repaid all debts according to the Chapter 13 plan. Funds subsequently began to intercept Espinosa's income tax refunds, claiming that Espinosa had improperly discharged his student loans, because Espinosa had not initiated a statutorily required adversary proceeding to determine whether repayment of the student loans would constitute an "undue hardship." While the U.S. District Court of Arizona held that Espinosa had violated Funds' due process interests by failing to initiate an adversary proceeding and serve a complaint and summons upon Funds according to the statutory procedure, the United States Court of Appeals for the Ninth Circuit reversed, and Funds now appeals. The Supreme Court’s decision in this case will determine how student loans and other debts are collected in bankruptcy and will affect the overall relationship between debtors and creditors in America.
1. Student loans are statutorily non-dischargeable in bankruptcy unless repayment would cause the debtor an "undue hardship." Debtor failed to prove undue hardship in an adversary proceeding as required by the Bankruptcy Rules, and instead, merely declared a discharge in his Chapter 13 plan. Are the orders confirming the plan and discharging debtor void?
2. Bankruptcy Rules permit discharge of a student loan only through an adversary proceeding, commenced by filing a complaint and serving it and a summons on an appropriate agent of the creditor. Instead, debtor merely included a declaration of discharge in his Chapter 13 plan and mailed it to creditor's post office box. Does such procedure meet the rigorous demands of due process and entitle the resulting orders to respect under principles of res judicata?
1. Is a bankruptcy court’s confirmation of a debtor’s Chapter 13 plan void when the plan improperly discharges the debtor’s statutorily non-dischargeable student loans?
2. Does a debtor violate the due process rights of a student loan creditor when, instead of commencing a statutory adversary proceeding by filing a complaint and serving it, the debtor merely states in his Chapter 13 plan that the debt owed to the creditor will be discharged?
In 1988, Respondent Francisco J. Espinosa borrowed $13,250 in student loans through the Federal Family Education Loan Program, which grants federally guaranteed loans. See Brief for Petitioner, United Student Aid Funds, Inc. at 2. In 1992, Espinosa voluntarily filed for bankruptcy under Chapter 13 in the United States Bankruptcy Court for the District of Arizona. See Brief for Respondent, Francisco J. Espinosa at 2.
Under Chapter 13, a debtor is required to file with the bankruptcy court a repayment plan proposing how the debtor's creditors will be repaid. See Brief for Petitioner at 4; (citing 11 U.S.C. §1321). In his Chapter 13 repayment plan, Espinosa proposed to repay $13,250 in student loans to United Student Aid Funds ("Funds"). See Espinosa v. United Student Aid Funds, Inc., 553 F.3d 1193, 1197 (9th Cir. 2008). After receiving notification about Espinosa's bankruptcy petition, Funds filed a proof of claim for the $13,250 in student loans, and an additional $4,582.15 in interest, totaling to $17,832.15. See id. However, the bankruptcy court confirmed the amount proposed in Espinosa's repayment plan. See id. Espinosa's bankruptcy trustee subsequently notified Funds that the amount specified for payment in the plan differed from the amount Funds claimed. See id. The notification sent to Funds also included a warning stating that if Funds wished to object to Espinosa's repayment plan, Funds had thirty days to do so. See id. Funds, however, did not proceed with an objection, and Espinosa paid off all obligations required by the repayment plan. See Brief for Respondent at 5. Following completion of the repayment plan in 1997, the bankruptcy court granted Espinosa a discharge of all remaining debts not included in the repayment plan. See id.
Three years later, Funds began intercepting Espinosa's income tax refunds. See Espinosa, 553 F.3d at 1197. Espinosa then petitioned the bankruptcy court to hold Funds in contempt for violating the bankruptcy court’s grant of discharge. See id. Funds countered, arguing that Espinosa had failed to properly discharge his student loans. See id. Specifically, Funds claimed that student loans are generally not dischargeable unless the debtor proves in an adversary proceeding that repayment of the student loans would be an "undue hardship," and Espinosa had failed to initiate such an adversary proceeding. See id.
The bankruptcy court rejected Funds’ argument and required Funds to stop intercepting Espinosa’s income tax refunds. See Espinosa, 553 F.3d at 1197–98. The bankruptcy court also did not allow Funds to appeal Espinosa's repayment plan, stating that Funds should have objected to the plan before it was confirmed. See id. at 1198. The U.S. District Court of Arizona reversed the bankruptcy court, indicating that Espinosa had violated Funds' due process interests because Espinosa had not initiated an adversary proceeding by serving Funds with a complaint and summons before discharging his student loans. See id. On appeal, the Ninth Circuit Court of Appeals reversed the district court, holding that Espinosa could properly discharge his student loans in his Chapter 13 repayment plan. See Espinosa, 553 F.3d at 1205. The Ninth Circuit also held that Funds' due process interests were adequately protected because Espinosa had notified Funds and given Funds the opportunity to object before the repayment plan was confirmed. See id.
Petitioner United Student Aid Funds ("Funds") argues that Respondent Francisco J. Espinosa should not be able to discharge his non-dischargeable student loan by declaring in his Chapter 13 repayment plans that he will not repay his student loans. See Brief for Petitioner, United Student Aid Funds at 12. Conversely, Espinosa argues that Funds should not be able to claim repayment after he already provided Funds with notice and opportunity to object to his Chapter 13 repayment plan. See Brief for Respondent, Francisco J. Espinosa at 13–14. The Supreme Court’s decision in this case will affect how debtors are able to discharge student loan debts in bankruptcy actions. The Court’s decision in this case is of particular significance during economic times where graduates of vocational programs, colleges, and professional schools face the prospect of having to repay student loans in a challenging job market.
A decision in favor of Funds may hamper the functionality of America’s bankruptcy system. The National Association of Chapter Thirteen Trustees ("NACTT") claims that Funds' arguments challenge the finality of Chapter 13 plans that have been confirmed by a bankruptcy court. See Brief of Amicus Curiae the National Association of Chapter Thirteen Trustees in support of Respondent at 8. According to the NACTT, the finality of confirmed Chapter 13 plans is necessary to ensure the efficiency and effectiveness of the Chapter 13 bankruptcy process, as it brings to the table all the various creditors' interests and ultimately binds both the debtor and all the creditors to a compromise on how the debts should be settled. See id. at 5, 17. In reliance of this plan, creditors will give loans to the reorganized debtor. See Brief of Amici Curiae Professor Richard Aaron, et al. in support of Respondent at 11. The NACTT argues that creditors simply would not participate in bankruptcy proceedings if the confirmed Chapter 13 plan could be changed after they had already acted in reliance upon the plan. See Brief of NACTT at 18. Thus, as Professor Richard Aaron, et al. emphasize, the finality of confirmed plans is of fundamental importance to the Chapter 13 bankruptcy process and to the reorganization allowed under Chapters 9, 11, and 12 of the Bankruptcy Code. See Brief of Professor Richard Aaron, et al. at 1.
Conversely, Funds argues that allowing discharge by merely declaring the debt in a Chapter 13 repayment plan would needlessly increase costs to federal student loan programs. See Brief for Petitioner at 48. According to Funds, a decision in favor of Espinosa would cause debtors to routinely attempt to discharge non-dischargeable debts in their Chapter 13 plans and thus force creditors to scrutinize every plan. See id. at 49–50. Funds maintains that such scrutiny would require "an enormous expenditure of resources." See id. at 50. Indeed, the Educational Credit Management Corporation, which is the primary Chapter 13 bankruptcy processor of the Federal Family Education Loan Program, claims that it receives about 3,600 Chapter 13 plans each month, which would all require additional scrutiny and review if federal loans were subject to declaration by discharge. See Brief of Amicus Curiae the Educational Credit Management Corporation in support of Petitioner at 2–3.
Funds also argues that if the Court rules in favor of Espinosa, debtors would be able to discharge by declaration other types of debts which have heretofore been designated by Congress as non-dischargeable debts, such as taxes and child support payments. See Brief for Petitioner at 43–45. Funds points out that while loan creditors may have the resources to protect their interests, less sophisticated creditors such as divorced spouses who are owed family support do not, and a decision in favor of Espinosa would establish a precedent that would make it more difficult for these individuals to recover debts they are owed. See id. at 45. State governments contend that if the Court rules in favor of Espinosa, the increased costs of collecting from debtors who attempt to discharge taxes by declaration will be passed on to the states' taxpayers. See Brief of Amici Curiae Oregon, et al. in support of Petitioner at 4–5. Municipalities also argue that a decision in favor of Espinosa would require them to incur more legal costs and would divert resources from municipal services such as education and police protection. See Brief of Amicus Curiae the International Municipal Lawyers Association in support of Petitioner at 3–4.
The Court’s decision in this case will thus have substantial ramifications for how not only student loans and other debts are collected in bankruptcy, but other types of non-dischargeable debts as well.
Special statutory process required to discharge student loans
A person declaring bankruptcy must file a plan outlining, among other things, which debts shall be discharged. See 11 U.S.C. § 1321–22. Once a court approves and confirms the plan and orders the discharge of the debts that will not be repaid, all matters are presumed settled according to the confirmed plan. See 11 U.S.C. § 1327. However, when declaring bankruptcy and preparing such a plan, student loans are generally considered non-dischargeable, unless paying them would cause undue hardship for the debtor. See 11 U.S.C. § 1328(a)(2); 11 U.S.C. § 523(8)(a)(i). In order to discharge a student loan, a special adversary proceeding generally needs to take place. See Fed. R. Bankr. P. 7001(6); Brief for Petitioner, United Student Aid Funds, Inc. at 5. However, the courts are split as to whether such an order loses its finality when no adversary proceeding took place to determine if the student loans should have been discharged. See Espinosa v. United Student Aid Funds, Inc., 553 F.3d 1193, 1198 (9th Cir. 2008).
Can a bankruptcy court discharge liability for student loans without specialized adversary proceedings?
Petitioner United Student Aid Funds (“Funds”) argues that student loan debt cannot be discharged without proving hardship in a specialized adversary proceeding. See Brief for Petitioner at 16. Funds claims that the plain language of the relevant bankruptcy statutes makes it clear that Congress intended student loans to be presumptively non-dischargeable. See id. at 17 (citing 11 U.S.C. §1328(a)). In support of this view, Funds cites Tennessee Student Assistance Corp. v. Hood, where the Supreme Court indicated that student loans are “presumptively non-dischargeable” unless they would inflict undue hardship on the debtor. See Brief for Petitioner at 18 (citing Tennessee Student Assistance Corp. v. Hood, 541 U.S. 440, 450 (2004)). Funds argues that Congress expressly and presumptively made student loans non-dischargeable to prevent harm to the public interest and abuses of the educational loan system. See Brief for Petitioner at 18–20. Funds also points out that Congress has added more and more restrictions over the past thirty years to prevent abusive discharges of student loans in bankruptcy proceedings, such as if a student discharged student loans in bankruptcy proceedings shortly after graduation, and then went on to enjoy the fruits of higher earning power made possible by their education without repaying their loans. See id. at 20–23.
Funds also stresses that the rule that student loans are presumptively non-dischargeable is self-executing, meaning that a student loan cannot be discharged unless the debtor first successfully establishes undue hardship. See Brief for Petitioner at 23–25 (citing Tennessee Student Assistance Corp., 541 U.S. at 450 (2004)). According to Funds, permitting student loan discharges by simply including them in the bankruptcy plan without adversary proceedings (“discharge by declaration”) strips creditors of this statutory protection. See Brief for Petitioner at 23–25. Thus, according to Funds, it is immaterial that Funds did not object to the initial repayment plan, as the student loans could not be legally discharged without Espinosa first demonstrating undue hardship in an adversarial proceeding. See id. at 33, 40.
Funds argues that a lack of adversary proceedings to establish undue hardship voids a court order that discharges student loans. See Brief for Petitioner at 25. In this respect, Funds argues that a plan to discharge a non-dischargeable debt would violate the bankruptcy provisions of the U.S. Code, and therefore no court may issue an order confirming such a plan. See id. at 30; see also 11 U.S.C. § 1325. Funds points out that it is well established that court decisions made without the necessary authority or in contravention of the law are simply void and can, thus, not be considered res judicata or final. See id. at 31, 36–37, 40–42 (citing United States ex rel. Wilson v. Walker, 109 U.S. 258 (1883)). Funds cites Vallely v. Northern Fire & Marine Ins. Co. in which the Court stated that “[i]f [courts] act beyond [their] authority, and certainly in contravention of it, their judgments and orders are regarded as nullities. They are not voidable, but simply void, and this even prior to reversal.” See id. at 31 (citing Vallely v. Northern Fire & Marine Ins. Co., 254 U.S. 348, 353-54 (1920)).
On the other hand, Respondent Francisco J. Espinosa claims that the relevant statutes indicate on their face that if the court confirms a discharge, then student loans become dischargeable. See Brief for Respondent, Francisco J. Espinosa at 20–21. Espinosa adds that the order confirming his plan is valid and final even if it contains legal errors because it has passed direct review. See id. at 21-22. As such, Espinosa claims that all issues associated with the order, regardless of whether they were addressed by the parties, are considered res judicata—meaning that they are settled and can neither be raised nor decided again in court. See id. at 21-22.
Espinosa continues by addressing Funds’ argument that the confirmation order was void due to a lack of adversary proceedings and distinguishes the Supreme Court precedents Funds cited. See Brief for Respondent at 27–28. According to Espinosa, the reason why the judgment was void in Walker was because the court had no jurisdiction over the matter at issue. See id. at 27 (citing Walker, 109 U.S. 258 (1883)). Espinosa points out that in the present case, however, the bankruptcy court did have jurisdiction over the student loans at issue and that Walker is therefore inapplicable. See Brief for Respondent at 27. Instead, Espinosa suggests that Supreme Court jurisprudence shows that only in very rare circumstances—where a court significantly departs from its granted authority—can a judgment be considered void. See id. at 25–26. Espinosa cites Travelers Indem. Co. v. Bailey, where the Supreme Court indicated that a judgment could be found non-binding in particularly extreme circumstances, such as when the court lacked subject-matter jurisdiction. See id. (citing Travelers Indem. Co. v. Bailey, 129 S.Ct. 2195, 2206 n. 6 (2009)). Since the bankruptcy court was not acting in a completely different jurisdictional area than usual here, Espinosa claims that the present case does not involve the extreme circumstances that would warrant considering the decision by the bankruptcy court void. See Brief for Respondent at 26–27.
Espinosa also argues that if the creditor fails to object to the discharge before the bankruptcy court confirms the repayment plan, the creditor is bound and has waived all of its objections. See Brief for Respondent at 31–32. Espinosa does not believe that a self-executing provision making student loans generally non-dischargeable is sufficient to make a Chapter 13 nonbinding when a creditor had its chance to object to the plan and did not take the opportunity to do so. See id. at 31–33. As such, Espinosa claims this is a “waiver case” and that even if student loan discharges generally require separate proceedings, these proceedings can be, and have been in this case, waived. See id. at 35-36.
Does discharging a student loan in bankruptcy proceedings violate due process if the creditor did not receive the kind of notice typical to adversary proceedings?
Funds believes that a notice typical of adversary proceedings is absolutely necessary to satisfy due process requirements to inform a creditor that a debtor is attempting to discharge student loan debts. See Brief for Petitioner at 51–52. Specifically, Funds insists that unlike a general notice in bankruptcy proceedings, a heightened notice, including serving a summons, is required when discharging a student loan. See id. at 52–53. Funds stresses that Espinosa only mailed his plan to its post office box, providing only minimal notice, which failed to meet the due process requirements of notice and an opportunity to be heard that “Congress prescribed to be due” to student loan creditors. See id. at 53.
Espinosa counters that this case does not involve questions of due process because Funds did receive actual notice and knew when and how it could object to the repayment plan. See Brief for Respondent at 35-36. Instead, Espinosa claims this case is a waiver case because actual notice spoils any kind of due process violations claims. See id. at 35–38. Espinosa also rejects Funds claim that it was entitled to the kind of notice required in adversary proceedings, pointing out that the authority cited by Funds only established that notice was required—but not what kind. See id. at 38–39. Espinosa argues that there is nothing in the language of the relevant statute that would indicate an adversary proceeding is necessary to satisfy due process requirements. See id. at 40-41 (citing 11 U.S.C. 523(a)(8)). Neither Congress nor the Supreme Court can establish any special due process guarantees of the Constitution. See Brief for Respondent at 40–43. Likewise, Espinosa argues that the notice it gave Funds fulfills all requirements of due process and that the fact that Funds has to deal with a lot of bankruptcy cases has no bearing on due process analysis. See id. at 43, 46.
In this case the Supreme Court will decide whether student loans can be discharged by declaration without first determining undue hardship in an adversary proceeding, and if a court order confirming such a discharge can be considered final. Petitioner United Student Aid Funds claims that the Court should not allow this method of discharging student loans because student loans are non-dischargeable debts, which, by statute, can only be discharged following a showing of undue hardship in an adversary proceeding. Respondent Francisco J. Espinosa claims that when courts confirm a discharge of student loans without adversary proceedings—especially when the creditor has not objected—then such an order should be regarded as final. A decision for Funds could thus hamper the reliability and effectiveness of the U.S. bankruptcy system because final decisions by bankruptcy courts might not be considered final anymore. A decision in favor of Espinosa, however, could increase the cost of student loan programs and make most other non-dischargeable debts dischargeable. The Court’s decision in this case is especially important in light of the current economy—both the ability of graduates to meet student loan obligations and the ability of debtors to pay other types of non-dischargeable debts, such as taxes and child support obligations, are of particular concern when unemployment is high.
Edited by: Katie Worthington
- FindLaw: Do Chapter 13 and Student Loans Go Together?
- Forbes: Bankruptcy: New Haven for Student Borrowers?
- USAToday: College graduates struggle to repay student loans
- U.S. Courts: Bankruptcy Basics: Chapter 13