The Supreme Court has agreed to decide whether student loans can be dismissed in bankruptcy without showing that repayment constitutes an "undue hardship."
In 1994, Francisco Espinosa filed for Chapter 13 bankruptcy and proposed a plan that provided for the repayment of his $13,250 in federal student loans to United Student Aid Funds.
After U.S. Aid Funds was notified, it filed a proof of claim roughly $4,500 greater than that was included in the plan -- or $17,832. The bankruptcy court approved the original plan and Funds was notified it would be paid the lower figure.
Espinosa subsequently completed the plan and his loans were discharged by the court. Three years later, the lender began intercepting Espinosa's income tax refunds to satisfy the unpaid portion of his student loans. Espinosa petitioned the bankruptcy court for an order holding Funds in contempt for violating the discharge injunction.
In response, the lender argued that Espinosa's student loans were improperly discharged because student loans cannot be discharged unless the debtor can show "undue hardship." This can only be shown in an adversary proceeding, which did not take place. Moreover, it argued the lack of an adversary proceeding denied Funds its Fourteenth Amendment due process rights. These arguments were rejected by the bankruptcy court, but, on appeal, were accepted by the Arizona federal district court.
Meanwhile, in October 2008, a three-judge panel on the 9th U.S. Circuit Court of Appeals reversed:
"The provision giving student-loan creditors a right to special procedures comes into play when the case is pending before the bankruptcy court," the appeals court held. "If a debtor proposes to discharge a student-loan debt without invoking the special procedures applicable to such debts, the creditor can object to the plan until the debtor shows undue hardship in an adversary proceeding."
In asking the Supreme Court to take the case, U.S. Aid Fund pointed to a split among five other circuit courts, which reached the opposite conclusion "on indistinguishable facts."
Question presented: Where a debtor declares to discharge a student loan debt in his Chapter 13 bankruptcy plan, has the debtor satisfied the due process requirements of Mullane v. Cent. Hanover Bank & Trust Co, and does the fact that the debtor failed to initiate an adversary proceeding render the enforceability of the discharge order under 11 U.S.C. 1327(a)inapplicable?
