High court to review student loans discharge

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The U.S. Supreme Court has granted re-view to determine whether a debtor could obtain a discharge of his student loans (non-dischargeable absent a showing of undue hardship) merely by declaring it to be a hardship, or whether he must commence an adversarial action against the creditor.

In another bankruptcy case, the court requested the Solicitor General’s views on an issue that has been plaguing lower courts ever since the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) was enacted -– whether the BAPCPA eliminates all judicial discretion in determining a debtor’s disposable income and ability to pay unsecured creditors.

Student Loans

The Seventh Circuit has held that, to discharge a student loan, a debtor must file an adversary proceeding, and show undue hardship. In re Hanson, 397 F.3d 482 (7th Cir. 2005).

Every other circuit to consider the issue had agreed with this holding, until the Ninth Circuit considered it.

In In re Espinosa, 545 F.3d 1113 (9th Cir.2008), the Ninth Circuit created a split of authority by holding that, if a debtor includes discharge of a student loan in his Chapter 13 plan, and the creditor fails to object, then the debt is discharged.

Petitioning the Supreme Court for review, attorney Charles W. Wirken, representing the lender, quoted the Seventh Circuit in Hanson: “due process entitles creditors to the heightened notice provided for by the Bankruptcy Code and Rules, and the dictates of due process trump policy arguments about finality.” Hanson, 397 F.3d at 486.

Claire Ann Resop, chair of the State Bar’s Bankruptcy, Insolvency & Creditors Rights section, said the case is about more than just student loans, and could affect all Chapter 13 debts.

“If an adversary proceeding is not required,” Resop said, “debtors could bury a change in a loan’s interest rate in the Chapter 13 plan, say, ‘here it is on page 45 of a 108 page plan,’ and if the creditor fails to object, it loses.”

“It raises an important notice and due process issue,” Resop said. “The issue comes in all different types of bankruptcy cases. The court could answer the question narrowly with respect to student loans, or very broadly.”

Disposable Income

Wisconsin courts considering the disposable income issue have largely concluded that the BAPCPA eliminates all judicial discretion. However, that is the minority view nationwide.

Prior to the BAPCPA, a Chapter 13 debtor was required to commit to his plan all of his “projected disposable income” to be received in the three-year plan period. The amount of disposable income was determined subtracting the debtor’s monthly expenses (Schedule J) from his monthly income (Schedule I).

Under the BAPCPA, monthly income is determined by calculating the average of the debtor’s monthly income for the six months prior to filing.

From this, debtors with above-average income must deduct allowable expenses based on household size and geographic region. The form for these calculations is known as Form 22C or Form B22C.

Courts have divided over whether disposable income as calculated on Form 22C is dispositive, or if it merely creates a presumption that can be rebutted by showing that it does not provide a fair projection of the debtor’s disposable income in the future.

The Eighth Circuit has adopted what is called the “forward-looking approach.” In re Frederickson, 545 F.3d 652 (8th Cir. 2008).

Under this view, disposable income, as calculated on Form 22C, is only a starting point, but the final calculation can take into consideration changes that have occurred in the debtor’s financial circumstances.

The 10th Circuit adopted a variation of the forward-looking approach. In re Lanning, 545 F.3d 1269 (10th Cir. 2008). Under this view, courts can look to changes, but only as to income; courts have no authority to review expenses.

In contrast, the Ninth Circuit has adopted what has been called the “mechanical approach.” Under this view, the plain language of the BAPCPA eliminates any discretion to calculate disposable income except by reference to Form 22C. In re Kagenveama, 541 F.3d 868 (9th Cir. 2008).

The Seventh Circuit has yet to decide the issue, but the issue has been frequently presented in Wisconsin courts.

First to weigh in was Bankruptcy Judge Susan V. Kelley, who concluded that the unambiguous language of the statutes require that disposable income be based solely by reference to Form 22C. In re Guzman, 345 B.R. 640 (E.D.Wis.2006).

Bankruptcy Judge Robert D. Martin later adopted the same approach. (In re Long, 372 B.R. 467 (W.D.Wis.2007).

However, Bankruptcy Judge Thomas S. Utschig disagreed and adopted the forward-looking approach, concluding “Blind adherence to the Form B22C for determination of a debtor’s income could lead to arbitrary results based solely on the timing of a petition, potentially penalizing both debtors and creditors unfairly.” In re Mancl, 375 B.R. 514, 517 (W.D.Wis.2007).

On appeal, though, Utschig’s opinion was reversed by U.S. District Court Judge Barbara B. Crabb, who adopted the mechanical approach. In re Mancl, 381 B.R. 537 (W.D.Wis.2008).

Notably, none of the courts adopting the mechanical approach defend it on policy grounds, but solely on the language of the statute.

In the Guzman case, Judge Kelley wrote, “While this provision of the new statute does not perform as advertised, perhaps prompting trustees, unsecured creditors and even some bankruptcy judges to long for the ‘good old days’ of reviewing Schedules I and J and determining whether private school, high speed internet access, and a pack-a-day habit were reasonable and necessary for the debtor’s maintenance and support, the mandate of new sec. 1325(b)(3) is clear.” In re Guzman, 345 B.R. at 646.

This quote was included in the Trustee’s petition for review, which added, “For better or worse, Congress enacted BAPCPA, and it is within the discretion of Congress to fix it.” Resop framed the issue as whether to enforce a law as written when it makes no sense, or to do what makes sense. “I personally think the court should interpret it so it makes sense, but I think most bankruptcy attorneys’ attitude is ‘just tell us what to do, and we’ll do it.’”

Resop said it is absurd to base disposable income on a high income earned the previous six months, if the debtor doesn’t earn that any more, or to base it on lower past income, if the debtor is now a high wage-earner. “It’s inappropriate in my opinion, but it is what the code says to do.”

The cases are Hamilton v. Lanning, No. 08-998 (disposable income) and United Student Aid Funds, Inc., v. Espinosa, No. 08-1134 (student loans).