Bankruptcy courts divide on student loans

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Wisconsin’s bankruptcy courts are divided over whether a Chapter 13 debtor can give preferential treatment to student loan debts.

In November, U.S. Bankruptcy Judge James Shapiro held that the debtor could not. But on March 11, Judge Susan Kelley held that the debtor could.

However, the difference in the results depended more on the circumstances of the individual debtors, than on statutory interpretation.

At issue are two provisions in the bankruptcy code. 11 U.S.C. 1322(b)(1) prohibits payment plans from discriminating unfairly against unsecured creditors. But 11 U.S.C. 1322(b)(5) provides that a debtor may maintain regular payments on any obligation on which the last payment is due after the final plan payment.

Judge Shapiro

In the case before Judge Shapiro, Robert and Carol Edmonds filed for bankruptcy in 2009. Their payment plan proposed continuing to make regular payments of nondischargeable student loan debt.

If confirmed, that plan would have resulted in the student loan creditors receiving approximately a 53 percent dividend, and the other unsecured creditors receiving only an 18 percent dividend.
The trustee objected to the plan, and Judge Shapiro sustained the objection.

He began by stating, “This court is not of the view that long-term student loans can never be separately classified (emphasis in original).”

However, because their annual income was approximately $130,000, Judge Shapiro concluded, “There is nothing in the case at bar which establishes that the debtors are unable to formulate a plan that provides for equal treatment of unsecured creditors. Student loan debts should not be paid at the expense of the other general unsecured creditors.”

Judge Shapiro further found that approving the proposed plan would result in the payment of post-petition interest, even though not all of the unsecured creditors would be fully paid, in violation of 11 U.S.C. 1322(b)(10).

Judge Kelley

In the case decided by Judge Kelley last week, Jodi Johnson filed for Chapter 13 in 2010. More than $98,000 of her approximately $149,000 in unsecured debts were nondischargeable student loans incurred to attend law school.

Johnson proposed continuing to make student loan payments of $641 per month outside of the bankruptcy estate. Under this plan, the unsecured creditors would receive only $8,700 during the five-year plan.

However, if the plan were not approved, she would exit bankruptcy after five years owing more on the student loan than when she entered it.

The trustee objected, but Judge Kelley overruled the objection and confirmed the plan.

Judge Kelley found the obligations on the student loans were not “special circumstances” under 11 U.S.C. 707(b)(2)(B), rejecting the reasoning of some bankruptcy judges in jurisdictions outside of Wisconsin.

But she held that Johnson could separately classify the student loans under sec. 1322(b)(5), without unfairly discriminating against the other unsecured creditors.

Judge Kelley acknowledged the conflict with that subsection and the antidiscrimination requirement of sec. 1322(b)(1), and Judge Shapiro’s opinion in Edmonds.

Nevertheless, Judge Kelley concluded, “The Edmonds debtors had over $130,000 in combined income, and did not establish that they were unable to propose a plan that provided equal treatment of unsecured creditors. … Here, the Debtor … lives frugally, and has promised to amend again and propose even higher payments if she is able to secure a higher paying job as an attorney. Even in light of Edmonds, this Court concludes that the Debtor’s plan does not unfairly discriminate by proposing to maintain payments on her long-term student loans, while proposing to pay her other unsecured creditors less.”

Judge Kelley also cited two other opinions from bankruptcy courts in Wisconsin that have permitted a debtor to maintain full monthly payments on long-term debt. In re Hanson, 310 B.R. 131 (Bankr.W.D.Wis. 2004)(Martin, J.); In re Truss, 404 B.R. 329 (Bankr.E.D.Wis. 2009).

The cases are In re Edmonds, Case No. 09-33033 (Bankr.W.D.Wis., Nov. 5, 2010)(Shapiro, J.), and In re Johnson, Case No. 10-32528 (Bankr.E.D.Wis., Mar. 11, 2011)(Kelley, J.)

David Ziemer can be reached at [email protected].