The United States Supreme Court agreed on Monday to  decide whether an individual who owes on a student loan may wipe out a portion of the debt in a bankruptcy without showing that the debt posed an “undue hardship.” United Student Aid Fund v. Espinosa (08-1134).  See the cert petition by clicking here.

In Espinosa v. United Student Aid Funds, Inc.,  530 F.3d 895; 2008 U.S. App. LEXIS 13314 (9th Cir. June 24, 2008) (click here for .pdf file,  here for the subsequent opinion, and here for the third opinion), the issue was whether a debtor could discharge a portion of his student loan debt in his Chapter 13 plan where he provided notice of the deadline for objections and the confirmation hearing, but did not file an adversary proceeding under secion 523(a)(8).  

This is the nub of Funds’s argument: To satisfy its obligations under the Bankruptcy Code, a Chapter 13 debtor usually only has to notify creditors by mail of the deadline for filing objections and when the confirmation hearing will occur, Fed. R. Bankr. P. 2002(b), as Espinosa did here. However, student loans may be discharged under Chapter 13, 11 U.S.C. § 1328(a)(2), only if the debtor can show “undue hardship,” id. § 523(a)(8), and such a showing can only be made in an adversary proceeding, Fed. R. Bankr. P. 7001(6). To initiate an adversary proceeding, a debtor must file a complaint, id. 7003, which must be served on the creditor along with a summons, id. 7004. Espinosa didn’t commence an adversary proceeding and therefore did not obtain a judicial declaration of “undue hardship.” Absent such a declaration, Funds argues, the bankruptcy court lacked authority to discharge the student loan debt by means of the Chapter 13 plan. Funds’s motion for relief from the discharge order was based on the fact that Espinosa obtained his discharge without following the statutorily-prescribed procedures for discharging student loan debt.

The Court noted that its prior precedent dictated that the Court rule against the creditor:

 Funds argues that the confirmed bankruptcy plan is void, because Funds didn’t receive service of a complaint and summons and there was no adversary proceeding to establish “undue hardship,” which the Bankruptcy Code and Rules require as a condition for discharging a student loan debt. We rejected this argument in Pardee v. Great Lakes Higher Education Corp. (In re Pardee), 193 F.3d 1083, 1086 (9th Cir. 1999).

Relying on the Tenth Circuit’s opinion in Andersen v. UNIPAC-NEBHELP (In re Andersen), 179 F.3d 1253, 1258 (10th Cir. 1999), overruled by Educ. Credit Mgmt. Corp. v. Mersmann (In re Mersmann), 505 F.3d 1033, 1046-47 (10th Cir. 2007) (en banc), we held that “[i]f a creditor fails to protect its interests by timely objecting to a plan or appealing the confirmation order, ‘it cannot later complain about a certain provision contained in a confirmed plan, even if such a provision is inconsistent with the Code.’ ” Pardee, 193 F.3d at 1086. In reaching this conclusion, Pardee also relied on a long line of cases, from our circuit and elsewhere, that “recognized the finality of confirmation orders even if the confirmed bankruptcy plan contains illegal provisions.” Id

However, the Court then discussed the fact that the Pardee opinion had become the minority position, even with its own Bankruptcy Appellate Panel:

Since Pardee, there have been significant developments in this area of the law: Two other circuits have rejected Pardee’s reasoning—significantly including the Tenth Circuit, which overruled its own Andersen opinion, on which Pardee principally relied. Mersmann, 505 F.3d at 1046-47; Whelton v. Educ. Credit Mgmt. Corp., 432 F.3d 150, 154 (2d Cir. 2005). Our own Bankruptcy Appellate Panel has questioned the reasoning of Pardee, albeit by a divided vote. Educ. Credit Mgmt. Corp. v. Repp (In re Repp), 307 B.R. 144, 148 n.3 (B.A.P. 9th Cir. 2004). And three circuits, as well as our Bankruptcy Appellate Panel, have held that the procedures employed here violate the creditor’s due process rights. Ruehle v. Educ. Credit Mgmt. Corp. (In re Ruehle), 412 F.3d 679, 684 (6th Cir. 2005); In re Hanson, 397 F.3d 482, 486 (7th Cir. 2005); Banks v. Sallie Mae Servicing Corp. (In re Banks), 299 F.3d 296, 302 (4th Cir. 2002); Repp, 307 B.R. at 154. It is thus fair to say that our position in Pardee is in the minority; indeed, among the circuits we now stand alone….

We have therefore taken a look at the cases from the other circuits and do not immediately find them persuasive; the rationale of Pardee and Andersen, relying as it does on straightforward notions of notice and waiver, seem far more consistent with accepted principles concerning the finality of judgments that transcend this particular corner of the law.