The U.S. Supreme Court began hearing today the case involving a debtor whose student loans were discharged in a Chapter 13 bankruptcy—though possibly against the U.S. Bankruptcy Code.
Student loans are notorious for being difficult to discharge in bankruptcy, even in a Chapter 13 bankruptcy. In order to have student loan debt eliminated, a debtor must prove undue hardship.
In the case before the Supreme Court, the debtor, Francisco Espinosa, was allowed to enter a Chapter 13 plan without ever proving undue hardship to the bankruptcy court, according to a story on National Public Radio.
The Bankruptcy Case
In 1988, Espinosa was a baggage handler for America West Airlines when he began taking computer drafting classes at a technical school. Espinosa took out four student loans totaling over $13,000 from United Student Aid Funds.
After earning his degree, Espinosa was unable to find work in the computers field, and continued working at America West. However, that company was facing its own financial strain, and began cutting salaries. In 1992, Espinosa, a college graduate earning $6 an hour, filed bankruptcy.
According to the NPR story, Espinosa agreed to repay the full amount of the student loan debt through a three-to-five year Chapter 13 plan—but not the $4,000 of interest accrued on the loan. USAF was notified several times of the terms of the plan, and never objected to the case.
In 1997, the bankruptcy court declared Espinosa's debt repaid, and issued him a debt discharge.
However, two years later, USAF issued a lien on Espinosa's tax return for the unpaid interest. USAF claimed that the bankruptcy plan was illegal—11 years after the court confirmed it—because of the undue hardship requirement.
Undue Hardship Hearing Never Held
The student loan company argues that the bankruptcy court should have held a special hearing to determine whether Espinosa's situation qualified as an undue hardship, and should have summonsed USAF to appear in court. Because the hearing was never held, undue hardship was never established, and the loan should not have been dischargeable, USAF argued.
Espinosa's attorney has argued that USAF was properly notified and did not raise any objections at the time. A federal appeals court agreed.
Now it's up to the Supreme Court to decide just when a creditor can raise objection to a Chapter 13 bankruptcy plan—and when the can still collect on debts.
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