March 23, 2010

Supreme Court Decides United States Aid Funds, Inc. v. Espinosa

On March 23, the Supreme Court decided United States Aid Funds, Inc. v. Espinosa, No. 08-1134, holding that, although a bankruptcy court erred in granting a discharge of student loan debt without finding that repayment of the debt would cause "undue hardship," the creditor should have raised the error by a direct appeal from the order. The error does not render the discharge order "void" so as to entitle the creditor to overturn the judgment after the time for appeal has run.

Under Chapter 13 of the Bankruptcy Code, a debtor may obtain a discharge of government-sponsored, student-loan debt only if the debtor commences an adversary proceeding and the bankruptcy court finds that failure to discharge the debt would cause the debtor "undue hardship." In this case, debtor Espinosa proposed a bankruptcy plan under which he would repay the principal of his student-loan debt over time, and the interest on the debt would then be discharged. Espinosa did not commence an adversary proceeding with respect to the proposed discharge, but his lender received actual notice of the plan and did not object to it. The bankruptcy court approved the plan without making an undue-hardship finding, and the lender did not appeal. Espinosa repaid the principal in accordance with the plan, and the bankruptcy court then granted the discharge. Several years later, when the U.S. Department of Education tried to collect the unpaid interest, Espinosa asked the bankruptcy court to enforce the discharge. The lender then objected, arguing that the discharge was void because it had been granted without the required finding of undue hardship and without an adversary proceeding. The bankruptcy court enforced the discharge; the district court reversed; and the Ninth Circuit reversed again, reinstating the discharge.

The Supreme Court unanimously affirmed the Ninth Circuit and enforced the discharge. The order confirming Espinosa's proposed plan, the Court noted, was a final judgment that the lender could have appealed. That appeal would have been the appropriate method to challenge the errors of a lack of an undue-hardship finding and the absence of an adversary proceeding. The lender could not, however, later challenge the judgment under Federal Rule of Civil Procedure 60(b)(4) because the errors did not make the judgment void. An order is void for this purpose only if the court lacks even "an arguable basis" for asserting jurisdiction over the case or if a party's due-process rights are violated. Here, the bankruptcy court had jurisdiction to consider Espinosa's plan, and the lender was not deprived of due process because it received actual notice of the proceeding.

Although it affirmed the judgment on procedural grounds, the Court specifically rejected the Ninth Circuit's alternate holding that bankruptcy courts must approve plans for the discharge of student-loan debt without a determination of undue hardship unless the creditor raises a timely and specific objection. As the Court said, failure to comply with the statutory requirement of an undue-hardship finding "should prevent confirmation of the plan even if the creditor fails to object or to appear in the proceeding at all."

Justice Thomas delivered the opinion for the unanimous Court.

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