Pandora’s Box Opens: Chapter 13 Plans May Be Final Even If Contrary to the Bankruptcy Code

By: Beth Ann Schenz, Esq. and Milan Kubat, Esq.

The Supreme Court admits that its decision from March 23, 2010, “is potential for bad-faith litigation tactics” by debtors.

The Facts

A Chapter 13 debtor listed his student loan debt in his plan. In the Chapter 13 plan, the debtor proposed to repay only the principal while the remainder (accrued interest) would be discharged. The United States Department of Education (the “Government”) did not object to the plan or appeal the order confirming the plan. During the bankruptcy case, the Government filed a proof of claim and received the principal on the debt. When the Government proceeded to collect on the debt after the debtor received a discharge in the Chapter 13, the debtor filed a motion to enforce the discharge order and direct the Government to cease all collection efforts. The Government responded to the debtor’s motion to enforce and filed a motion under Federal Rule 60(b)(4) to set aside the confirmation order as void.

The Court’s Ruling

Whether the confirmation order is void was the focus of the Supreme Court’s ruling. For a judgment to be void, there must be some jurisdictional issue (the court does not have the power to hear the matter) or a due process issues (the creditor did not receive sufficient notice to defend the matter). The Supreme Court states that there was no jurisdictional error or due process violation so the confirmation order providing for a discharge on student loans is binding on the creditor.

Normally, a Chapter 13 debtor receives a discharge for all his or her debts except in some situations. One example where a Chapter 13 debtor would not receive a discharge is under 11 U.S.C. §523(a)(8) – the student loan exception. Some student loans are excepted from discharge and such exception is self-executing. The caveat is that the Court can find that such nondischargeable student loans create an undue hardship for the debtor and can be discharged. According to the Bankruptcy Rules, such action requesting a finding of undue hardship is brought by the debtor in an adversary proceeding upon summons and complaint.

The Supreme Court found that the undue hardship provision in the Bankruptcy Code is not a limitation on the bankruptcy court’s jurisdiction but only a precondition to obtaining a discharge order. Also, the Court stated that the Bankruptcy Rules that require a complaint to be brought to determine undue hardship are only procedural rules and not jurisdictional rules. Therefore the confirmation order was well within the jurisdictional authority of the Bankruptcy Court and can not be determined as void.

On the positive side, the Court found that, “[g]iven the Code’s clear and self-executing requirement for an undue hardship determination, the Bankruptcy Court’s failure to find undue hardship before confirming the plan was a legal error.” Unfortunately for the Government, a legal error does not make an order void.

Going further, the Supreme Court stated that the Government’s due process rights were not violated as they had ample time to either object to the Chapter 13 plan or appeal the confirmation order. A finding of due process by the Supreme Court means that the confirmation order can not be found as void.

Where the Supreme Court said that the lower court’s ruling went too far is when they considered that any plan can be confirmed if it provides for a discharge of a non-dischargeable debt. “Failure to comply with the self-executing requirement should prevent confirmation of the plan even if the creditor fails to object, or to appear in the proceeding at all.”

What This Means To You

A debtor can put any provision in his or her plan, which may be contrary to the code (i.e. discharging a debt that is otherwise nondischargeable). This provision should prevent confirmation. However, the creditor may be bound under the order if the Chapter 13 plan confirms. If the creditor fails to object to the plan or appeal the confirmation order in a timely manner, the confirmation order whether contrary to the Bankruptcy Code or not will be binding on the creditor.

As a creditor, you will need to make a business decision whether to object or not. WWR can help guide you through the decision making process.

If you have any questions concerning this matter, please contact Ms. Beth Ann Schenz, Esq. or Mr. Milan Kubat, Esq. Beth is an associate in the Bankruptcy department located in the Brooklyn Heights office. She can be reached directly at 216-739-5645 or via email at bschenz@weltman.com. Milan is also an associate in the Bankruptcy department located in the Brooklyn Heights office. He can be reached directly at 216-739-5647 or via email at mkubat@weltman.com.

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One thought on “Pandora’s Box Opens: Chapter 13 Plans May Be Final Even If Contrary to the Bankruptcy Code

  1. So, exactly where is the trustee in these cases? In the tenth circuit, we have a judge that believes he writes the rules and the code is subjective. So even when it is argued, we still lose as do most of the CH 13 trustees. So there would appear to be little, if any power in the US Trustee Program.
    The following is from the US Trustee Program web site.
    Specific responsibilities of the United States Trustees include:
    Appointing and supervising private trustees 3/ who administer Chapter 7, 12, and 13 bankruptcy estates (and serving as trustees in such cases where private trustees are unable or unwilling to serve);

    Taking legal action to enforce the requirements of the Bankruptcy Code and to prevent fraud and abuse;

    Referring matters for investigation and criminal prosecution when appropriate;

    Ensuring that bankruptcy estates are administered promptly and efficiently, and that professional fees are reasonable;

    Appointing and convening creditors’ committees in Chapter 11 business reorganization cases;

    Reviewing disclosure statements and applications for the retention of professionals; and

    Advocating matters relating to the Bankruptcy Code and rules of procedure in court.

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