United Student Aid Funds v. Espinosa

Background

In 2010, the Supreme Court of the United States decided United Student Aid Funds v. Espinosa, 130 S. Ct. 1367 (2010). The Espinosa case involved a Chapter 13 bankruptcy case where the debtor sought to discharge his student loan debts in his Chapter 13 plan. The U.S. Bankruptcy Code does not allow individuals to discharge their student loan debts unless they can demonstrate an undue hardship. This undue hardship must be demonstrated in a special proceeding known as an adversary proceeding.

In Espinosa, the Chapter 13 plan provided for the discharge of Mr. Espinosa's student loan debt. Mr. Espinosa did not follow the proper procedure for establishing an undue hardship. The Bankruptcy Court confirmed Mr. Espinosa's Chapter 13 plan. Mr. Espinosa's student loan provider, United Student Aid Funds, was notified of Mr. Espinosa's bankruptcy filing and the confirmation of his Chapter 13 plan. United Student Aid Funds even filed a proof of claim in the case. However, it did not object to the confirmation of Mr. Espinosa's plan or the plan's treatment of Mr. Espinosa's student loan debt.

A few years after Mr. Espinosa's Chapter 13 case was discharged, United Student Aid Funds filed a motion to set aside the discharge of the student loan debts. The Bankruptcy Court denied the lender's motion. United appealed to the District Court. The District Court held that United was denied due process because there was no service of a summons and complaint as required by the Bankruptcy Rules. Espinosa then appealed to the Court of Appeals for the Ninth Circuit.

The Court of Appeals reversed the District Court's ruling and held that because United had notice of Espinosa's bankruptcy and the confirmation of Espinosa's plan, it had actual notice of Espinosa's treatment of the debt, making the discharge valid. The Supreme Court granted certiorari and unanimously upheld the Ninth Circuit's ruling.

Basis for Ruling

The Court focused on a very narrow issue: is an order confirming a Chapter 13 plan void under Rule 60(b)(4) if the plan is confirmed in a manner that does not conform with the Bankruptcy Rules or Code? Some observers maintain that the narrow scope of the court's ruling will have minimal impact on bankruptcy law. While the Court's ruling involves the specific issue of the discharge of student loan debt, the underlying basis for that ruling has applications that go beyond the issue of student loan debts.

The Court noted that the Bankruptcy Court misapplied the law when it confirmed Espinosa's Chapter 13 plan. However, because United had actual notice of Espinosa's Chapter 13 case and the confirmation of his plan, it could not use Rule 60(b)(4) to attack the Bankruptcy Court's confirmation of the plan. The Court stated that the Rule does not provide a license for litigants to sleep on their rights. Espinosa, 130 S.Ct. at 1380. In addition to having notice of the plan and its confirmation, United also filed a proof of claim in Espinosa's case. United was aware that Espinosa's plan attempted to discharge his student loan debt.

Had United filed a timely appeal when the Bankruptcy Court confirmed Espinosa's plan, this case would have never made its way to the Supreme Court. The Court looked to the purpose of Rule 60(b) - striking a balance between the need for finality of judgments and ensuring that litigants have a full and fair opportunity to litigate a dispute. A full and fair opportunity to litigate is the hallmark of due process. Once a party to a lawsuit is aware of its opportunity to litigate, failing to take advantage of that opportunity is its own fault.

The law provides litigants with several mechanisms to timely appeal erroneous rulings; Rule 60(b)(4) is not one of them. Rule 60(b)(4) applies only in the rare instance where a judgment is premised either on a certain type of jurisdictional error or on a violation of due process that deprives a party of notice or the opportunity to be heard. Espinosa, 130 S.Ct. at 1377. A motion under Rule 60(b)(4) is not a substitute for a timely appeal. Id.

Impact of Espinosa

Since Espinosa was decided in 2010, many courts have distinguished the ruling to limit its effect. For example, a debtor attempting to discharge his student loans in a Chapter 13 plan would never see that plan confirmed. Courts will not allow debtors to violate the Bankruptcy Code via a Chapter 13 plan. However, Espinosa remains important because a creditor's failure to object to terms of a confirmed Chapter 13 plan will make the terms of that plan binding upon the creditor. This means that Chapter 13 plans can be crafted to follow the law, yet favor the debtor.

One of those methods is the Chapter 13 surrender. In a Chapter 13 surrender, the debtor proposes a plan wherein a piece of real estate is surrendered to the creditor in full satisfaction of the debt. If the creditor does not specifically object to these terms and the plan is confirmed, then the creditor is bound by the terms of the plan. When the plan is completed and the discharge order is issued, the creditor is simply out of luck.

Some creditors do object to this type of plan. However, many do not. Chapter 13 surrenders have been highly effective for destroying liability on underwater properties. Underwater properties are one of the biggest factors killing the mobility of American homeowners. Many people are unable to take new job or business opportunities that require geographic relocation because they cannot sell their homes. The Chapter 13 surrender allows people to gracefully exit an underwater property and get a fresh start.

If you are considering a short sale to exit an underwater property, then contact us to fully explore your options. A graceful exit from a bad investment requires predictability and a solid strategy.