Discriminatory Treatment of Student Loan Debt Not Unfair

Posted by NCBRC - December 13, 2016

“This Court respectfully disagrees with other courts’ holding that, without more, nondischargeability of student loans is an insufficient reason for discriminating in favor of Student Loan Claims.”

In a thoughtful, in-depth discussion addressing the state of student loan debt and the treatment of such debts separately from other debts in chapter 13, the Kansas Bankruptcy Court found that the debtors did not unfairly discriminate against general unsecured creditors by prioritizing their student loan debts in their plan. In re Engen, No. 15-20184 (Bankr. Kans. Dec. 12, 2016).

Mark and Maureen Engen’s chapter 13 plan proposed to pay their student loans debts before the general unsecured claims. Their student loans represented approximately 71% of the total unsecured claims. When the trustee objected to the plan, the debtors argued that the separate treatment of the student loans was justified by the fact that prior to filing bankruptcy, they entered into a Debt Management Plan under which they paid down their general unsecured debts, not including student loans, from $73,884.89 to $12,192.16.

On consideration of the trustee’s motion, the court began with the general principle that, under section 1122, similar claims may, but need not, be classified together, and that separate treatment of a given class is only prohibited if, under the circumstances, the discriminatory treatment is unfair. The court emphasized that the determination of what is unfair is properly the domain of the “first-line decision maker.” It walked through the approaches various courts have taken, and concluded that the offerings were generally either too rigid or too amorphous.

The Tenth Circuit has not confronted the issue but lower courts in that circuit have favored either the four-part “Multi-Factor” approach or the Bentley Baseline Test. The Multi-Factor test looks to whether: 1) the discrimination has a reasonable basis, 2) the debtor can carry out the plan without the discrimination, 3) the discrimination is proposed in good faith, and 4) the degree of discrimination is directly related to the reason for the discrimination. The Bentley Baseline Test considers: 1) equality of distribution, 2) nonpriority of student loans, 3) mandatory versus optional contributions, and 4) the debtor’s fresh start. In re Bentley, 266 B.R. 229 (B.A.P. 1st Cir. 2001).

The Engen court adopted the Bentley Baseline Test as its starting point. With respect to equality of distribution, the court found that the early distribution to student loan creditors through the plan, was counterbalanced by the Engens’s pre-bankruptcy payments to the general unsecured creditors.

Addressing the second factor, the court noted that student loans are necessarily non-priority and disagreed with the Bentley court’s finding that that factor disfavored separate classification of those debts. Rather, the court noted that the Code’s nondischargeability of other debts is generally supported by policy considerations, such as domestic support (child support/alimony), punishing wrongful conduct (fraud, criminal restitution), and paying taxes. Student loan nondischargeability, on the other hand, is not justified by those considerations as borrowers have typically not come by the loans through misconduct. The fact that Congress did not specifically prioritize student loan debt the way it did other debts such as child support, does not preclude a finding that student loan debts may be separately treated in the plan. Priority debts must be fully paid in chapter 13, and had Congress made student loan debts priority, it might have rendered many chapter 13 plans infeasible.

The court found that nondischargeability alone justifies the separate classification of student debt without regard to its lack of priority.

It went on to consider the remaining Bentley factors. The third factor—mandatory vs optional contributions—was held to be neutral in this case as the Engens were not offering any contributions to their plan other than those that were mandatory, but their pre-petition voluntary payments under the DMP balanced out that factor.

As to the debtor’s fresh start, the court found that leaving bankruptcy with intractable student loan debts would seriously impact debtors’ ability to move on. In fact, pro rata distribution of the plan funds to all unsecured creditors, and the inability to pay off the student loan debt faster than its nondischargeable interest may be incurred, could result in the debtors owing more at the end of their plan than they owed going into it. Hardly the goal of chapter 13 bankruptcy.

Because the Code distinguishes student loan debt for substantially more burdensome treatment than other unsecured loans, a bankruptcy court may take that increased burden into consideration when addressing whether separate treatment of those loans in a chapter 13 plan is unfair. Inside and outside bankruptcy, student loan debt is uniquely difficult to ameliorate as government lenders, unlike consumer creditors, have, among other advantages, substantial collection power and no limitations period within which to seek repayment.

The existence of income based repayment programs did not change the court’s view. As a practical matter, forgiveness of debt at the end of the program frequently merely exchanges one debt—student loan—for another—tax. Because the tax debt is not subject to deferred payments, it may simply result in a new financial burden on debtors just as they may be nearing retirement age.

“Nondischargeable student loan debt may create a virtual debtor’s prison, one without physical containment, but assuredly a prison of emotional confinement.” Bankruptcy Judge Robert Berger.

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