Debtor May Not Discriminate in Favor of Student Loan Creditor

Posted by NCBRC - August 6, 2012

Substituting its judgment for that of the Bankruptcy Court, the court for the Eastern District of Virginia found that the debtor’s chapter 13 plan should not have been confirmed where it proposed to treat her student loan outside the plan. Gorman v. Birts (In re Birts), No. 12-427 (E.D. Va. August 1, 2012). Under her plan as proposed, the debtor would have maintained her monthly payments on her student loan outside the plan while paying 7% to unsecured creditors within the plan.

In considering whether the debtor’s plan violated section 1322(b)(1), the Bankruptcy Court applied the following analysis which the district court approved:

“(1) Whether the discrimination has a reasonable basis;

(2) Whether the debtor can carry out a plan without the discrimination;

(3) Whether the discrimination is proposed in good

faith; and

(4) The difference between what the creditors discriminated against will receive as the plan is proposed, and the amount they would receive if there were no separate classification.”

Upon this framework, the Bankruptcy court found that separate classification of student loans had a reasonable basis where, even though Congress did not assign priority status to student loans under section 507, there is a long-standing public policy favoring the federal student loan program. The court then balanced the benefit that would adhere to the other creditors if the debtor paid her student loan on a pro rata basis through the plan against the detriment to the debtor of being unable to reduce the principal on the loan through regular plan payments and the risk that she would, therefore, have little incentive to complete the plan. Taking these practical considerations into account the court, noting that the issue must be decided on a case-by-case basis, found that the balance tipped in favor of confirmation. The weighing of interests performed by the Bankruptcy Court was in step with and supported by established case law, such as In re Coleman, 560 F.3d 1000, 1011 n. 26 (9th Cir. 2009) and In re King, 66 Collier Bankr. Cas. 2d 1039, 460 B.R. 708 (N.D. Tex. 2011).

In reversing, the district court treated the lower court’s decision as if it were a blanket approval of discrimination in favor of student loan lenders despite the fact that the bankruptcy court stated otherwise. Finding that the bankruptcy court’s decision was clearly erroneous, the district court went on to essentially replace the judgment of the bankruptcy court with its own judgment. Without finding that any of the facts determined by the bankruptcy court were unsupported by the record, it simply reweighed them and reached a different conclusion. Moreover, where the lower court specifically found no evidence of bad faith, the district court based its finding to the contrary on an argument that had not been presented to the bankruptcy court.

Birts opinion

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