August 2, 2019

The following article provides information regarding student loan treatment in chapter 13 bankruptcy proceedings and discusses some of the issues in ongoing case law and impact on chapter 13 plans in the 6th Circuit. To discuss these issues further, please contact Keller & Almassian, PLC, to set up a consultation or phone call.

Chapter 13 and Student Loans

In light of the difficulty of obtaining a discharge of student loan debt under the Brunner test, debtors frequently turn to Chapter 13 for longer term relief from student loan creditors. In a Chapter 13, the question becomes whether the debtor may treat his or her student loan debts differently than his or her other nonpriority unsecured creditors and not violate the provisions of 11 U.S.C. § 1322(b)(1). The analysis under 1322(b)(1) turns on whether the treatment of the student loan debt “discriminates unfairly.”

  1. 11 U.S.C. § 1322

Under § 1322(b), a Chapter 13 plan may “designate a class or classes of unsecured claims, as provided in section 1122 of this title,  but may not discriminate unfairly against any class so designated; however, such plan may treat claims for a consumer debt of the debtor if an individual is liable on such consumer debt with the debtor differently than other unsecured claims.” 11 U.S.C. 1322(b)(1) (emphasis added). Section 1122 requires that a claim or interest be placed in a particular class only if the claim or interest is substantially similar to other claims or interests of that class, but permits dissimilar claims to be classified together for administrative convenience. See 11 U.S.C. § 1122(a) and (b). Implicit in section 1122 is the requirement that claims be sufficiently dissimilar to warrant separate classification. See Teamsters Nat'l Freight Industry Negotiating Committee v. U.S. Truck (In re U.S. Truck), 800 F.2d 581, 586 (6th Cir. 1986) (“There must be some limit on a debtor's power to classify creditors ….”).

Section 1322(b)(5) further provides “for the curing of any default within a reasonable time and maintenance of payments while the case is pending on any unsecured claim or secured claim on which the last payment is due after the date on which the final payment under the plan is due.” Section 1322(b)(5) is frequently used to justify payments on student loan interest that accrues after the case is filed. In applying Section 1322(b), the Courts have relied upon various approaches and theories when determining whether student loan debt is treated “fairly” within the Chapter 13 Plan.

  1. “Unfair Discrimination”

Two of the most important terms in Section 1322(b)(1) are “unfair” and “discrimination.” Discrimination is simple to define and easy to apply. “To discriminate,” in its broadest sense, is to make a distinction or to note a difference between two things. Derivatively, it is to treat two things differently on account of a distinction between them. Bentley v. Boyajian (in Re Bentley), 266 B.R. 229, 237 (B.A.P. 1st Cir., 2001). “Accordingly, in § 1322(b)(1), to discriminate is simply to treat two classes differently on the basis of a difference between them; the difference in treatment need not be unfair, wrongful, or even adverse to a class in order to constitute discrimination within the meaning of this statute. The treatment need only be different.” Id. In other words, treating unsecured claims differently will amount to “discrimination” under Section 1322(b)(1).

On the other hand, “unfair” or “fairness” is far more difficult to define and conceptualize. “The world is full of competing theories and perspectives from which to determine what is fair, and the word ‘fair,’ standing alone, does not specify which of them to apply. This problem has left the courts casting about for a definite standard of its meaning in this statute.” Id. As indicated in Bentley, the term “unfair” in Section 1322 is difficult to define, which has resulted in multiple courts developing and applying wildly different results. In fact, one Court stated, “this is one of those areas of the law in which it is not possible to do better than to instruct the first-line decision maker, the bankruptcy judge, to seek a result that is reasonable in light of the purposes of the relevant law, which in this case is Chapter 13 of the Bankruptcy Code; and to uphold his determination unless it is unreasonable (an abuse of discretion).” In re Crawford, 324 F3d 539, 542 (7th Cir., 2003). The various approaches that have been employed are explored in more detail below.

    1. The Reasoning Behind Unfair Discrimination

Regardless of the tests used below, courts frequently cite the follow rationale when treating student loan debt differently than unsecured creditors:

(1) a debtor will not be afforded a fresh start in bankruptcy if the debtor is defaulting on student loan payments over the term of a 3-5 year plan, considering that on-going monthly plan payments are likely to be less than the amount owed on the student loan debt, interest is accruing, and the debts survive the debtor's discharge; (2) strong public policy supports the repayment of education loans; (3) Congress prefers Chapter 13 over Chapter 7, and debtors in Chapter 7 fare better with making post-bankruptcy payment on student loans debts because a Chapter 7 debtor will not have been in forced default of student loan debt obligations for 3-5 years; and (4) other unsecured creditors in Chapter 13 are not harmed by the preferential treatment for student loan debt because unsecured creditors must receive a return in Chapter 13 that is equivalent to what they would receive in Chapter 7 pursuant to 11 U.S.C. § 1325(a)(4).

In re Mason, 456 B.R. 245, 248 (Bankr. N.D. W. Va. 2011) (citing Seth J. Gerson, Note: Separate Classification of Student Loans in Chapter 13, 73 Wash. U.L.Q. 269, 290-92 (1995)). While Courts agree that student loan debt may be treated differently than other unsecured debt, Courts disagree as to the proper test or approach to employ.

    1. The Four Part Test for Unfair Discrimination (8th Cir. Test)

The Eighth Circuit has adopted a four part test for “unfair discrimination” under Section 1322(b)(1). See In re Leser, 939 F.2d 669, 672 (8th Cir., 1991); see also Jordahl v. Burrell (In re Jordahl), 539 B.R. 567, 572 (B.A.P. 8th Cir., 2015). Under the Eighth Circuit four part test, the court examines the following prongs: “(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) whether the degree of discrimination is directly related to the basis or rationale for the discrimination.” Id. The debtor bears the burden of proving that the classification of the student loan debt does not discriminate unfairly. Jordahl, 539 B.R. at 572-573.

In Jordahl, the debtors proposed a Chapter 13 Plan that provided for full monthly payments of the debtors’ student loan, while the other unsecured non-priority creditors would receive a 6% to 11.5% dividend. The trustee objected to the treatment, and the bankruptcy court granted the objection. The debtors appealed the decision. The issue on appeal was whether the classification of the unsecured debt under Section 1322(b)(5) is subject to the unfair discrimination test found in Section 1322(b)(1).

On appeal, the Eighth Circuit bankruptcy panel determined that “all applicable subsections of Section 1322(b) must be satisfied.”[1] Id. at 573. The Court further stated, “The bankruptcy court stated that the Debtors failed to establish that the discrimination was reasonable, the Debtors and the Trustee had agreed before that court that the Debtors could not satisfy the second part of the test, the Debtors satisfied the good faith requirement, and the last part of the test was inapplicable. Id. Based upon the debtors admissions, the Court determined that the debtors failed to meet the four-part test. The Eighth Circuit bankruptcy panel affirmed the bankruptcy court. Id.

    1. The Bentley Test (1st Cir. Test)

Similar to the Eighth Circuit, the First Circuit uses a four part test. However, the factors considered in the First Circuit are different than the Eighth Circuit when determining fairness under Section 1322(b)(1). “When a plan prescribes different treatment for two classes but, despite the differences, offers to each class benefits and burdens that are equivalent to those it would receive at the baseline, then the discrimination is fair. On the other hand, when the discrimination alters the allocation of benefits and burdens to the detriment of one class, the discrimination is unfair and prohibited.” Bentley v. Boyajian (in Re Bentley), 266 B.R. 229, 240 (B.A.P. 1st Cir., 2001). In determining “fairness” in a given case, the First Circuit looks at (1) equality of distribution; (2) nonpriority of student loans; (3) mandatory versus optional contributions (a comparison of what the dischargeable unsecured creditors would receive in a pro rata distribution of the mandatory contribution under chapter 13; and (4) the debtor’s fresh start. Id.

            In Bentley, the debtors proposed a plan that provided for their student loan obligations to be paid in full, but to pay all other nonpriority unsecured claims a dividend of three percent. Id. at 232. The Trustee objected to the treatment of the student loans under Section 1322(b)(1). Id. at 233. The bankruptcy court granted the objection and denied confirmation. Id. at 233. On appeal, the bankruptcy panel for the First Circuit affirmed the bankruptcy court’s decision to deny confirmation.

            The bankruptcy panel affirmed the bankruptcy court ruling on the following grounds. First, the bankruptcy code requires “equality of distribution” among non-priority unsecured creditors, and burden of justification is on those who propose plans to the contrary. Id. at 240. Second, the Code specifically does not grant student loans priority treatment, and therefore, “nothing in the nature of the claims . . . warrants or justifies treating student loans more favorably than others.” Id at 241. Third, the debtors must contribute a minimum to their Chapter 13 plans. The minimum (i.e. disposable income) represents the only assured source of satisfaction for their claims. A debtor can always contribute more money to their Chapter 13 Plan. Finally, there is nothing in the Code or case law that defines “fresh start” as an emergence from bankruptcy completely free of all debt. Id. at 242. Ultimately, the Court held that “ [i]n the balance of burdens and benefits that the Code establishes as a baseline, the postbankruptcy balance due on student loans should be paid by the Debtors out of assets that they are not required to commit to the plan, not by general unsecured creditors out of their share of the Debtor's minimum contribution.” Id. at 243.

    1. The Streamlined Test

Besides the First and Eighth Circuits, other Circuits have developed their own streamline test. See e.g. In re Belton, ___B.R.___; 2016 Bankr LEXIS 4179, at *19 (Bankr. D.S.C., Oct. 13, 2016). According to the Belton court, “the streamlined test better reflects the balance of factors pursuant to which a debtor must submit evidence to enable the Court to analyze the separate classification of unsecured debt:

(1) Is there a good faith, rational basis for the separate classification;

(2) Is the separate classification necessary to the debtor's rehabilitation under Chapter 13; and

(3) Is there a meaningful payment to the discriminated class [Id.]

            In Belton, the debtors proposed a Chapter 13 plan which, (1) permitted the debtor to pay for and enroll in an income based repayment plan; and (2) proposed to cure the defaults of her student loans. Id. at *8-9. The Trustee objected to the Chapter 13 plan on the grounds that it unfairly discriminated against the unsecured creditors. Id. The Court disagreed with the Trustee’s objection and confirmed the proposed Chapter 13 plan. Id.

            In ruling for the debtor, the court found that there was a good faith rational basis for the proposed classification. Id. at *20-23. At the time of filing, the debtor was struggling to find employment. Id. The debtor contributed her lack of gainful employment, in part, to her student loans that were in default. The debtor testified that she cannot obtain a state or a federal job while her student loans were in default. Id. Additionally, the unsecured creditors in a Chapter 7 case would receive nothing. Id.

            The Court also found that the separate classification was necessary to the debtor’s rehabilitation. Id. at 23. The court reasoned that “[m]erely filing Chapter 7 will not resolve the Debtor's current difficulties with her student loan creditors and may limit her family's ability to retain essential secured property.” Id. Further, the Court found that there was a meaningful payment to the class discriminated against. Id. “[I]t is clear that the Plan is paying all general unsecured creditors more and in a better manner than they would receive if the Plan were not confirmed. The financial differential resulting from the separate classification and treatment is not excessive, and the benefit to the general unsecured creditors is meaningful.” Id. Ultimately, the court in Belton applied the streamline test and approved the plan.

    1. Totality of the Circumstances

Because the term “fairness” is difficult to define, some courts, including the Eastern District of Michigan, have moved away from a “test” or “factoring”, and instead look to the totality of the circumstances. In re Quinn, 586 BR 1, 6 (Bankr. E.D. Mich, 2018) (“The Court agrees that a totality of the circumstances inquiry is appropriate when making the determination of whether the favorable treatment of a student loan debt in a Chapter 13 plan is unfairly discriminatory.”). Courts following the totality of circumstances approach reasons that it is the appropriate test because a determination on whether a claim is treated unfairly lies directly in the Court’s discretion. Id.

In Quinn, the unsecured creditors filed claims in the amount of $227,193.33. Id. at 1. Of that amount, $192,936.15 was owed to the federal government on student loans. Id. The debtors proposed a plan whereby they agreed to pay $1,200 per month for sixty months. Id. Of the $1,200, $850.00 was to be paid on the student loans, if not more. Id. The way that the plan was proposed, the other unsecured creditors were to receive nothing. Id. The Court granted the Trustee’s objection to confirmation. Id. at 2.

In applying the totality of circumstances approach the Court looked at (1) the total amount of the student loan claims; (2) the amount that student loan claim is to receive each month; (3) and what, if anything, the other unsecured creditors are to receive. Id. at 6. The Court also examined whether the student loans would be in default at the conclusion of the bankruptcy. Id. The Court reasoned that the debtors unfairly discriminated under 1322(b)(1) because the unsecured creditors would receive nothing, which is similar to what they would receive in a Chapter 7 bankruptcy. Id. The Court noted that there is no “meaningful payment to the discriminated class.” Id. Ultimately, the Court found that the plan proposed by the debtors was unfairly prejudicial. Id.

  1. The Takeaway

Student debt has been termed as a “crisis” for our country. According to recent reports, the total amount of student debt that is outstanding is estimated to be more than $1.3 trillion. With rising student loan debt, the treatment of student loans in a Chapter 13 will continue to create a hotbed of issues. While “fairness” is difficult to determine within the contours of 1322(b)(1), courts are more frequently looking at all of the circumstances of a given debtor. The line of what is fair and what is unfair is still in the process of being developed by the courts. Without a Sixth Circuit decision, this circuit is left with the analysis in Quinn. The major takeaway from Quinn is (1) the other nonpriority unsecured creditors should receive something; and (2) the debtors, if paying the student loan creditors more, should not be in default when they emerge from their Chapter 13 bankruptcy. Further, any other factor that is specific to the debtor may persuade the court that the treatment of the student loan creditors is fair. Practitioners should continue to look at the debtors circumstances and find reasonable grounds for treating student loan creditors differently. Student loans play a critical role in today’s bankruptcies and a practical approach to their treatment in Chapter 13 is necessary. To discuss further, please contact an attorney at Keller & Almassian, PLC for an in person review, or to set up a phone consultation at 616-364-2100.


[1] It is worth noting that a minority of courts have found that Section 1322(b)(5) trumps Section 1322(b)(1). See, e.g., In re Truss, 404 B.R. 329, 332 (Bankr. E.D. Wis. 2009) ("Because section 1322(b)(5) is specific and clear in its language, statutory construction principles dictated that it trump the more general terms of section 1322(b)(1). In other words, if the provisions of section 1322(b)(5) for the cure of arrearages and maintenance of regular payments on long-term student loan indebtedness apply, then the specific provisions of section 1322(b)(5) supercede [sic] the general unfair discrimination provisions of section 1322(b)(1)."); In re Williams, 253 B.R. 220, 227 (Bankr. W.D. Tenn. 2000) (inclusion of unsecured creditors in (b)(5) indicates that it is a type of discrimination that [*14]  is expressly contemplated and sanctioned by the Code); In re Hanson, 310 B.R. 131, 134 (Bankr. W.D. Wis. 2004) (specific statutory provision of § 1322(b)(5) trumps the general provisions of (b)(1)); In re Johnson, 446 B.R. 921, 925 (Bankr. E.D. Wis. 2011) (citing with favor Truss analysis, supra).

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