Paying Student Loans First in Ch. 13 Plan Isn’t Unfair to Other Creditors

Understand the complexities and nuances of the Bankruptcy Code to better advise clients and prepare for court.

By Daniel Gill

The Chapter 13 plan of a married couple was approved even though the plan provides that unsecured student loans would be paid in full before the couple’s other unsecured creditors would receive any distribution ( In re Engen , 2016 BL 412485, Bankr. D. Kan., No. Chapter 13, 12/12/16 ).

Judge Robert D. Berger of the U.S. Bankruptcy Court for the District of Kansas Dec. 12 held that even though the debtors’ plan discriminated against the general unsecured creditors, that discrimination was not “unfair” under the law, and he confirmed the plan. A key element to the decision was the fact that the debtors significantly paid down unsecured creditors in the years immediately preceding the bankruptcy filing.

Mark and Maureen Engen on Feb. 4, 2015, filed a bankruptcy case under Chapter 13, which allows individuals receiving regular income to obtain debt relief while retaining their property. To do so, the debtors must propose a plan that uses future income to repay all or a portion of their debts over a three to five year period.

Before the debtors filed, however, they paid their general unsecured creditors nearly $80,000 during the preceding four years, through a voluntary Debt Management Plan (DMP). That amount represented nearly 80 percent of their total unsecured debt (excluding outstanding student loans they were responsible for), the court said.

But although the DMP payments helped get the debtors’ general unsecured debt under control, the court explained, they fell behind in mortgage and student loan payments and incurred tax liability as the result of changing their pay withholdings, precipitating their need for bankruptcy relief.

Planning Around Student Loans

Student loan obligations are among those debts which Congress deemed should be exempt from a bankruptcy discharge, as set forth in Section 523(a)(8) of the Bankruptcy Code.

The debtors’ Chapter 13 plan proposed to classify student loan unsecured debt separate from their other unsecured debt. The plan provided that the student loan debt would be paid in full (without post-petition interest) before the other unsecured creditors would be paid at all, the court said.

Chapter 13 plans can discriminate but can’t do so “unfairly,” the court explained. It then went through a lengthy analysis to determine that this plan did not unfairly discriminate against the non-student loan unsecured creditors.

Although the money received by the unsecured creditors pre-petition was a significant factor, the court said that the non-dischargeable status of student loans itself supports a plan paying the student loan debt first. “Among § 523(a)'s nondischargeable debts, student loans stand alone as the only debt ‘incurred for a supposedly socially beneficial purpose.’ If repayment of the loans relies upon Debtors’ future income, then a Chapter 13 plan seems an appropriate means to accomplish this task,” the court said.

The court suggested that because Congress designated student loans non-dischargeable, it reflected a policy favoring payment of those loans. The proposed plan achieved that goal, the court said: “Here, the Debtors do not seek to escape their liability for the Student Loan Claims, but to the contrary, they seek to pay them.”

The debtors were represented by David A. Reed, Kansas City, Kan. William H. Griffin is the Chapter 13 trustee for cases filed in Kansas City, Kan.

To contact the reporter on this story: Daniel Gill in Washington at dgill@bna.com

To contact the editor responsible for this story: Jay Horowitz at JHorowitz@bna.com

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