Sometimes, in a bankruptcy, we want to separately classify student loans, particularly federal student loans, where our client debtors can benefit from public service or income driven plans with debt forgiveness. It’s also helpful to separately classify private student loans if we’ve otherwise reached a settlement agreement with the creditor. The key is to avoid harm to the other unsecured creditors by doing so.
In a recent case out of North Carolina, a Bankruptcy Court considered factors to permit separate classification of debts that included moral obligation and tangible benefit.
A parent who cosigned a student loan for a child cannot separately classify the loan and pay it in full under a chapter 13 plan, according to Bankruptcy Judge David M. Warren of Raleigh, North Carolina.
Before filing, the debtor-mother cosigned a 12%, $15,000 student loan to finance her daughter’s freshman year in college. Interest payments are deferred until the daughter graduates in 2021, but more than $8,000 in interest will have accrued when payments come due.
In her plan, the mother proposed to classify the student loan separately and pay it in full over the course of her five-year commitment period. If the separate classification were permitted, other unsecured creditors would recover 13%. If the student loan were not separately classified, the recovery for unsecured creditors would rise to 25%, Judge Warren said, because more disposable income would be devoted to the unsecured class.
The chapter 13 trustee objected to separate classification. Judge Warren sustained the objection in his September 26 opinion.
The case turned on Section 1322(b)(1), which allows debtors to “designate” a class of unsecured claims, but the plan “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.”
Judge Warren said that some courts have interpreted the “however” clause as creating a carve out automatically permitting favored treatment of consumer debts that were cosigned by another individual.
Judge Warren rejected the idea of an automatic carve out, based in part on his interpretation of the legislative history of a bill in 1983 that was not adopted by Congress until later. He then launched into an analysis of whether the debtor would have a legitimate, moral obligation to repay the cosigned loan. He quoted another judge who had said there is no moral obligation to repay a cosigned loan in full if no help was given to the debtor.
Even though the debtor and the daughter were both primarily liable for the loan, Judge Warren said that the daughter was the “primary beneficiary” because the loan was used to pay for her education. He went on to say that the mother received no “tangible and measurable benefit.”
Absent tangible and measurable benefit, Judge Warren said that separate classification was “inappropriate and cannot survive confirmation.”
Judge Warren buttressed his conclusion by the fact that the loan would not be in default absent payment by the mother, because repayment will be in deferment until 2021. When payments come due, he said that the daughter “presumably” will be able to cover the payments.
The deferment status of the loan, Judge Warren said, “further persuades the court that separate classification of the Claim is inappropriate” and “is not indicative of a good faith attempt to repay creditors.”
Separate classification of student loans is a hot topic right now. It is available in bankruptcy courts in the Middle District of Florida under the new Student Loan Management Program. The separate classification provision should be included under the Non-conforming language in the Chapter 13 Plan.
For help with student loan both in or outside of bankruptcy, please consider scheduling a phone or in person consultation with our team.