United States Supreme Court Holds That A Creditor Is Bound By An Unlawful Provision In A Chapter 13 Bankruptcy Plan

On March 23, 2010, a unanimous United States Supreme Court decided United Student Aid Funds, Inc. v. Espinosa, No. 08-1134 (March 23, 2010), a case closely watched by creditors for its potential adverse impact on creditor claims in chapter 13 bankruptcy cases.


In Espinosa, the bankruptcy court confirmed the debtor’s chapter 13 plan which contained a provision for discharge of the interest portion of a student loan. This plan provision violated the discharge provision of the Bankruptcy Code and the procedures for a determination of discharge under the Bankruptcy Rules. The student loan creditor did not object to confirmation of the plan, although it had notice of the plan and the opportunity to object to its confirmation. After the debtor completed all plan payments and received a bankruptcy discharge, the creditor took steps to collect the interest portion of the student loan. The debtor filed a motion in the bankruptcy court seeking to enforce the discharge injunction to prevent further collection efforts by the creditor. The creditor responded by filing a counter motion for relief from the order confirming the plan on the grounds that it was void because the plan provision violated the Bankruptcy Code and it was procedurally improper under the Bankruptcy Rules.


The Supreme Court ruled in favor of the debtor holding that once the plan was confirmed by bankruptcy court order and the time to appeal the order expired, the creditor was bound by the terms of the confirmed plan. It held that the confirmation order was not void. The Supreme Court recognized that the plan provision clearly violated the Bankruptcy Code and the Bankruptcy Rules. Nevertheless, the Supreme Court held that the creditor was bound by the improper plan provision because the creditor had notice of the plan and an opportunity to object to plan confirmation but it failed to do so. If the creditor had objected, its objection would have been sustained. The Supreme Court was not persuaded by the creditor’s argument that a ruling in favor of the debtor would encourage unscrupulous debtors and their counsel to slip improper and illegal provisions into plans. As some comfort for creditors, the Supreme Court held that a bankruptcy judge has an obligation to scrutinize plans for improper provisions and to deny confirmation of a plan that has an improper provision, even though no party in interest objects.


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