Debtor’s Chapter 13 Plan Cannot Favor Student Loans

The U.S. District Court in Alexandria, in the case of Gorman v. Birts, while approving the bankruptcy court’s test to consider the debtor’s chapter 13 plan, reversed its decision to confirm the plan because it unfairly discriminated against unsecured creditors by proposing to pay the debtor’s student loans student loans outside of the plan.

Bankruptcy Code Section 1322(b)(5) permits a plan to provide 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 plan is due.  In Gorman the debtor’s student loans would qualify as this type of long term debt.

The parties in Gorman agreed that Bankruptcy Code Section 1322(b)(5) is subject to the unfair discrimination limitation described in subsection (b)(1).  By proposing to pay her student loan outside of the plan the debtor in Gorman designated a separate class of unsecured claims.  As a result of the proposal, the student loan lender would be paid more than three times as much in dollar amounts as the other unsecured creditors, even though the student loan debt constituted only one-third of the total unsecured debt.  Accordingly, the question presented was whether the differential treatment constituted “unfair” discrimination under Bankruptcy Code Section 1322(b)(5).

As the bankruptcy court in Gorman recognized, courts across the country have not settled on a uniform test to assess whether a classification unfairly discriminates within the meaning of the statute.  Courts have developed two primary tests to evaluate what constitutes unfair discrimination, neither of which has been adopted by the 4^th Circuit (our local circuit).  The 8^th Circuit’s test in the case of In re Lester (a 1991 case) has been widely applied.  Bankruptcy courts in this District have also applied a slightly different test from the case of In re Linton (from an E.D. of Virginia bankruptcy court in 2011).  The bankruptcy court in Gorman applied a hybrid version of the Lester and Linton cases.  The Circuit Court in Gorman found that the proposed test of the bankruptcy court included all of the factors relevant to a reasonable determination and was the proper test to apply in this case.  However, the Circuit Court found that the decision of the bankruptcy court in Gorman that the plan did not unfairly discriminate against the non-student loan creditors was clearly erroneous.

Using the non-dischargeable nature of student loans, as cited by the bankruptcy court in Gorman, as a basis for discrimination would eviscerate the detailed priority system of Bankruptcy Code Section 507 and make preferential treatment of student loans the rule rather than the exception.  The Circuit Court agreed with the view that there are strong policy considerations underlying the student loan program that would favor preferential treatment of student loan debt; however, that is not the law.  By not designating student loans as priority claims under Bankruptcy Code Section 507, Congress chose not to categorically treat them differently.  Otherwise, the bankruptcy court in Gorman relied on the debtor’s status as a single mother with three children in concluding that the discrimination was reasonable.  The debtor did not point to any case law supporting her view that student loans are properly favored under these circumstances.  The Circuit Court found that the bankruptcy court erred in finding a reasonable basis for the discrimination. The court sided with the bankruptcy trustee, who challenged the bankruptcy court’s good faith finding by arguing that the debtor had acted in bad faith by failing to pledge her entire disposable income to the plan, instead proposing to retain the disposable income of half of the amount she dedicated to the plan for these creditors.  The Circuit Court in Gorman ruled that the bankruptcy court abused its discretion in failing to consider the effect of the disposable income issue on its finding of good faith.

Garnishments Out-of-State

While I have had good results in issuing garnishments out of state, especially when the garnishee is a bank that operates nationwide, success is not always guaranteed.  Diversity in jurisdiction does create some issues.  A good example of this arose in a case in the United States District Court where the Court granted a debtor’s motion to quash a garnishment summons after finding that the debtor’s wages were not located in Virginia.  The garnishment summons had been issued by a Virginia creditor that was a Virginia hospital.  The debtor was a Pennsylvania resident doctor.  The garnishee was an Ohio company.  The court ruled that the garnishment summons issued by the court was ineffective to garnish the wages not located in Virginia. 

Foreclosure Sale Deficiency Actions

Frequently there will be a deficiency balance after the sale is completed and the accounting is done.  The account of sale will set forth the distribution of the sale proceeds and also establish any amounts remaining due on the indebtedness following application of the net proceeds from the foreclosure sale.  This deficiency amount is usually recovered by a personal judgment against the maker of the promissory note or other obligors on the indebtedness that was secured by the deed of trust.  An action to recover the deficiency balance remaining after a foreclosure sale need not be brought on the chancery side of the court, and may properly be brought as an action at law.  A plaintiff’s action to recover on an assumed promissory note may be maintained as an action at law even though the plaintiff is not named in the deed of trust.

The Virginia Property Owners’ Association Act – An Introduction

The Virginia Property Owners’ Association Act provides homeowner’s associations with additional protections when homeowners fail to pay their dues; it also defines responsibilities of the association. Accordingly, homeowner’s associations should be knowledgeable of the Act and its provisions. The Act applies to developments subject to a declaration recorded after January 1, 1959, associations incorporated or otherwise organized after such date, and all subdivisions created under the former Subdivided Land Sales Act. In the next issue of Creditor News, I will briefly introduce this Act and some of the special duties it imposes on homeowner’s associations.  Subsequent issues will address memorandum of liens and foreclosures.