U.S. Supreme Court Agrees to Hear Student-Loan Case

Washington — A relatively small amount of money at stake in an unusual bankruptcy case could have big implications for the student-loan industry.

The U.S. Supreme Court agreed today to hear arguments in a case that hinges on whether students can avoid repaying their federally backed student loans without showing that making the payments would cause them financial distress or “undue hardship.”

In 1994, Francisco J. Espinosa filed for a Chapter 13 bankruptcy, listing $13,250 in federal student loans as his only debts. He agreed to repay the loans, held by United Student Aid Funds Inc., over four years.

The lender was notified of the court-approved plan and did not object even though it had filed a claim for $17,832, which included interest on the borrowed amount.

After the repayment plan was finished, however, United Student Aid tried to collect the difference and then filed suit, arguing that the Chapter 13 plan was void because federally guaranteed loans cannot be discharged unless the borrower initiates an “adversarial proceeding,” showing both the bankruptcy court and the lender that repaying the loans would be nearly impossible.

A federal district court ruled in favor of the lender, but the U.S. Court of Appeals for the Ninth Circuit reversed that decision and in October 2008 found that United Student Aid had missed its opportunity because the bankruptcy court had made final its order discharging Mr. Espinosa’s debts.

“The provision giving student-loan creditors a right to special procedures comes into play when the case is pending before the bankruptcy court,” wrote a three-judge panel of the Ninth Circuit court. “If a debtor proposes to discharge a student-loan debt without invoking the special procedures applicable to such debts, the creditor can object to the plan until the debtor shows undue hardship in an adversary proceeding.”

In its petition to the Supreme Court, the lender notes that the Ninth Circuit ruling conflicts with rulings in five other federal circuits. —Eric Kelderman