The U.S. Supreme Court ruled unanimously Tuesday that when a lender fails to object to a bankruptcy plan and files no timely appeal, it cannot come back to court years later seeking to collect the unpaid part of the debt.
The court refused to disturb a bankruptcy plan in a student loan case, even though the court said the bankruptcy judge made a mistake in approving the plan.
No Objection, No Appeal
Student loans are big business in America.
More than one-third of those enrolled in post-high school classes borrow money to advance their education. The federal government guarantees most such loans to the tune of some $818 billion. And to prevent people from just walking away from their obligation, federal law makes it very hard to get out of paying the money back.
Enter Francisco Espinosa, a one-time baggage handler for America West, who could not pay off the loan he received to attend technical school. With the lender calling his mother to suggest that she cash in her pension, Espinosa was scared. Then he fell in love.
"When I met my wife, I wanted to, you know, get serious with her, and I needed to get my finances squared away," he says. "I can't just come into a relationship and have bill collectors calling me."
Espinosa had no debts except his student loan, but he was making only $6.70 an hour.
So he filed to restructure the loan under the bankruptcy law and agreed to repay the $13,000 loan over five years in regular installments every two weeks. But he did not agree to repay the $4,000 due in interest and penalties.
The lender, United Student Aid Funds Inc., was notified repeatedly of the repayment plan in bankruptcy. It filed no objection, nor did it appeal the bankruptcy court order approving the plan.
But years later, after Espinosa fulfilled the terms of the plan and had his debt formally marked paid by the court, United went after him for the unpaid interest and penalties.
United contended that the bankruptcy court had made an error because it made no finding that repayment of the whole debt, including interest, would impose an undue hardship on Espinosa.
On Tuesday, though, the Supreme Court ruled that because United was notified repeatedly of the plan and failed to object at the time, it is now out of luck.
Writing for a unanimous court, Justice Clarence Thomas said, even though the bankruptcy court did make an error in not finding undue hardship that is not a license for United to "sleep on its rights" and come back after the plan has become final and the debt repaid.
To bankruptcy specialists, the message was clear. "Once an order goes down, as long as there's adequate notice of the order, it's final," says Henry Hildebrand, who wrote a brief in the case on behalf of bankruptcy trustees. "If you don't appeal the order, then the order stands."
Applications Across The Board
Hildebrand says Tuesday's ruling extends far beyond student loans or any one provision of the bankruptcy code. "It goes to the finality of the bankruptcy court order that does anything," he says.
In short, Tuesday's ruling applies to any bankruptcy matter, whether it is GM, the local shoe store or a single-student borrower and lender.
The decision also imposes an additional duty on bankruptcy judges in approving a student loan repayment plan, according to Alan Morrison, George Washington Law School's associate dean.
"The bankruptcy judge has an affirmative obligation to oversee the process in a way that it does not with regard to other debts," he says. "They will have to look at it with more care than they have done."
In short, the bankruptcy judge should not just rubber-stamp a repayment plan that, like Espinosa's, provides for only partial repayment unless there is a formal finding of undue hardship.
Congress, said the Supreme Court, went out of its way to treat student loan debts differently from other debts. And the law only permits a restructuring of the loan when full payment would impose any undue hardship.
That said, lenders may realize that they can't get blood out of a stone and may agree to partial payment, knowing that that is the best they can hope for.
In any event, the court said, lenders cannot have their cake and eat it too. They cannot remain silent when a plan is approved, and then object years later.