Whelton v. Educational Credit Management Corp., Docket No. 04-4844-CV.

• Citation: 432 F.3d 150
• Decision Date: 15 December 2005
• Docket Number: Docket No. 04-4844-CV.
• Parties: Christopher J. WHELTON, Defendant-Appellant, v. EDUCATIONAL CREDIT MANAGEMENT CORPORATION, Plaintiff-Appellee.
• Court: United States Courts of Appeals. United States Court of Appeals (2nd Circuit)

432 F.3d 150

Christopher J. WHELTON, Defendant-Appellant, v. EDUCATIONAL CREDIT MANAGEMENT CORPORATION, Plaintiff-Appellee.

Docket No. 04-4844-CV.

United States Court of Appeals, Second Circuit.

Argued: August 3, 2005.

Decided: December 15, 2005.

Bernard M. Lewis, Esq., Randolph, VT, for Defendant-Appellant.

Julie K. Swedback, Esq., St. Paul, MN, for Plaintiff-Appellee.

Before: CALABRESI, RAGGI, Circuit Judges, and MURTHA, District Judge.^*

MURTHA, District Judge.

I. BACKGROUND

In two very thorough and well-reasoned opinions, the Bankruptcy Court and the District Court outlined the undisputed facts underlying this case. See generally Educ. Credit Mgmt. Corp. v. Whelton (In re Whelton), 312 B.R. 508 (D.Vt.2004); Educ. Credit Mgmt. Corp. v. Whelton (In re Whelton), 299 B.R. 306 (Bankr.D.Vt.2003). The salient facts are as follows.

In 1990, defendant-appellant Christopher J. Whelton obtained his juris doctor degree from Thomas Jefferson School of Law in San Diego, California. Shortly after graduating, he consolidated his student loans through Sallie Mae. In exchange for a promissory note, Sallie Mae disbursed a total of $52,229.89 to the holders of his eight student loans. The California Student Aid Commission ("CSAC"), predecessor in interest to plaintiff-appellee Educational Credit Management Corporation ("ECMC"), guaranteed the consolidated loan.

On or about May 19, 1999, Whelton and his wife filed for relief pursuant to chapter 13 of the Bankruptcy Code. On their Schedule F, they listed CSAC as the holder of an unsecured, non-priority claim for an educational loan in the amount of $103,830.83. This loan constituted the majority of the couple's unsecured debt.

In relevant part, the Wheltons' chapter 13 plan dated May 17, 1999 (hereinafter, with the First Amendment, referred to as "the Plan") provided for "payment of 3% to all allowed unsecured claims" over a period of 36 months. The Plan also included a statement that "the confirmation of this Plan will constitute a finding that excepting the debtor's [sic] educational loans from discharge will impose an undue hardship upon the debtors." Such language is commonly referred to as "discharge by declaration." In re Whelton, 312 B.R. at 512, n. 1 (internal quotations omitted).

On or about June 7, 1999, CSAC received by mail a notice of the Wheltons' Plan and a Notice of Meeting of Creditors. The notice stated that objections to the Plan must be filed by June 24, 1999, and a confirmation hearing was scheduled for June 29, 1999.

Neither CSAC nor ECMC attended the creditors' meeting or objected to the Plan. On June 29, 1999, however, ECMC filed a proof of claim in the amount of $102,882.51.

That same day, the Wheltons filed a First Amended Chapter 13 Plan that increased the dividend on all allowed unsecured claims from 3% to 5%, but otherwise left unchanged the Plan's declaration of undue hardship. Neither the Plan nor the First Amendment names ECMC or CSAC, nor do they identify specific student loans. The "discharge by declaration" language is located under "Other Provisions" and is not highlighted in any way.

On June 30, 1999, the Bankruptcy Court (Conrad, Bankr.J.) confirmed the Plan. ECMC did not appeal the confirmation order.

Approximately one year after the First Amendment was confirmed, the Wheltons borrowed money from a family member and paid the full amount due under the Plan. On or about June 27, 2000, ECMC accepted payment under the Plan of $4,997.00.

On July 7, 2000, the Wheltons received their discharge, which specifically provided: "Pursuant to 11 U.S.C. § 1328(a) the debtors are discharged from all debts provided for by the plan or disallowed under 11 U.S.C. § 502, except any debt ... for a student loan or educational benefit overpayment as specified in 11 U.S.C. § 523(a)(8)." They did not file an adversary proceeding to determine the dischargeability of the student loans. As of the date of their discharge, ECMC was the sole holder of the Wheltons' consolidated loan.

Following the Wheltons' discharge, ECMC attempted to collect the student loan debt by wage garnishment. In a decision dated June 25, 2001, a U.S. Department of Education hearing officer concluded the department could not permit the wage garnishment in contravention of the confirmation order and advised ECMC to seek review of the confirmation order in the Bankruptcy Court.

On July 10, 2001, ECMC filed an adversary proceeding in the United States Bankruptcy Court for the District of Vermont by which it sought to have the consolidated student loan declared nondischargeable. On September 9, 2003, the Bankruptcy Court (Brown, Bankr.J.) examined whether the Wheltons' treatment of their student loan debts in their Plan and the purported discharge by declaration effectively barred ECMC, which had never objected to the Wheltons' treatment of its claim in the Plan, from seeking a determination in a subsequent adversary proceeding that those debts had not been discharged. See 299 B.R. at 308. Judge Brown found, inter alia, "that the discharge-by-declaration provision in Whelton's plan is inconsistent with the Bankruptcy Code, is outside the scope of relief that may be effected by a chapter 13 plan, and should not have been confirmed." Id. at 312. In addition, she found "the Debtor's failure to serve a summons and complaint upon ECMC deprived ECMC of proper notice of the Debtor's intent to discharge the student loan and, hence, constituted an abrogation of ECMC's due process rights." Id. at 317.

Consequently, Judge Brown found the discharge declaration was void and of no legal effect. Id. at 318. Mr. Whelton appealed the Bankruptcy Court decision vacating the discharge of his student loan debt. On August 4, 2004, the District Court (Sessions, Ch. J.), affirmed the Bankruptcy Court "on the grounds that discharge by declaration language in a plan does not effectively except the debt from nondischargeability, and employment of such a process denie[d] the student loan creditor due process." 312 B.R. at 520.

DISCUSSION

While creditors ordinarily are not entitled to personal service before a bankruptcy court may discharge a debt, the Federal Rules of Bankruptcy Procedure provide student loan creditors "greater procedural protection" because these particular types of debts are not automatically dischargeable. See Tenn. Student Assist. Corp. v. Hood, 541 U.S. 440, 451, 124 S.Ct. 1905, 158 L.Ed.2d 764 (2004). Title 11 U.S.C. § 523(a)(8) establishes the statutory presumption against the discharge of student loans. In pertinent part, it states that a discharge under § 1328(b) "does not discharge an individual debtor from any debt ... for an educational benefit overpayment or loan made, insured or guaranteed by a governmental unit... unless excepting such debt from discharge ... will impose an undue hardship on the debtor." 11 U.S.C. § 523(a)(8). In Tennessee Student Assistance Corp. v. Hood, the Supreme Court ruled that this presumption is "self-executing" and that "[u]nless the debtor affirmatively secures a hardship determination, the discharge order will not include a student loan debt." 541 U.S. at 450, 124 S.Ct. 1905. The Court further ruled that "[b]ecause student loan debts are not automatically dischargeable ... [t]he current Bankruptcy Rules require the debtor to file an `adversary proceeding' ... to discharge his student loan debt." Id. at 451, 124 S.Ct. 1905 (emphasis added). "[A]s prescribed by the Rules, an `adversary proceeding' requires the service of a summons and a complaint." Id. at 452, 124 S.Ct. 1905 (citing Fed. R. Bankr.P. 7001(6), 7003, and 7004). Whelton plainly did not follow this mandatory procedure. Instead, by employing a discharge by declaration, Whelton attempted to avoid the adversary process to which ECMC was entitled. As the Bankruptcy Court aptly observed, "[t]he inclusion of such a provision in a plan, where it has no legitimacy, constitutes ... `practice by ambush,'" hardly consistent with the Bankruptcy Court's duty to serve equity. In re Whelton, 299 B.R. at 318.

Our sister circuits have split in ruling on the validity of student loan discharges obtained by declaration. The Ninth and Tenth Circuits have acknowledged that such a discharge procedure violates the Bankruptcy Code and Rules; nevertheless, these courts have upheld such discharges where a student loan creditor had notice of the declaration's placement in the plan and failed to object. See, e.g., Great Lakes Higher Educ. v. Pardee (In re Pardee), 193 F.3d 1083 (9th Cir.1999); Andersen v. UNIPAC-NEBHELP (In re Andersen), 179 F.3d 1253 (10th Cir.1999). In the view of these courts, the creditor's failure to object to a plan or to appeal its confirmation "constitutes a waiver of [its] right to collaterally attack the confirmed plan postconfirmation on the basis that the plan contains a provision contrary to the Code." In re Pardee, 193 F.3d at 1085 (internal quotation marks omitted); accord In re Andersen, 179 F.3d at 1257-58 (holding that creditor's failure to object or appeal from confirmation of debtor's chapter 13 plan precludes subsequent attack; the plan confirmation is final and constitutes res judicata as to all creditors, including those holding student loans).

More recently, however, the Fourth, Sixth, and Seventh Circuits have ruled that a discharge by declaration provision is unenforceable as against a student loan creditor. See Ruehle v. Educ. Credit Mgmt. Corp. (In re Ruehle), 412 F.3d 679 (6th Cir.2005); In re Hanson, 397 F.3d 482 (7th Cir.2005); Banks v. Sallie Mae Serv. Corp. (In re Banks), 299 F.3d 296 (4th Cir.2002). As the Seventh Circuit recognized in In re Hanson, a debtor inserts conclusory "undue hardship findings" into a discharge by declaration provision in the "hope ... that an unsuspecting bankruptcy court will confirm the plan and that the [student loan] lender will not recognize the discharge by declaration ploy in time to object to confirmation or to file an...