In re Kolbe

• Citation: 199 BR 569
• Decision Date: 01 August 1996
• Docket Number: Bankruptcy No. 95-5-7551-SD,95-5-7553-SD.
• Parties: In re James S. KOLBE, Debtor. In re Patricia A. WHITLEY, Debtor.
• Court: U.S. Bankruptcy Court — District of Maryland

199 B.R. 569 (1996)

In re James S. KOLBE, Debtor.

In re Patricia A. WHITLEY, Debtor.

Bankruptcy Nos. 95-5-7551-SD, 95-5-7553-SD.

United States Bankruptcy Court, D. Maryland.

August 1, 1996.

Ellen Cosby, Chapter 13 Trustee, Baltimore, Maryland.

Mark F. Scurti, Baltimore, Maryland, for debtors.

MEMORANDUM DENYING CONFIRMATION OF CHAPTER 13 PLANS

E. STEPHEN DERBY, Bankruptcy Judge.

I. INTRODUCTION

The issue in the present cases is whether debtors' proposed separate classification and treatment of student loan debts in their respective Chapter 13 plans unfairly discriminates against other unsecured creditors. For reasons discussed herein, the court finds that the current proposals by the debtors unfairly discriminate against the other unsecured creditors. Therefore, the plans cannot be confirmed.

II. FACTS

The debtor in each case has filed a Motion to Classify Governmental Secured Student Loans Under 523(a)(8) as a Separate Unsecured Class and to Allow for Treatment Separate from General Unsecured Creditors. The trustee has filed a memorandum objecting to confirmation in each case. Each debtor has submitted a plan that calls for 100% repayment of student loans and pro rata distributions on all other unsecured claims, which each Debtor originally estimated would aggregate 10%. Both plans are presently underfunded to make these intended payments to unsecured creditors, based on claims filed. However, each debtor has stated an intention to amend his or her plan to fund distributions at approximately these levels over 60 months, and the court accepts this premise for purposes of this opinion.

Prior to graduation from college in January, 1991, James Kolbe incurred student loan debt. Mr. Kolbe began making payments on his student loans as required, but at some point he became unable to keep payments current. When his accounts were placed in default, his loans were accelerated; and full payment was demanded. The State of Maryland has filed a claim for an NDSL/Perkins loan in the amount of $8,550.30. The claim for Mr. Kolbe's other student loan has been filed for $1,728.26, making his total student loan claims $10,278.56. Priority claims aggregate approximately $2,100, and other general unsecured claims are $2,469.07.

The facts of In re Whitley are similar. Patricia Whitley graduated from college in May, 1993, and began repaying her student loan debt as required. At some point Ms. Whitley was unable to continue payments on her two student loans. She has had payment of her student loans deferred, and her next payment is due on May 11, 1998. However, interest continues to accrue. Her two student loans currently aggregate $3,139.03, based on claims filed. There is a home mortgage arrearage claim of $8,943.44, and other general unsecured claims of $2,846.24.

III. DISCUSSION

A. Burden of Proof in § 1322(b)(1) Classification Disputes.

"The proponent of a Chapter 13 plan has the burden of proving that the proposed classification does not discriminate unfairly." In re Groves, 39 F.3d 212, 214 (8th Cir.1994). See also In re Eiland, 170 B.R. 370, 380 (Bankr.N.D.Ill.1994) ("Debtors have a heavy burden to demonstrate fairness to creditors under § 1322(b)(1)."). Therefore, Mr. Kolbe and Ms. Whitley carry the burden of showing that his or her plan does not unfairly discriminate against each's general unsecured creditors. If either is unable to carry this burden, his or her motion cannot be granted.

B. Approaches for Resolving § 1322(b)(1) Classification Disputes.

In 1990 Congress passed the Student Loan Default Prevention Initiative Act, making student loans that are sponsored or backed by a government or nonprofit institution nondischargeable in Chapter 13 plans. 11 U.S.C. § 1328(a)(2). See id. § 523(a)(8). Since then, many courts have considered whether, and under what circumstances, a debtor may place his or her nondischargeable student loan debts in a special class, pursuant to § 1322(b)(1), in order to pay a higher percentage on the student loans than on the debtor's other unsecured debt.

Section 1322(b)(1) permits a plan to "designate a class or classes of unsecured claims, as provided under section 1122 of the Bankruptcy Code, but may not discriminate unfairly against any class so designated,. . . ." Since § 1322(b)(1) expressly authorizes separate classification of unsecured claims, the focus of the instant inquiry is on whether there is justification for the disparate treatment of student loans. In re Sullivan, 195 B.R. 649, 654 (Bankr.W.D.Tex.1996). Several different tests have been used by various courts to determine whether a special classification unfairly discriminates against creditors.

1. The Leser Test.

The Leser test is a four part test: "(1) whether the discrimination has a reasonable basis; (2) whether the debtor can carry out a plan without the discrimination; (3) whether the discrimination is proposed in good faith; and (4) whether the degree of discrimination is directly related to the basis or rationale for the discrimination." In re Leser, 939 F.2d 669, 672 (8th Cir.1991). This test is the oldest test for determining whether a nondischargeable student loan may be separately classified and treated. It is also the most widely used test, but it has many deficiencies.

One problem associated with the Leser test is that the term "reasonable basis" in the first prong lacks precision, and its interpretation is open to a court's subjective discretion. Therefore, the term is no more explanatory than the statutory limitation of "may not discriminate unfairly." McCullough v. Brown, 162 B.R. 506, 509 (N.D.Ill.1993). A judge that decides to use the Leser test "wields a nearly unchecked discretion, implementing his or her personal preferences by the manner in which the judge goes about deciding on reasonableness. . . ." Id. The test gives no indication of what should be considered reasonable nor why it should be considered as such.

Another problem courts have with the Leser test is that the concept of necessity to the plan's success that is inherent in the second prong of the test is not an element of fairness or unfairness to creditors. The mere fact that a debtor has the ability to formulate an alternate, nondiscriminatory plan does not by itself mean that a proposed classification discriminates unfairly. McCullough, 162 B.R. at 510. The existence of a nondiscriminatory alternative to the plan proposed, without more, does not mean that the proposed plan is necessarily unfair. In re Benner, 156 B.R. 631, 634 (Bankr.D.Minn. 1993). Nevertheless, many courts have held that if there is an alternate plan that does not discriminate, the discriminatory plan can not be confirmed. See In re Chapman, 146 B.R. 411, 415 (Bankr.N.D.Ill.1992) ("Every extra dime that goes to holders of nondischargeable claims in a Chapter 13 case is one less dime that holders of dischargeable claims get under the plan.").

Finally, the good faith requirement in the third prong of the Leser test has been criticized as adding little to the test because every Chapter 13 plan must be made in good faith to be confirmed. 11 U.S.C. § 1325(a)(3); McCullough, 162 B.R. at 510. While the Leser test is used most often in situations similar to the cases at bar, courts have continued to search for a better test to determine if a special class discriminates unfairly.

2. The Lawson Test.

A second test that courts have used to determine if a special classification discriminates unfairly is known as the Lawson test. In re Lawson, 93 B.R. 979 (Bankr.N.D.Ill. 1988). Under the Lawson test "discrimination is `fair,' and therefore permissible, to the extent that it rationally furthers an articulated, legitimate, interest of the debtor." Id. at 984. Mr. Lawson proposed to pay the full amount of his student loans, while paying other unsecured creditors 10% of their claims. Id. at 981. The court held that Mr. Lawson's proposed plan was unfair because Mr. Lawson did not show why paying more to his student loan creditors would be in his interest. However, Lawson was decided in 1988, when student loan debts in Chapter 13 were dischargeable.

In In re Willis, 189 B.R. 203 (N.D.Okl. 1995) the district court applied the Lawson test and found that there was no unfair discrimination, because allowing the debtor to pay his student loan debt in full was in his legitimate interest since it would help him obtain a fresh start. Id. at 205.

Like the Leser test, the Lawson test has frequently been criticized. As stated by the court in McCullough:

The Lawson test invokes the rubric and phraseology of equal protection jurisprudence, which does indeed take such an approach in evaluating the fundamental fairness of any differential treatment of separate classes of people. But the analysis depends on a false parallel, for it equates the decision making status of a private debtor with that of a sovereign state. If a state government were to design a bankruptcy plan and propose some type of discriminatory treatment, perhaps such a rational interest test would be appropriate. But it is readily apparent that individual Chapter 13 debtors cannot properly be viewed as ranking on a parity with a sovereign charged with maximizing its citizens\' welfare.

McCullough, 162 B.R. at 511. Further, the Lawson test focuses on whether a proposal is unfair to the debtor, but it is the debtor who is proposing the discriminatory classification. Id. at 511. It appears unlikely that a debtor would propose a plan that unfairly discriminates against the debtor. It will always be in the debtor's best interest to maximize the repayment of nondischargeable debt during the plan, because it will enhance the debtor's fresh start. If the interest in a better fresh start is the primary reason for allowing a discriminatory classification, a debt incurred as a criminal restitution penalty could also be specially classified and paid back at a higher rate than other unsecured debts simply because it too is...