Star-Cross’d: The Tragedy of Chapter 13 and the Modern Student Loan Debtor

Student loan debt is (mostly) presumed nondischargeable under § 523(a)(8).[1] Hardship discharge of such debt has become a vanishingly probable outcome. And yet, while educational costs soar along with the accompanying debt, the chapter 13 debt limits under § 109 chug along at the rate of growth reflective of the Consumer Price Index[2] without distinction for the nature of the unsecured debt or its potential dischargeability.

            Assuredly, the unsettling balances and high interest rates of many student loans play a part in bringing to bankruptcy the debtor saddled with student loans. But alas, a consumer debtor, who would otherwise be a perfect fit for chapter 13, is effectively barred from proceeding as a chapter 13 debtor if he has acquired too much student loan debt in pursuing an education so that his nondischargeable debt exceeds the unsecured debt limits.

            Many student loan debtors, however, have tested fate and attempted to enter into a chapter 13 repayment plan to repay at least some portion of their unsecured debt and obtain a discharge. But if a party-in-interest points out the illicit affair, the majority of case law suggests that the relationship will end in tragedy, even if at first the relationship seems promising.

Stearns v. Pratola

            Christopher V. Pratola filed a voluntary chapter 13 petition, scheduling a total of $568,671 in student loan debt.[3] When coupled with his non-student loan unsecured debt, Mr. Pratola’s unsecured debt totaled $591,223, which far exceeded the $394,725 unsecured debt limit imposed by § 109(e).[4]

            Faced with patent ineligibility, the chapter 13 trustee moved to dismiss Mr. Pratola’s case citing both §§ 109(e) and 1307(c).[5] Mr. Pratola opposed this request, arguing that his student loan debt was contingent based on the nature of his income-based repayment plan and thus should not be included in the debt-limit calculation.[6] Mr. Pratola prayed that Hon. Janet S. Baer of the U.S. Bankruptcy Court for the Northern District of Illinois would allow him to remain in chapter 13.

            Judge Baer initially dispensed with the debtor’s first argument, holding that the debt was noncontingent and would be included for purposes of the debt limits of § 109.[7] The bankruptcy court then turned to whether exceeding the debt limits of § 109 constituted “cause” for dismissal under § 1307(c), noting that “ineligibility is not an absolute cause for dismissal or conversion when a debtor owes more than the § 109(e) debt limit.”[8] The bankruptcy court then narrowed the issue specifically to whether cause to dismiss existed in this particular situation in which student loan debt pushed the unsecured debt totals well beyond the statutory thresholds of eligibility.

            Judge Baer analyzed the legislative intent in imposing the debt limits of § 109 in reaction to the expansion of eligibility for chapter 13 to certain small business debtors. In particular, the Report of the Committee on the Judiciary, related to what would become the Bankruptcy Reform Act of 1978, emphasized that the debt limits were imposed “in order to prevent sole proprietors with large businesses from abusing creditors by avoiding chapter 11.”[9] The bankruptcy court determined that Congress did not wish to exclude individuals, like Mr. Pratola, with extreme amounts of student loan debt from obtaining a fresh start through a chapter 13 plan, as opposed to the more cumbersome and impractical individual chapter 11 plan.[10] To bolster this outcome, the bankruptcy court provided resulting benefits to creditors in allowing the student loan borrower to utilize the chapter 13 process. Additionally tackling a few policy arguments and the modern reality of student loan debt, the bankruptcy court concluded that § 1307(c) did not compel it to dismiss Mr. Pratola’s case merely because he incurred too much debt to obtain his education.[11]

            The chapter 13 trustee, not about to let an individual with excessive nondischargeable debt enter into a happy union with a chapter 13 repayment plan, appealed.[12] The district court reversed the bankruptcy court, heavily relying on the fact that the debt limits imposed by Congress in § 109 are quite clear and unambiguous.[13] The district court respectfully disagreed with the bankruptcy court and held that such ineligibility constituted cause for dismissal pursuant to § 1307(c).[14] While “not unsympathetic” to the debtor’s plight, the district court highlighted that the solution “lies with Congress rather than the courts.”[15]

Chapter Choice?

            Clearly, Mr. Pratola is by no means the first debtor to be barred from the gates of chapter 13 due in large part to his accumulation of student loan debt.[16] However, Judge Baer is not alone in her attempt to reconcile the debt limits with the purposes of the Bankruptcy Code and the best interests of debtors, creditors and the estate.[17]

            The student loan situation persists in the U.S. Student loan debtors may wish to make use of the benefits of chapter 13, and creditors may even prefer that debtors pursue this option. “Proceedings under Chapter 13 can benefit debtors and creditors alike. Debtors are allowed to retain their assets … [a]nd creditors, entitled to a Chapter 13 debtor’s ‘disposable’ postpetition income, § 1325(b)(1), usually collect more under a Chapter 13 plan than they would have received under a Chapter 7 liquidation.”[18]

            Student loan debtors may qualify as honest but unfortunate, but they may be ineligible for relief under chapter 13 based on excessive amounts of student loan debt. The consumer student loan debtor may instead turn to chapter 7 for relief. But what if the consumer debtor’s education has resulted in gainful employment, enabling him to pay enough to creditors that he fails the means test?

            When faced with the choice of (1) dismissal of a chapter 13 petition pursuant to § 1307(c), (2) dismissal of a chapter 7 petition pursuant to § 707(b), or (3) the cumbersome individual chapter 11 process, the latter may be the only resort for the consumer loan debtor in need of a fresh start. This emerging reality creates a Hobson’s choice for debtors with staggering student loan debt: File a chapter 11 petition or go away. Filing for chapter 11, however, is not nearly as attractive or alluring as chapter 13 to the basic consumer debtor. The individual chapter 11 debtor has a much more complicated set of duties and obligations than the chapter 7 or 13 debtor. Further, from a creditor’s perspective, the fees and costs associated with meeting the requirements of chapter 11 will eat at the recovery of unsecured creditors that may have otherwise received a reasonable dividend under a chapter 13 plan. And under any chapter, the student loan debt will (most likely) still be there waiting patiently for the debtor post-discharge.

            Unless Congress amends § 109 to reflect an exception for student loan debt (or perhaps even more broadly, nondischargeable debt) from the debt-limit calculation or to increase the debt limits, the reality remains that debtors and creditors alike will lose the benefits of a chapter 13 repayment plan. Until such congressional deus ex machina materializes, however, no matter how perfect a debtor may be for chapter 13, like the titular star-cross’d lovers, the pairing appears doomed.