I recently fielded a question from a fellow bankruptcy attorney. The question raised some interesting factors to consider when preparing a set of Chapter 13 bankruptcy papers. First here is an edited version of the question:
Debtor only has $2,500 in credit card debt. He has $120,000 in student loan debt and wants to do a chapter 13 to get some breathing room on the monthly student loan payments. On Form 22C his disposable monthly income (DMI) is very high: $2,800. This is purely theoretical and includes his wife’s income, who will not be filing. He doesn’t actually have that kind of disposable income. My question is: if we propose to pay 100% of the non student loan unsecured debt ($2,500), do we have to still pay the equivalent of $2,800/month for 60 months (which would all go to the student loans)? Are student loans considered as part of the “general unsecureds” for the purpose of this calculation? Although student loans are not currently dischargeable, we are not allowed to give them priority payments; but can we pay them less than DMI x 60? Are we able to designate that certain payments go to principal? Does the nonfiling spouse’s income HAVE to be considered when the plan is really meant to pay down the separate student loan debt of the filer husband? She’s not liable on this debt as it was incurred before marriage.
For your edification, here is my response:
I. The Wife’s Income Is Community Property
The fact that the wife is not filing does not exempt her income from consideration. Her income is community property, and is considered available for plan payments. See, e.g., In re Hull, 251 B.R. 726 (B.A.P. 9th Cir. 2000). Thus, unless there was a prenuptial agreement indicating otherwise, the debtor really does have disposable income of $2,800 per month.
II. Student Loans Are Class 5 General Unsecured Debt
While student loans are not dischargeable, they are still considered general unsecured debt for Chapter 13 plan purposes because they are unsecured and are not given any priority in 11 U.S.C. § 507(a). Therefore, they belong in Class 5, i.e., the unsecured nonpriority debts in a Chapter 13 plan. Consequently, the general rule is that they must be paid at the same percentage as the other general unsecured debts because of 11 U.S.C. § 1322(b)(1) (unless there is a codebtor — that’s the gist of the qualifying language in the second half of that subsection).
For the record, here is the relevant statutory language from § 1322(b)(1) (with emphasis added):
[T]he plan may — designate a class or classes of unsecured claims, as provided in section 1122 of this title, but may not discriminate unfairly against any class so designated; however, such plan may treat claims for a consumer debt of the debtor if an individual is liable on such consumer debt with the debtor differently than other unsecured claims . . .
Therefore, the Chapter 13 Trustee may argue that the debtor cannot repay the $2,500 at 100%, and the student debt at less than 100%, because to do so would unfairly discriminate against the student loan creditor.
III. The “Discriminate Unfairly” Test
Interestingly, there is a string of cases that focuses on the phrase “discriminate unfairly” in the first half of § 1322(b)(1) (the portion not involving a codebtor), and concludes that some discrimination among unsecured creditors is permissible as long as it is not “unfair.” There is a four-part test, called the Wolff test, first stated in In re Wolff, 22 B.R. 510, 512 (B.A.P. 9th Cir. 1982), that courts use to determine whether a particular discrimination in a Chapter 13 plan is unfair:
The test is (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. Restating the last element, does the basis for the discrimination demand that this degree of differential treatment be imposed?
If you are hoping to apply this test successfully, it is worth noting that:
(a) the debtor has the burden of establishing all four prongs of the test (see In re Wolff, 22 B.R. at 512); and
(b) “[T]he nature of student loans as nondischargeable is not, by itself, a reasonable basis for giving them preferential treatment. Instead, the Debtor must show some other factors which demonstrate that discrimination is necessary.” In re Sperna, 173 BR 654, 660 (B.A.P. 9th Cir. 1994). Conversely, it can reasonably be argued that the nondischargeability of student debt is not, by itself, a reasonable basis for giving the other general unsecured creditors preferential treatment.
If you have questions about this, or any other post, or would like to suggest a blog topic, or wish to discuss your finances and the bankruptcy option, please drop me a line. And check out my website as well.