MEMORANDUM OF DECISION
These Chapter 13 cases have come before the Court on objections to confirmation, filed by the standing trustee. In each case, the only ground asserted by the trustee for denial of confirmation is that the plan proposes to pay student loan claims at a higher rate than other unsecured claims. The principal issue raised is whether this discriminatory treatment of unsecured claims is “unfair” pursuant to Section 1322(b)(1) of the Bankruptcy Code (Title 11, U.S.C., “the Code”).
1
For the reasons stat
Jurisdiction
This court has jurisdiction over these matters pursuant to 28 U.S.C. § 1334(a), 28 U.S.C. § 157(a), (b)(1) and (2), and General Rule 2.33 of the United States District Court for the Northern District of Illinois. The confirmation of plans is a core proceeding under 28 U.S.C. § 157(b)(2)(L).
Findings of Fact
The relevant facts are undisputed. The debtors in each of the cases before the court have proposed Chapter 13 plans that classify the general unsecured claims into two classes. One class consists of student loan claims that are nondischargeable under Section 1328(a)(2). The other class consists of all nonpriority unsecured claims except student loans. In each plan, it is proposed that the student loans be paid in full, while the other unsecured claims are paid between ten and twenty percent of their allowed amount. The standing trustee has represented to the court that, apart from the preferential classifications, the plans in these cases meet all the requirements for confirmation. No creditor has objected to confirmation in any of the cases.
Conclusions of Law
The cases now before the court present a single question: can Chapter 13 debtors who owe nondischargeable student loans pay those loans in full through their Chapter 13 plans, even though they have insufficient income to make full payment to their other unsecured creditors? A number of courts have given a negative answer to this question, but the structure and history of the Bankruptcy Code indicate that the answer should be yes: if the other requirements for confirmation are met, Chapter 13 plans may provide for payment of student loans at a higher rate than other claims.
The uncertain case law.
The treatment of student loans in Chapter 13 has long been a troubling one for the courts. Under the Bankruptcy Code as originally enacted, student loan claims were generally excepted from discharge in Chapter 7 liquidations, pursuant to Section 523(a)(8) of the Code. However, Section 523(a)(8) did not apply to the discharge granted under Chapter 13. This led to a controversy over whether and under what circumstances Chapter 13 could properly be used by debtors to discharge student loan claims. Some courts confirmed Chapter 13 plans that proposed equal payment of all unsecured claims, including student loans, at less than the full amount due.
E.g., In re Winthurst,
Since November, 1990, the Code has been amended to provide that student loan claims are nondischargeable in Chapter 13 on the same basis as in Chapter 7.
2
Thus,
One response is that, if the other requirements for confirmation are met, a Chapter 13 plan may properly provide for student loan claims to be paid at a higher percentage than other unsecured claims.
In re Boggan,
A second holding is that a Chapter 13 plan may preferentially classify student loans, but only in the manner specified by Section 1322(b)(5) of the Code,
i.e.,
curing of any default within a reasonable time and maintaining payments while the case is pending.
In re Christophe,
Finally, a third group of decisions, without a common rationale, holds that preferential classification of student loans constitutes unfair discrimination under Section 1322(b)(1), and so is prohibited.
In re Chapman,
The issue is further confused by the treatment that has been given to claims for alimony, maintenance and support. Like student loans, these family support claims are excepted from discharge in Chapter 13 by Section 1328(a)(2), which incorporates the exceptions of Section 523(a)(5). Indeed, family support claims were nondischargeable in Chapter 13 as originally enacted.
See In re Estus,
The inadequacy of the four-part test.
The wide range of judicial decisions here is, in the first instance, due to an ambiguity in the Bankruptcy Code. Section 1322(b)(1) of the Code expressly allows discrimination between classes of unsecured claims in Chapter 13 plans, as long as the plan does not “discriminate unfairly.”
3
The Code provides no definition of unfair discrimination. However, in resolving the resulting ambiguity, the courts have most commonly applied a four-part test that has significantly added to the uncertainty. The test is set forth in
In re Leser,
Lacking more explicit direction from Congress, courts have developed a four-part test to determine whether a proposed separate classification of unsecured claims is fair by inquiring: (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.
Although frequently cited, this test has also been frequently criticized.
Husted,
The first difficulty is with the test’s central focus: reasonableness. Both the first and fourth part of the test essentially ask whether the extent of discrimination is reasonable.
See Green,
The next difficulty with the test is the uncertain nature of its second part: whether the debtor can complete the plan without the discrimination. Is the necessity of the discrimination an absolute requirement of fairness, or is necessity simply one factor that the court should take into consideration? In
In re Ratledge,
Finally, the four-part test generates confusion through its reference to good faith. Under Section 1322(a)(3) of the Code, all Chapter 13 plans are required to be “proposed in good faith.” Although the meaning of this good faith requirement is uncertain — see
In re Schaitz,
The difficulties with the four-part test may well result from a misuse of the decision that first employed it. The test derives from the decision in
In re Kovich, 4
B.R. 403 (Bankr.W.D.Mich.1980).
Kovich
involved two different Chapter 13 plans, one of which preferentially classified cosigned debt and the other debt owing to a landlord. The court found that the classifications did not require a denial of confirmation, reasoning as follows (
Pursuant to Section 1322(b)(1) [separate classification of unsecured claims] must not “discriminate unfairly.” The fact that [the preferred creditors] receive more than other unsecured creditors, certainly is a form of discrimination. But it is not necessarily unfair. It may be that in order for a debtor to avail himself of a Chapter 13 instead of Chapter 7 liquidation, he will have to make special arrangement in the plan for an obligation that a friend or relative cosigned.... Likewise, because of a debtor’s financial and family situation and the availability of other housing, it may be necessary to make a special provision for past due rent. Such classifications may not be unfair to other unsecured creditors because if they are not permitted the debt- or may be forced to file under Chapter 7 and they may receive nothing. Therefore, the classifications are not ipso facto unfair discrimination.
Based on these considerations, the court set the plans for hearing on the fairness of their discrimination and listed a number of questions that might be relevant at the hearing on the particular plans then at issue (id.):
Each ease must be decided on its own merits. Is there a reasonable basis for the classification? Is the debtor able to perform a plan without the classification? Has the debtor acted in good faith in the proposed classifications? Certainly the debtor should not be permitted to pay a creditor less because of ill will. Another consideration must be the treatment of the class discriminated against. Are they receiving a meaningful payment or is the plan just a sham?
Although these questions were quickly adopted as the test of fairness in discrimination,
4
they do not appear to have been so intended. The discussion that preceded the questions makes it clear that
Kovich
viewed the necessity for discrimination simply as a way in which the plans then before the court could be shown to have a rational basis. Far from holding that necessity was required for any discrimination to be fair, the court favorably cited
In re Curtis,
Because of all its problems — ambiguity, redundancy, and lack of foundation — the four-part test is not useful in determining whether discrimination between classes of claims in a Chapter 13 case is fair.
The legitimate interests of the debtor as the basis for a test of fairness.
In
In re Lawson,
But why should the interests of the debt- or be controlling? The principal reason is that the right to preferentially classify claims was placed in Chapter 13 as an incentive to debtors to choose Chapter 13 for their cases. As the Seventh Circuit recognized in
In re Lybrook,
To encourage the use of Chapter 13 over Chapter 7 liquidations, Congress enacted a number of provisions making Chapter 13 uniquely advantageous to debtors.
7
The right to classify unsecured debt is one of these special features. As discussed in
Lawson,
Unsecured creditors, therefore, have no right to pro rata payment in Chapter 13. This is a departure from otherwise applicable bankruptcy law, and some courts have expressed aversion to it.
E.g., Saulter,
Moreover, unsecured creditors who are paid less than a pro rata amount in Chapter 13 are not left without protection. They must receive at least as much through a Chapter 13 plan as they would have received in a Chapter 7 liquidation. 11 U.S.C. § 1325(a)(4). They may demand, since they are not to be paid in full, that the debtor contribute all of his or her disposable income to the plan for a three-year period. 11 U.S.C. § 1325(b). And, finally, the unsecured creditors have the protection of the provision at issue here: the debtor must demonstrate that any discrimination between classes of unsecured creditors is fair, under Section 1322(b)(1). Thus, not all of the discriminations a debtor may wish to make are permissible. Yet the fundamental purpose for allowing discriminatory classification remains to provide the debtor with flexibility. The fairness test stated in Lawson addresses this purpose, allowing the debtor to make discriminations that further a legitimate interest, but denying discriminations that are arbitrary.
What interests are not legitimate? Plainly, a debtor should not be allowed to penalize certain creditors for purely subjective reasons
{e.g.,
proposing to pay a judgment creditor less because the debtor disagrees with the judgment) or to prefer others for similar subjective reasons
(e.g.,
proposing to pay friends and family members more than commercial creditors because of personal affection). Thus, prior to the 1984 amendment of Section 1322(b)(1) regarding codebtors, “many courts ... found payment in full on cosigned debts to be unfairly discriminatory (especially when the cosigner is a member of the debtor’s family)_”
In re Dziedzic,
On the other hand, if the debtor can point to an objective benefit to be obtained or harm to be avoided by the discrimination, consistent with the purposes of Chapter 13, the debtor’s interest should be recognized as legitimate. Here, the debtor’s interest is in emerging from bankruptcy free of debt, with a “fresh start.” This is an objective interest entirely consistent with the purposes of Chapter 13. In discussing the need for a limit on the extent of Chapter 13 plans, Congress referred to the fresh start as "the essence of modern bankruptcy law” H.R.Rep. No. 595, 95th Cong., 1st Sess. 117 (1977), and its importance has long been recognized by the courts.
E.g., Local Loan Co. v. Hunt,
Indeed, if Congress’s aim of encouraging the use of Chapter 13 over Chapter 7 is to be honored, debtors must be allowed to preferentially classify debt that is nondis-chargeable in Chapter 13. Without preferential classification, debtors who are obligated to pay debts that are nondischargeable in Chapter 13 will have a strong incentive to use Chapter 7 instead of Chapter 13. In Chapter 7, the debtors are only required to surrender their nonexempt assets — often nothing; they can then retain all of their postpetition disposable income, to use, if they wish, in paying the nondischargeable debt. 9 By contrast, in Chapter 13 without preferential classification, the debtors are required to pay into the plan at least the value of their nonexempt assets, and any disposable income that remains would have to be shared with the unsecured creditors pro rata, for a minimum of three years. Thus, in Chapter 13 without preferential classification, debtors may be required to devote substantial amounts of postpetition disposable income to payment of discharge-able debt, which income, in a Chapter 7, could be devoted exclusively to the nondis-chargeable debt.
The family support cases.
The test of fairness based on the legitimate interests of the debtor is supported by the many decisions that hold it permissible for Chapter 13 debtors to preferentially classify family support arrearages.
10
The debtor’s interest in a fresh start is, in fact, the reason given for allowing the preferential discrimination in many of the family support decisions.
E.g., Whittaker,
“Payment in full of the nondischargeable child support arrearage obligation is reasonably related to the Debtor’s legitimate interest in not being burdened with a substantial debt at the completion of his Chapter 13 plan, and thus the different treatment of the child support arrear-age claim does not discriminate unfairly against the nonpriority unsecured claims.... ”
However, some of the decisions disallowing preferential classification of student loan claims have suggested grounds for distinguishing the family support cases. One proposed distinction is that repayment of student loans is not “as favored in public policy as are alimony and child support payments.”
Scheiber,
These distinctions are not persuasive. First, the relative strength of public policy concerns regarding payment of student loans and family support is not relevant here.
11
Congress has indicated that both types of debt are equally nondischargeable in bankruptcy. The interests of the parties involved in the bankruptcy — the debtor who must pay the nondischargeable claim in full, and the creditors who may receive less than pro rata payments — are therefore the same in each situation. Nor can it be said that the needs of the supported family members require a different treatment. Current support payments are not governed by a Chapter 13 plan; the disposable income that is contributed to the plan is calculated by deducting all payments required for “maintenance or support of ... a dependent of the debtor.” 11 U.S.C. § 1325(b)(2). And it has been held that the debtor may preferentially classify support arrearages even when they are not being paid to the supported family members.
Leser,
Similarly, the automatic stay does apply to prevent enforcement of family support claims against the postpetition earnings of a Chapter 13 debtor, so that full payment of these claims is not necessary to allow completion of a Chapter 13 plan. Section 362(a)(6) effectuates an automatic stay of “any act to ... recover a claim against the debtor that arose before the commencement of the case.” Section 362(b)(2) creates an exception to this stay so as to allow the collection of family support “from property that is not property of the estate.” However, postpetition earnings of a debtor in Chapter 13 are property of the estate under Section 1306(a)(2), and remain such until “the case is closed, dismissed, or converted.” 12 Nor is there any assurance that a court would feel compelled to grant relief from the stay to a family support claimant. It is completely possible that the claimant would not have a compelling need for immediate payment of past due family support. The situation of the county collection agency in Leser is a clear example.
Again, then, it is the nondischargeable nature of the claim that justifies preferential classification of family support claims. The same justification applies to student loans.
The good faith of student loan debtors.
It may be that the courts have accorded harsher treatment to student loan debtors than to family support debtors because of a
This court is particularly desirous of preventing debtors from avoiding the obligation incurred by loans for educational purposes when debtors have the means, potential, and ability to repay student loans which have permitted them to prepare themselves for well-paying positions in business and the professions.
It is certainly possible that student loan debtors may be acting in bad faith. For example, a student might deliberately make lavish use of unsecured credit extended in anticipation of a lucrative career, and then file a Chapter 13 case just as that career begins. However, family support debtors may also act in bad faith, deliberately withholding needed payments from their dependents while they live luxuriously, and filing bankruptcy only when apprehended. In neither situation are the courts required to tolerate abuse of the bankruptcy system. As noted above, good faith is separate requirement for Chapter 13 plans, distinct from fairness in discrimination. Thus, even though the discrimination in the case of a student loan (or support) debtor is fair, the plan may be denied confirmation because of a lack of good faith. See
In re Doersam,
However, it certainly cannot be said that all cases involving preferential classification of student loans are filed in bad faith. For example, a recent graduate may take on a good job, and, using credit obtained in reliance on that job, incur substantial debt in setting up a household, while paying the student loans. If that debtor is then unexpectedly laid off, both the student loans and substantial additional debt will be due. Such a debtor may, in complete good faith, seek to discharge all of the indebtedness in a Chapter 13 case. The courts should not discourage such a filing by ruling that preferential classification of student loans is unfair.
In re Saulter,
In the present case, the only suggestion of bad faith on the part of any of the
Other sections of the Code.
The remaining arguments in favor of limiting preferential classification of student loans rely on other sections of the Bankruptcy Code.
In re Saulter,
Finally, in
In re Chapman,
The other sections of the Code cited in the opinions disallowing preferential classification of student loans thus do not provide a basis for interpreting Section 1322(b)(1).
Conclusion
In Section 1322(b)(1) Congress accorded Chapter 13 debtors a right to classify the unsecured claims that were to be paid through their plans, and to pay some of those claims at a higher rate than others. This right was intended to encourage use of Chapter 13. The limitation imposed on that right by the “unfair discrimination” provision must be interpreted in a way that allows Section 1322(b)(1) to serve its intended purpose. Thus, debtors should be allowed to make preferential classifications when the resulting discrimination rationally furthers a legitimate interest of the debtors. In the cases now before the court, the debtors have a legitimate interest in paying their nondischargeable student loans in full through their Chapter 13 plans, so that they may complete their plans free of debt. Accordingly, their plans do not unfairly discriminate by providing for full payment of student loans and proportionately smaller payments of other unsecured claims. Because this classification is the only ground asserted as a basis for denial of confirmation, and because it appears that all of the other requirements for confirmation — including good faith — have been met, the objections of the standing trustee are overruled, and the debtors’ plans are confirmed. Separate orders will be entered in conformity with this decision.
Notes
. Section 1322(b)(1) of the Code provides:
(b) Subject to subsection (a) and (c) of this section, the plan may—
(1) 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 maytreat 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.
. The Student Loan Default Prevention Initiative Act of 1990, part of the Omnibus Budget Reconciliation Act of 1990, amended the Chapter 13 discharge provisions of Section 1328(a) of
. The provisions of the Bankruptcy Code leading to this conclusion are thoroughly analyzed in
In re Leser,
. See
In re Wolff,
. Section 1325(b) of the Code, which was added by the Bankruptcy Amendments and Federal Judgeship Act of 1984, Pub.L. No. 98-353, 98 Stat. 333 (1984) (“BAFJA”), addresses the concern that Chapter 13 debtors make meaningful payments into their plans. Section 1325(b) requires that Chapter 13 debtors, if requested by an unsecured creditor or by the standing trustee, either pay all of their unsecured claims in full or else pay all of their disposable income into the plan for at least a three year period.
See In re Smith,
. The general legislative history of Chapter 13 is discussed in some detail in
In re Estus,
. Among these provisions are the following:
• Fully voluntary participation. A debtor cannot be forced into Chapter 13 through an involuntary petition, or by a nonconsensual conversion. 11 U.S.C. § 303(a) (involuntary cases may be filed only under Chapters 7 and 11); 11 U.S.C. §§ 706(c), 1112(d) (conversion to Chapter 13 only on request of the debtor). Once in Chapter 13, the debtor has an absolute right to convert the case to Chapter 7, and, if not previously converted to Chapter 13, to dismiss the case. 11 U.S.C. § 1307(a), (b). Only the debtor may propose a plan under Chapter 13, and so the terms of the plan may not be imposed on the debtor. 11 U.S.C. § 1321.
• Protection of codebtors. Individuals who cosigned consumer loans for a debtor in Chapter 13 are protected by a stay if the debtor proposes to pay the loan through the Chapter 13 plan, 11 U.S.C. § 1301, and, since the 1984 amendments, the debtor may discriminate in payments to holders of such cosigned debt, even if this discrimination would be unfair, 11 U.S.C. § 1322(b)(1).
• Protection of postpetition earnings. Earnings of the debtor after the commencement of the case become property of the debtor’s estate in Chapter 13 until the case is closed, dismissed, or converted. 11 U.S.C. § 1306. Hence, the automatic stay applies to prevent creditors from seeking to enforce claims against these earnings. 11 U.S.C. § 362(a)(3).
• Broader, flexible discharge. The normal discharge under Chapter 13 covers many debts that are nondischargeable in Chapter 7. Compare 11 U.S.C. § 1328(a) with 11 U.S.C. §§ 523(a) and 727. Moreover, in situations of hardship, the debtor may qualify for a discharge with the same scope as that in Chapter 7, without completing plan payments. 11 U.S.C. § 1328(b).
. See
In re Hall,
. If the debtor had a significant amount of post-petition disposable income, an objection might be made to the debtor’s use of Chapter 7, pursuant to Section 707(b). However, Section 707(b) itself directs that there should be a presumption in favor of granting the relief sought by the debtor, and the courts are in disagreement over its application.
E.g., Fonder v. United States,
. A number of the recent decisions so holding are:
In re Leser,
. However, it should be noted that in a time of extraordinary concern over the federal budget deficit, there is a substantial public interest in recovering the payments that the federal government has been required to make on guaranteed student loans in default. These payments were more than $2 billion in 1989.
Association of Accredited Cosmetology Schools v. Alexander,
. Section 1327(b) provides for the "vesting" of estate property in the debtor at confirmation. However, even if this "vesting" is seen as taking the property out of the estate, the automatic stay could be kept in place by providing in the plan that the property not vest in the debtor, an option expressly allowed under Section 1327(b).
. Debts incurred by fraud, breach of fiduciary duty, and intentional injury are all excepted from discharge in Chapter 7, but not in Chapter 13. Compare 11 U.S.C. § 523(a)(2), (4), (6) with 11 U.S.C. § 1328(a).
.
In re Harris,