In Re Mason
MEMORANDUM OPINION
The chapter 13 debtors William and Jill Mason propose in their Amended Plan to separately classify their nondischargeable, unsecured student loan obligations in the amount of $30,941.44 and to partially pay the student loan debt ahead of other general unsecured claims totaling $43,341.00. The chapter 13 trustee objects to confirmation of the debtors’ Amended Plan, contending that this proposed classification and treatment unfairly discriminates against the class of general unsecured creditors in contravention of 11 U.S.C. § 1322(b)(1). 1 For the reasons set forth below, the Court agrees with the trustee and denies confirmation of debtors’ Amended Plan.
Jurisdiction
This contested matter is a core proceeding of which the Court has jurisdiction. 2 It is submitted to the Court on stipulated facts and briefs. 3 These papers and the Court’s file comprise the only evidentiary record in this case. Based thereon, the Court makes the following findings of fact and conclusions of law pursuant to Fed. R. Bankr.P. 7052.
Findings of Fact
On May 16, 2002, the debtors William and Jill Mason (“debtors”) filed their petition for bankruptcy relief under Chapter 13. On this same date, debtors filed their chapter 13 plan.
On November 14, 2002, the debtors filed an Amended Plan wherein they proposed plan payments of $1,250 a month for a term of 56 months. 4 The Amended Plan further provided as follows:
Class C Claims: Dividends to unsecured creditors whose claims are duly filed and allowed as follows:
a) The penalties and interest owed to Internal Revenue Service and or State of Kansas for the tax 1999 through 2001 tax years are unsecured, nonpriority debts and shall be fully discharged upon the completion and discharge of this Chapter 13 Plan. 5
b) Income tax owed to Internal Revenue Service or State of Kansas, including principal, penalties and interest for the 1998 tax year, or any prior year, is an un-secured [sic], non-priority claim and shall be fully discharged upon the completion and discharge of this Chapter 13 Plan.
c) It is anticipated that there will be the sum of $5,660.00 remaining to be paid to unsecured creditors. 6 This sum constitutes approximately 8% of the Unsecured debt balance. This sum also represents 51% of funds paid in to Ms. Mason’s retirement account.
d) Said funds referenced in paragraph c) above shall be paid first to the non-priority unsecured claims of the United States Department of Education then amongst other general unsecured creditors.
[Emphasis added.]
The unsecured student loan obligations consist of the claim of Sallie Mae Servicing L.P. in the amount of $20,419.03 and the claims of Bank of America for three unsecured student loans in the amount of $10,522.41, for total student loan claims of $30,941.44. The amount of the general unsecured claims, exclusive of the student loan claims, total $43,341.00 as of the claim bar date. If the debtors make all of the payments proposed in the Amended Plan, the total distribution to the student loan creditors as proposed in the Amended Plan will be $5,202.91 — the full amount available for unsecured creditors, or roughly 17% of the amount of the student loan claims. The remaining general unsecured creditors would receive nothing on their claims.
If the student loan claims are paid pro rata with the other general unsecured claims, all of the unsecured creditors would receive a dividend of 7%.
Under either scenario, the student loan claims would not be paid in full at the completion of the Amended Plan. According to the stipulated plan calculations of the trustee, the Class C unsecured creditors would not receive any plan payments until the secured claims and priority claims are paid in full at month 52. Under the Amended Plan if the student loan claims are paid ahead of the other general unsecured claims, the remaining balance on the student loan claims upon completion of the plan payments would be $25,738.53. If the student loan claims were paid pro rata with the other general unsecured claims, the remaining balance on the student loan claims upon completion of the plan payments would be $29,428.78. In either event, the remaining balance on the student loan debt will be nondischargeable. 7
Conclusions of Law
Section 1322(a)(3) requires that a chapter 13 plan provide the same treatment for each claim within a particular class. Section 1322(b)(1), which is subject to subsection (a), permits designation of a “a class or classes of unsecured claims” but prohibits a designation that “discriminate[s] unfairly” against any class of unsecured claims. The debtors have the burden of showing that their Amended Plan complies with the statutory requirements for confirmation and does not unfairly dis
There is considerable dispute among reported decisions concerning the propriety of separately classifying and treating student loans. 9 Several tests have emerged from the case law for determining whether a separate classification and treatment of student loans unfairly discriminates against the class of general unsecured claims.
The Four-Step Test
A “four step test” for determining whether separate classification of unsecured claims is fair was stated and applied by the Eighth Circuit Court of Appeals in In re Leser, 10 a case involving separate classification of a nondischargeable child support claim. In that case, the debtor proposed to pay in full the nondischargeable debt and to pay 8% of other unsecured claims. The court described the relevant inquiries in the 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. 11
The bankruptcy courts have applied this four-part test in the context of separately classifying nondischargeable student loans. 12
The Balancing Test
A second test for determining whether a separate classification of student loan debt
The Baseline Test
Yet a third approach for determining whether a separate classification of student loan debt discriminates unfairly against other unsecured creditors is articulated by the First Circuit Bankruptcy Appellate Panel in In re Bentley 14 and is what this Court will refer to as the “baseline test.” Under this approach, the court looks to four guiding principles of chapter 13 itself for what is the norm, or the baseline from which departures can be evaluated for fairness: (1) equality of distribution; 15 (2) nonpriority of student loans; 16 (3) mandatory vs. optional contributions; 17 and (4) the debtor’s fresh start. 18
When a plan prescribes different treatment for two classes but, despite the differences, offers to each class benefits and burdens that are equivalent to those it would receive at the baseline, then the discrimination is fair. On the other hand, when the discrimination alters the allocation of benefits and burdens to the detriment of one class, the discrimination is unfair and prohibited. 19
Applying this analysis in Bentley, the court concluded that a plan proposing to pay student loan obligations in full and to pay all other unsecured claims a dividend of 3% discriminates unfairly against the class of other unsecured creditors. Such a plan redistributed the benefits and burdens to the debtor’s benefit and the unsecured creditors’ detriment when compared to the normal chapter 13 treatment. The Seventh Circuit Court of Appeals has recently cited Bentley’s baseline test favorably. 20
The Debtor’s Interest
The debtors rely primarily on
In re
Boggan
21
which appears to this Court to
The debtors in the case at bar make the same argument here although factually this case is very different. Here the debtors do not propose to pay the nondis-chargeable student loan in full while paying a portion of other unsecured debt. Rather, the debtors propose to pay 17% of the student loan obligation while paying nothing to the other general unsecured creditors. Under the debtors’ Amended Plan, debtors will in any event emerge from bankruptcy with a nondischargeable student loan obligation. They will simply emerge from bankruptcy with a slightly-reduced student loan obligation if the Amended Plan is confirmed. 22
This Court does not find Boggan persuasive and declines to follow it. 23 Numerous courts have rejected the premise that the nondischargeability of a claim (or the “fresh start” philosophy), in and of itself, is a legitimate debtor interest that permits preferential treatment of student loan creditors. 24
Application of the Tests in this Case
The debtors rely exclusively on the fact that their student loan debt is nondischargeable as the basis for their separate classification of the student loan claims and justification for discriminating against the class of general unsecured creditors. They assert that the proposed discrimination furthers the fresh start philosophy of bankruptcy. The trustee contends that debtors’ discriminatory treatment of unsecured creditors is unfair under all of the above enumerated tests. This Court agrees.
A. The four-part test.
Debtors cannot meet the first prong of this test — showing a reasonable basis for the discrimination. As noted above in this Court’s discussion of
Boggan,
the clear weight of authority holds that the mere fact that student loan claims are not dis-chargeable is an insufficient basis for discrimination. The Court further questions the relationship between the degree of discrimination to the basis for the discrimination — nondischargeability and fresh start. Debtors propose to pay nothing to the other unsecured creditors yet this degree of discrimination will not pay in full the debtors’ student loan obligations. The payment of all available monies to the student loan creditors will only result in a modest reduction in the amount of the student loan obligation that would survive debtors’ discharge. In short, even with the degree of discrimination proposed
Nor is there any evidence in the record before this Court to enable the Court to make findings on the other prongs of the four-part test. For example, debtors have come forward with nothing of evidentiary value demonstrating that they are unable to carry out a plan of reorganization without the discriminatory provision. It is apparent to this Court that the debtors could easily proceed under chapter 13 without preferential treatment of the student loan creditors. There is nothing in the record suggesting any necessity for or anticipated hardship as a result of the student loan creditors participating pari passu in the dividend distribution.
In sum, debtors have failed to meet their burden of proving that the separate classification and preferential treatment of their student loan creditors does not unfairly discriminate against the class of other unsecured creditors.
B. The balancing test.
An analysis of the relative benefits and detriments to the debtors, the student loan creditors, and the general unsecured creditors also militates against debtors. Under the Amended Plan, the student loan creditors are given priority over other unsecured creditors that is not provided for by any provision in chapter 13. At the same time, the student loan creditors retain the right to collect the balance of the student loan obligations after debtors’ discharge, while other unsecured creditors are left with no such recourse. The debtors gain a reduction in the amount of the nondis-chargeable debt that will remain upon completion of the Amended Plan and a discharge of all the other unsecured claims, without paying any dividend to the holders of the unsecured claims. Because of the discharge, the only means available for other unsecured creditors to be paid anything on their claims is eliminated. Clearly, what is the debtors’ burden for the nondischargeable student loan debt has been unfairly shifted to the unsecured creditors. The treatment afforded the student loan creditors discriminates unfairly against the unsecured creditors under the balancing test.
C. The baseline test.
Here, the case against confirmation is even more persuasive. The unsecured creditors are denied any distribution whatsoever during the 56 month period in which they can hope to recover anything while the student loan creditors, who will have the ability to collect long after the discharge is granted, receive all of the distribution.
Chapter 13 is directed at allowing debtors to retain their assets while under the Court’s protection on the condition that they make regular payments to their creditors for a minimum period of time, even their unsecured creditors. Preferring holders of nondischargeable, unsecured claims like these without some showing of need or hardship results in a judge-created “priority.” Congress well knows how to create priorities, and would have expressly accorded priority to student loans, had that been its intent. 25 Given that lack of priority, chapter 13 contemplates that student loan creditors share equally in distributions like all other unsecured creditors. Debtors’ Amended Plan alters chapter 13’s priority and distribution schemes to the detriment of the general unsecured creditors.
Moreover, given the fact that the unsecured creditors will realize nothing on their claims until the tail end of the
The debtors justify their favorable treatment of the student loan creditors by their interest in obtaining a “fresh start.” This argument might have some facial appeal if debtors were paying their nondis-chargeable student loan debt in full through the Amended Plan. Here, however, debtors propose to pay only 17% of the student loan debt. Thus, at the completion of the Amended Plan the debtors will not be freed of their student loan obligations. Although debtors are not paying the student loan debt in full, payment of the entire dividend that would ordinarily be available to all unsecured creditors reduces the amount of the nondisehargeable debt and gives the debtors a “head start” that is not otherwise provided by chapter 13. Indeed, the “fresh start” in chapter 13 is not without limit. Congress has addressed the scope of the fresh start in chapter 13 and has determined that student loan obligations shall survive discharge. Debtors’ effort to mitigate the consequences of nondisehargeable student loan debt outside the statutory scheme of chapter 13 is unfair discrimination under the facts of this case.
The Court concludes that when debtors’ treatment of nonpriority unsecured creditors under the Amended Plan is compared to their normal treatment under chapter 13, the proposed discrimination alters the allocation of benefits and burdens to the detriment of the class of general unsecured creditors and is therefore unfair. Debtors’ proposed discriminatory treatment of general unsecured creditors does not pass the baseline test.
This Court finds persuasive the logic and reasoning of the First Circuit BAP in Bentley. In its view, the baseline test is most loyal to the objective goals and motivations of Chapter 13 and the Bankruptcy Code. It is essentially objective and measurable in that it would require courts to determine (1) whether the preferred debt is accorded statutory priority; (2) whether the unsecured creditors would receive at least as much as they would receive without the debt being preferred; (3) whether the unsecured creditors would receive a fair pro rata share of the debtor’s mandatory contribution of disposable income (and, if not, whether the debtor has agreed to make an additional contribution to “square up” the unsecured creditors’ distribution); and whether the preferential treatment of one creditor somehow furthers the debtor’s fresh start. The baseline test appeals to this Court as objective and fairly easy to implement. It is in accord with the statutory scheme of priority established by the Code and prevents the courts from legislating priorities as these debtors would have this Court do today.
Conclusion
The Court concludes that debtors have failed to meet their burden of showing that the Amended Plan does not discriminate unfairly against the class of general unsecured creditors. The debtors propose paying all seventeen percent of the anticipated dividend to the student loan creditors while paying nothing (not the “very small amount” euphemistically referred to in debtors’ brief at page 4) to the other unse
Notes
. All statutory references are to the Bankruptcy Code, 11 U.S.C. § 101, et seq. unless otherwise specified.
. 28 U.S.C. § 157(b)(1) and (b)(2)(L); Fed. R. Bankr.P. 9014.
. See Dkt. 31 [stipulations], Dkt. 25 [debtors' brief] and Dkt. 32 [trustee's brief].
. See Dkt. 18. Class A claims include priority tax claims totaling $38,602. Class B claims consist of the secured claim of Honda finance in the amount of $14,500.
.Pursuant to the parties’ stipulation, the debtors have agreed to further modify this provision to pay the pre-petition interest on the IRS and Kansas Department of Revenue claims as unsecured priority claims. See Dkt. 31, ¶5.
. The parties have stipulated that the accurate figure that would be available for Class C claims is $5,202.91, rather than $5,660.00, assuming the debtors made all of the plan payments proposed. See Dkt. 31, ¶ 7. The slight discrepancy in the figures results from the amount of the priority tax claims as provided in the plan ($38,602) compared to the amount of the priority tax claims as shown in the proofs of claim ($39,139.79). See Ex. E and Ex. F attached to Stipulations.
. 11 U.S.C. § 1328(a)(2) and § 523(a)(8).
.
In re Groves,
. Neither the debtors nor the trustee has cited any authority from the Tenth Circuit Court of Appeals on this issue and this Court’s independent research has uncovered none. There are, however, three reported cases from districts within the Tenth Circuit.
See e.g., In re Willis,
.
. Id. at 672.
.
See In re Sperna,
.
.
. As a general rule, fairness requires equality of distribution among nonpriority unsecured creditors. Id. at 240.
. Nothing in the Bankruptcy Code gives priority to student loan obligations nor requires their payment in full. Id. at 241.
. This requires a comparison of what the dischargeable unsecured creditors would receive in a pro rata distribution of the mandatory contribution under chapter 13 (all of debtor's disposable income for a minimum three year period). Id. at 241.
. In chapter 13, the debtor does not emerge from bankruptcy totally free of all prepetition debt; absent undue hardship, chapter 13 expressly excepts student loan debt from discharge. Id. at 242.
. Id. at 240.
.
See In re Crawford,
.
. The amount of the nondischargeable student loan debt will be roughly either $26,000 or $29,000, depending upon whether the other unsecured creditors share pro rata in the distributions.
. This Court agrees with the reasoning in
Bentley
where the First Circuit BAP observed that chapter 13 and § 1322(b)(1) contemplate consideration of the interests of the affected classes, and not solely consideration of the debtor’s interest.
. See In re Sperna,
. See § 507(a).