(Warning: I go into a lot of detail here because I find the interaction between the justices and the lawyers to be fascinating. If you just want to get to my prediction about what will happen, you can skip to the end).
The Espinosa Facts
Espinosa involved a chapter 13 plan proposed by a debtor whose only debt was his student loans. His plan proposed to pay $13,250 on the student loan and provided that any amount unpaid would be discharged. The student loan creditor did not object and the plan was confirmed. The debtor made his payments under the plan and received his discharge. The discharge order stated that student loans would not be discharged. Several years later, United Student Aid Funds sought to collect the remaining balance of about $4,000. The debtor went back to the Bankruptcy Court for relief. The Bankruptcy Court amended the discharge order to clarify that the student loans were discharged, finding that entry of the form order was a clerical error which could be corrected after the fact. United Student Aid Funds appealed, arguing that the plan could not discharge the student loans without a finding of undue hardship. The Ninth Circuit ruled that the student loan creditor’s failure to object barred it from challenging the discharge and indeed went so far as to suggest that bankruptcy judges should not “intermeddle” where creditors fail to object.
The Issue: Void Order vs. Legal Error
The issue, as identified by several of the justices, is what to do about an order which should not have been entered. Section 523(a)(8) states that a student loan is not dischargeable absent a finding of undue hardship. Rule 7001 states that a determination of dischargeability must be done through an adversary proceeding. Section 1328(a)(2) states that a chapter 13 discharge does not encompass student loan debts. Thus, a chapter 13 plan which discharged student loan debts without an adversary proceeding and a finding of undue hardship does not follow either the procedural or substantive law. However, in this case, the plan was confirmed without objection and the issue was not teed up until some seven years later.
The issue was framed by Justice Scalia within the first minute of oral argument. Counsel for United Student Aid Funds started with a big concept that the Bankruptcy Code contained three categories of debts, those which are dischargeable, those which are dischargeable unless the creditor objects and those which are not dischargeable, but that the Ninth Circuit had eliminated the third category of debts. Justice Scalia interrupted, stating:
JUSTICE SCALIA: Only -- only -- only if the Bankruptcy Court disregards the law. I mean, it's -it's clear that the Bankruptcy Court should not have done what it did here. The only issue is, it having made that mistake, can it -- can it subsequently be -be undone in the manner that's -- that's sought here?
Justice Sotomayor picked up on the same theme as Justice Scalia.
JUSTICE SOTOMAYOR: It was wrong. Let’s assume –the circuit—the district court judge, the Bankruptcy Court judge, got it wrong. Should not have been discharged, a given. Neither – the confirmation plan should not have been approved, neither should the discharge order have been entered. . . .
How does that give you a right to undo that judgment seven years later – was it 5, 6, 7 years later? That’s the question here. How does something that’s in error become a void judgment?
This changed the focus from one of substantive bankruptcy law to civil procedure. However, when the attorney for United Student Aid Funds continued to argue that the order was void because it contradicted the Bankruptcy Code, Justice Sotomayor countered with:
JUSTICE SOTOMAYOR: But . . . most errors committed by courts, inadvertently or otherwise, are in contravention of some statutory command. This is no different.
Voidness, as I’ve heard it described by many others, appears to mean that the court is acting without jurisdiction over the people, and that’s not at issue here, . . . or without jurisdiction over the res. But the bankruptcy court does have jurisdiction, albeit in some, in all circumstances it had jurisdiction over the student debt. The issue is what it could do with it. But this is not a case involving a lack of jurisdiction by the court over property.
So why is this more than mere error?
MS. WANSLEE: Because Congress’s statutory scheme must be enforced as written. And it’s . . . unequivocal what Congress wants.
Of course, this answer was non-responsive to the question about mere error vs. voidness, prompting Justice Breyer to weigh in.
JUSTICE BREYER: What’s the strongest case you can muster, I mean, that you can muster in support of this proposition, my question being the same as Justice Sotomayor’s? What is the strongest case where you can find any court that said a matter is void . . . not just legal error so you can attack it 90 years later—it’s void—just because just because a lower court that made the error didn’t apply a clear statute?
Give me your strongest case.
MS. WANSLEE: Because Rule 60 says that void orders can be attacked, and the passage of time does not transmute a void order into a valid order.
JUSTICE BREYER: But I would like an answer to my question, because I can – I have read the treatises, which I have in front of me, that it’s void only if you show a – the same thing that Justice Sotomayor just said. And so, since I don’t think there is some kind of constitutional due process error here, and there is clearly jurisdiction over the parties, I guess you are saying there wasn’t subject matter jurisdiction, which is a little vague.
So I want to know what is the strongest case . . . where a court has ever said that a failure of some . . . other court to apply the language of a statute properly, no matter how clear, is a lack of subject matter jurisdiction? What is your strongest case? That’s all I’m asking.
The attorney for United Student Aid Funds responded with a rather weak, “Your Honor, we did cite a number of cases in the materials” and referred to a case about an insurance company in bankruptcy.
This exchange brings two things to mind. When a Supreme Court justice has to say, “I would like an answer to my question,” it is pretty apparent that you are not connecting with your audience. However, even a Supreme Court justice can get lost. Justice Breyer was on a roll as he pointed to his stack of treatises, but then missed his big finish when he said, “it’s void only if you show a –- the same thing that Justice Sotomayor just said.” Of course, maybe he was just shining a little attention on his junior colleague.
How Creative Can You Get?
After a little more sparring on jurisdiction, the justices turned their attention to a series of what-ifs which left the student loan creditor in the uncomfortable position of arguing that nothing other than strict compliance with the procedural rules could ever result in an enforceable order.
JUSTICE GINSBERG: Can a – can a – can a creditor say, oh, skip it, I know this bankrupt is going to be able to prove hardship, why go through the unnecessary expense? Can a – can a creditor waive the hardship determination?
(How cool is it to hear a Supreme Court justice say “oh, skip it”?)
MS. WANSLEE: No, your Honor, a creditor may not waive the undue hardship determination. 523 says that student loans are only discharged upon a finding of undue hardship.
JUSTICE GINSBERG: So he can’t . . . stipulate to say, I want the deal that is being proposed, I think that I am better off getting the principal, skipping the interest. I can’t make that deal? We have to go through this hardship procedure whether the creditor wants it or not?
MS. WANSLEE: Your Honor, within the context of an adversary proceeding has in fact been raised. However, there was never any allegation of undue hardship, ever—
JUSTICE STEVENS: Well, would the case be different if there had been such an allegation in the petition?
MS. WANSLEE: I think not, your Honor, because 523 requires a finding.
JUSTICE STEVENS: It would not have been different then? What if it had been not only an allegation but an affidavit? Would the case be different?
MS. WANSLEE: Once again, your Honor, I go back to the language of 1328, your Honor.
JUSTICE STEVENS: I am kind of curious to know what your answer to my question is. . . . Would the case be different if the Petitioner had filed an affidavit of undue hardship with the papers? Same notice, everything else the same.
MS. WANSLEE: Certainly a harder case, Your Honor. However, I don’t –
JUSTICE STEVENS: Why is it a harder case?
MS. WANSLEE: I don’t think—there would not have been an adjudication of undue hardship, however. Just because the debtor stated it didn’t mean there was then—
JUSTICE STEVENS: And I say it’s supported by an affidavit. . . . (W)ould then the case be different?
MS. WANSLEE: No, your Honor, there has to be—
JUSTICE STEVENS: There has to be an adversary hearing under your view?
MS. WANSLEE: Under our view, the creditor is entitled to the protections of 7001 to say—
From there, the justices went through more hypotheticals. What if there was an offer of proof? What if the creditor was present in the courtroom and participated in the hearing but remained silent on the issue of undue hardship?
In my view, the student loan creditor allowed itself to get backed into a corner by arguing that nothing short of compliance with procedural rules could result in an enforceable order.
At one point, the attorney for the student loan creditor stated that “Due process also requires compliance with whatever—“ prompting Justice Kennedy to exclaim:
JUSTICE KENNEDY: I think – I think that’s an astounding – an astounding conclusion, that you are simply writing out the doctrine of—of waiver altogether.
And Now For Something Completely Different
When debtor’s counsel had his turn, he did not attempt to defend what was done in the specific case.
JUSTICE SCALIA: Do you acknowledge that what the bankruptcy court did here was wrong? Do you acknowledge that?
MR. MEEHAN: I acknowledge that it did violate the statute.
JUSTICE SCALIA: Okay, and it should not have done it, and future bankruptcy courts shouldn’t do it? . . . It makes a big difference in how I am going to look at this case. I mean, if—
MR. MEEHAN: I would agree that it is correct, your Honor.
However, at that point, the debtor’s counsel backtracked slightly and suggested that debtors and creditors could always stipulate to dischargeability under a plan.
In response to a subsequent question, he wisely conceded that the bankruptcy judge could sua sponte question the propriety of a discharge by declaration.
The debtor’s lawyer also did a deft job of addressing the issue of whether a discharge by declaration was sanctionable.
JUSTICE ALITO: Was the Ninth Circuit correct in saying that an attorney can’t be sanctioned under the bankruptcy rules’ equivalent of Rule 11, for attempting to sneak through a discharge of student debt in a chapter 13 petition?
. . .
MR. MEEHAN: My position is that if it is up front, clear notice, in effect, a proposal that we just don’t have a Federal case out of an undue hardship determination for $4,000, that it does not violate Rule 11 or 9011 to make that proposal.
. . .
JUSTICE BREYER: But why would it not be a sanctionable matter under Rule 11? If the lawyer knows that he is supposed to make this special claim to get this kind of discharge. He knows an ordinary claim won’t do it. He submits a paper that asks for the ordinary discharge, that he has to sign it and that . . . signature is a certification that to the best of his knowledge, the claims and other legal contentions are warranted by existing law.
So if he signs it, knowing that that isn’t the way to do it – indeed, there is not even an argument for doing it that way, for modifying the law—then why isn’t that a sanctionable matter under rule 11?
MR. MEEHAN: I am not here to say absolutely that it is not, Justice Breyer.
. . .
I, as a lawyer who has litigated for 39 years and is very conscious of Rule 11, have never thought that if—again, if it was something that was plain and not obfuscated, that a proposal to simply omit one element of a claim violated Rule 11. I think it's debatable -
JUSTICE BREYER: The reason I ask that is, I think the argument on the other side is that it's so clear in the law that this is not the way to go about it that you have to make a separate piece of paper saying you have special hardship; that that is so clear what Congress wanted that four years later you can come back and attack it, if they didn't do it. I mean, that's basically, in my mind, their argument.
But I think a simpler way would be to say if it's that clear, if it really is that clear, the bar itself will enforce the rule by not knowingly deviating from the way that Congress set it out, to which there is no legal objection. Now, is it really -- what do you think of that?
MR. MEEHAN: I think that -- I think that, again, in the context of what this case -- the issue of this case, I think that's right.
I think -- and this Court said in Taylor v. Freeland & Kronz that we are not going to adopt a rule respecting finality that is going to take all the onus of policing the bar, and noted that rule in criminal bankruptcy fraud and the requirement that a petition be signed and filed on a verification. And I think that's -- I think that's absolutely right. I think that –
JUSTICE SCALIA: If that is the price of your winning this case, it's clearly worth it now. I am agreeing with Justice Breyer on that point.
MR. MEEHAN: You mean that the bar may have further scrutiny?
JUSTICE SCALIA: Yes. I mean, if indeed the Court would not be willing to go along with -- with your assertion that you can't undo it later, once it's been done, unless it is clear that it should not be done and that the bankruptcy judge shouldn't do it, and that the lawyer shouldn't propose it -- if that's the condition, then you should accept it, right? Because you want to win this case.
MR. MEEHAN: I would accept -- I would accept that in any condition.
In this exchange, debtor’s counsel’s reference to Taylor vs. Freeland & Kronz was a wise move. Taylor involved another situation where failure to object allowed an otherwise improper action to be taken without endorsing the strategy.
A Matter of Procedure and Finality
The discussion then moved on to the proper procedure which could have been followed. Under Rule 60(b)(2), the creditor could have moved to set the order aside based on mistake, inadvertence or surprise within one year, but instead chose to rely on Rule 60(b)(4) which allows a void order to be reconsidered at any time.
JUSTICE KENNEDY: I was going to ask whether or not in -- on the facts of this case the client could have voided into the final judgment, not appeal, but then come in under Rule 60?
MR. MEEHAN: I think that they could have. Rule 60, as it -
JUSTICE KENNEDY: So then the client is not required to -- the creditor is not required to appeal?
MR. MEEHAN: Well, they take the risk, Justice Kennedy, that they could fit within 60, (a), (b), or (c): Surprise, inadvertence, mistake, inexcusable neglect, fraud, et cetera. In this instance, I think they might have had a hard time, because at most stage -
JUSTICE KENNEDY: All right. So I don't think they could have -- and of course, you don't think it's void. It could come in under 60(b)if it's void, but you don't think it's void.
MR. MEEHAN: Well, void, under those circumstances, I think would throw us into the due process issue and I don't think so. No, I do not think so.
JUSTICE KENNEDY: All right. So you have to show mistake or surprise and you doubt that there was a mistake or surprise here.
MR. MEEHAN: Yes.
Notice and Unlisted Creditors
Debts owed to unlisted creditors are not dischargeable under section 523(a)(3). Justice Kennedy brought the discussion around to whether the “discharge by declaration” strategy would apply to an unlisted creditor.
JUSTICE KENNEDY: Let me just ask this and maybe I have bankruptcy law wrong. My -- my understanding is that if creditors are not listed they are not discharged, correct? I think that's right in most cases. If you don't list the creditor, the creditor is not discharged.
. . .
JUSTICE KENNEDY: I am just wondering, doesn't it happen all the time that creditors are not listed and then they come in later and say the debt is not discharge? Doesn't that happen all the time?
MR. MEEHAN: I think it does happen frequently.
JUSTICE KENNEDY: And is -- is the rationale that that -- that that discharge would be void as to them, or that they are just not covered?
Suppose the bankruptcy judge makes a mistake and lists a creditor by name as being discharged but that creditor never received notice. Is it void?
MR. MEEHAN: I think it is. I do think it is. I mean, bottom line, about the only thing I submit -
JUSTICE KENNEDY: Well, is this -- is this case all that different, then?
MR. MEEHAN: Well, in this case the creditor got fulsome notice. Submitted to the jurisdiction of the court, filed the proof of claim, accepted -
JUSTICE KENNEDY: He got notice of something that was void.
MR. MEEHAN: No, I may be misunderstanding your question. He was-
JUSTICE KENNEDY: I mean that -- that -that assumes -- he got notice of something that was legally improper.
MR. MEEHAN: But not void. To go -- to proceed without the adversary proceeding, I submit is not void, and what the Petitioners had to try to do is to ask you to interpret the statute, whether it's 1328 or 523(a)(8), to make this some sort of a -- there is no way you can touch it; if you didn't do the adversary it just didn't happen kind of a thing.
JUSTICE GINSBURG: So you think any of these things that are listed as non-dischargeable can become dischargeable unless the creditor -
MR. MEEHAN: If the creditor does not object and if the court does not -
JUSTICE GINSBURG: Then why do we have this third category, then? Nothing is non-dischargeable.
MR. MEEHAN: Well, may I submit, Justice Ginsburg, that the argument proves too much, and that is to say that if one can wait and make a voidance argument under rule 60(b) six years after the discharge and 12 years after the filing of the petition, and if that can happen to anything, then what we have is that we may as well just worry about litigating rule 60 motions whenever they come up.
JUSTICE SCALIA: I guess I don't understand your position, because I thought you had said that this should not have been discharged and now -- now you argued to Justice Ginsburg that so long as the -- as the creditor appears they can all be discharged. Which is it?
MR. MEEHAN: Well, Justice -
JUSTICE SCALIA: Even if the creditor appears it shouldn't be discharged. I thought that that's what you had said before. But now you are saying that so long as the creditor appears all of these are dischargeable.
MR. MEEHAN: What had I tried -- the position I had tried to explain -- again, I think it balances your point with Justice Stevens' point about waiver -- is that should, absolutely, unless there is an affirmative waiver. But let's remember that when we talk about "should," I think we are talking about appellate issues. We are talking about error on appeal, we are talking about what ought to happen. And the reason I say that, the point about the same effect accounting for taxes and breaches of fiduciary duty etcetera et cetera proves too much, is that if we are going to say that none of those is finally put to rest, even though there was notice, even though there was acceptance of benefits, as incurred here, even though there was a submission to the jurisdiction of the Bankruptcy Court, as occurred here -- even though there was, you know, just bypassing the early, if I may say "early" rule 60 remedies -- if we are going to say that none of those -
JUSTICE GINSBURG: But your answer to me was that if the creditor doesn't object, even to a non-dischargeable debt -- if the creditor doesn't object, it's discharged. That's what you answered, I thought.
MR. MEEHAN: Yes.
JUSTICE GINSBURG: And it doesn't matter whether it's child support, taxes, or student loans, right? Anything in the category -- you are saying the creditor must object; otherwise it's covered by the discharge.
MR. MEEHAN: Well, my position, I think, first is -- is that, as I think Justice Breyer said, this is a -- this is a clear waiver and I think the Court could rule on that basis. But number two, I think if this is a judgment -- a final judgment; proper notice, we do not have a notice issue, and the creditor has had plenty of opportunity to -- to raise the error -
JUSTICE KENNEDY: Well, I'm not sure there was proper notice. There was not a notice that there would be a contested hearing. Or that there would be an adversary hearing.
MR. MEEHAN: Justice Kennedy I think -
JUSTICE KENNEDY: I'm not sure there was a proper notice.
MR. MEEHAN: I think you must look at it this way. The notice that was given was for the confirmation of a plan. That is the notice them that is required under the bankruptcy rules and it was noticed in accordance with the bankruptcy rules.
Is it right to do it in a bankruptcy plan confirmation? If objected to, no, it's not. If not objected to, the plan says what the plan says and the notice that must be given is notice of the plan.
JUSTICE KENNEDY: Well, of course that's the problem in the case. Sometimes we decide cases that don't make a lot of difference and that once we decide the rule everybody will know what the rule is. But in this case the Petitioners say that if we adopt the rule that the Ninth Circuit adopted, it's going to be extremely burdensome and costly on -- on municipalities, e a due process concern, we do not on -- on those who give student loans, et cetera. And that -- and that you are just creating a -- a tremendous burden on already overburdened systems.
MR. MEEHAN: Well, the argument that was made by the Petitioner and its amici on that point, i think, as pointed out in one of our amicus briefs, overlooks the electronic notice, the instantaneous notice, the fact that under Federal regulations, which by the way also require the guarantee and lenders to do these things and to exercise due diligence before they can get repaid –
. . .
JUSTICE KENNEDY: On the practicality point, you talk about electronic notice. I suppose that that -- that the creditors for student loans could have the automatic electronic thing where they say, we insist on a hardship hearing. But that doesn't solve the problem, because they then have to go back and see whether or not there was a hardship hearing in the case.
So that -- that means they have -- they have -- they have to -- they have to inquire into every case whether or not the proper hearing has been made.
MR. MEEHAN: Well, Justice Kennedy, they have to inquire, in any event, because the Federal regulations require them to, number one, determine that there was a filing; and number two, even before there is an adversary proceeding to make its own assessment, the lender or the guarantee -- the guarantor to make its own assessment whether it is likely that there would be an undue hardship in the given case and there are other circumstances which are set forth in the -- in an amicus brief -
JUSTICE KENNEDY: Are you -- they can't ask for a hearing unless there is a reasonable doubt to believe that there is no undue hardship?
MR. MEEHAN: No, I don't mean to say that. What I mean to say is that -- is that I submit that the hardship argument is a little bit overblown because they have the obligations, even though they say they don't have -- even an obligation but open the envelope, they have an obligation to look at the petition, to see what the situation is, to see whether there is likely an undue hardship.
They don't have to forebear from making an objection to a plan unless they have a basis to determine that there was undue hardship.
My Take On the Argument
Based on the argument, it looks like the Supreme Court is inclined to affirm Espinosa. This is remarkable because the Ninth Circuit has a high reversal rate before the Supreme Court and because its position on this issue is in the minority. The Fourth, Sixth, Seventh and Tenth Circuits have all taken a contrary position.
However, the discussion before the Supreme Court focused much more on the civil procedure aspect of the case, i.e., what does it take to have an enforceable order. The justices essentially said that to have a valid order, you must have jurisdiction over the parties, jurisdiction over the res and notice satisfying due process. While there was some back and forth on whether notice was adequate, the justices seemed satisfied that the other elements were uncontested.
The argument also raises interesting issues about the tensions between procedure, substance and professional responsibility. The problem in this case was that the debtor proposed to discharge the debt without a finding of undue hardship. However, the hypotheticals posed to counsel for United Student Aid Funds raised the question of whether a hardship determination could be obtained without the necessity for an adversary proceeding. As a general rule, procedural requirements can be waived. There are many reasons why parties would agree to dispense with some procedures, such as allowing testimony by proffer, shortening time frames or using a contested matter as a vehicle to try a claim covered by Rule 7001. As a result, the creditor’s argument that procedural requirements could never be short-circuited seemed forced. However, the flip side to this is the sanctions issue posed to debtor’s counsel. Just because you can get away with something does not mean that it is right to do so. I thought that debtor’s counsel did a good job of framing the “discharge by declaration” plan as a proposal to the student loan creditor, while acknowledging that the bar had a duty to police itself so as not to engage in gamesmanship.
My prediction is that the Supreme Court votes 6-3 to affirm, with justices Breyer, Ginsberg, Kennedy, Scalia, Sotomayor and Stevens voting to affirm.