The Bankruptcy Lawyers Blog

Nathan Udell filed a Chapter 7 bankruptcy petition in 2002, and sought to discharge a debt of $123,692 to the United States government. The bankruptcy court discharged the debt, but the U.S. District Court for the Eastern District of Pennsylvania reversed that order and held that the debt was not dischargeable. The 3rd Circuit affirmed the reversal.

The debt stemmed from Udell's completion of three years at the Air Force Academy. Upon enrollment, Udell had signed a "Record of Acceptance, Obligation, Reimbursement, and Oath of Allegiance," agreeing to complete his education and serve on active duty for a period of eight years.

However, after three years at the Academy, Udell voluntarily separated from the service in the wake of misconduct that could otherwise have led to dishonorable discharge.

The Record of Acceptance signed by Udell specifically referenced 10 U.S.C. s. 2005(d) of the Armed Forces Code. The relevant provision imposes an obligation to reimburse the government for educational costs, and specifies:

(d) a discharge in bankruptcy under Title 11 shall not release a person from an obligation to reimburse the United States required under the terms of an agreement described in subsection (a) if the final decree of the discharge in bankruptcy was issued within a period of five years after the last day of a period in which such person had agreed to serve on active duty...

The facts are undisputed in that Udell incurred a reimbursement obligation under his agreement with the Air Force, and that more than five years had elapsed at the time his debt was discharged by the bankruptcy court.

Udell argued that the above provision of the Armed Forces Code authorized discharge of the debt after five years, and that as a more specific statute and one explicitly referenced by his agreement with the Air Force, it should control.

However, the District Court found, and the Appellate Court affirmed, that there was no conflict between the Armed Service Code and the U.S. Bankruptcy Code. Rather, the Armed Forces Code created a further restriction on the ability to discharge such a debt in bankruptcy. Within the initial five year period, even a debt that would have been dischargeable in bankruptcy based on a finding of undue hardship would not be dischargeable. However, once that five year period had elapsed, the debt would simply be subject to the regular provisions of the Bankruptcy Code.

The Bankruptcy Code provides in relevant part that there shall be no discharge

"for an educational benefit overpayment or loan made, insured, or guaranteed by a government unit, or made under any program funded in whole or in part by a governmental unit or nonprofit institution, or for an obligation to repay funds received as an educational benefit, scholarship or stipend, unless excepting such debt from discharge under this paragraph will impose an undue hardship on the debtor and the debtor's dependents"

Thus, the debt could have been discharged only on a finding of undue hardship--an issue Udell did not raise in his bankruptcy proceeding.

The Circuit Court distinguished the case from those, such as In re Borrero, 208 B.R. 792 (Bankr. D. Conn. 1997), concerning discharge of a Health Education Assistance Loan, since the Public Health Services Act not only prohibits discharge for seven years, but also specifies the terms under which the debt may be dischargeable thereafter.

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Although a bankruptcy petitioner hoping to discharge student loan debts is required to commence an adversary proceeding to demonstrate undue hardship, both the 9th and 10th circuits rules in 1999 that--in specific cases, at least--creditors could not upset a confirmed plan if they'd failed to take timely action to protect their interests. In both of those cases, the debtor had failed to initiate an adversary proceeding, but had included discharge of student loan balances in the plan, along with a declaratory statement of undue hardship.

Over the past few years, though, other circuits have been chipping away--and sometimes directly contradicting--those rulings. Since 2002, the 4th, 6th, and 7th circuits have ruled that the creditor's due process rights require notice, and even heightening the notice requirement. Both the 9th and 10th circuits have altered their positions in later rulings as well, with the 10th circuit referring to its own prior case as "wrongly decided".

The 6th circuit, in ruling that a purported "discharge by declaration" was both invalid and void (and therefore subject to being set aside), noted that "astute attorneys now insert student loan discharge language...hoping to achieve preclusive effect" notwithstanding the requirements of a finding of undue hardship, the specific requirement of an adversary proceeding, and lack of notice.

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