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The 2nd U.S. Circuit Court of Appeals has adopted a rule on the validity of student loan discharges in bankruptcy by declaration. Taking a position on an issue that has split other circuits, the 2nd Circuit found that the failure of a student loan recipient to seek a declaration of hardship through an adversary proceeding in the bankruptcy court meant that his “liability on the loan survives the purported discharge.” The opinion in Whelton v. Educational Credit Management Corp., 04-4844-cv was written by Judge J. Garvan Murtha, U.S. District Judge for the District of Vermont, sitting by designation. Murtha decided the case along with 2nd Circuit Judges Guido Calabresi and Reena Raggi. Christopher Whelton obtained his law degree from Thomas Jefferson School of Law in 1990 and consolidated his student loans through Sallie Mae, with the loans being guaranteed by Educational Credit’s predecessor in interest, the California Student Aid Commission. Whelton and his wife filed for Chapter 13 bankruptcy relief in 1999, listing CSAC as the holder of an unsecured, non-priority claim for an educational loan in the amount of $103,830. The Chapter 13 plan called for payment of 3 percent of all unsecured claims over a period of three years. The plan also contained a so-called “discharge by declaration,” stating that “the confirmation of this Plan will constitute a finding that excepting the [debtors'] educational loans from discharge will impose a hardship upon the debtors.” Neither the plan nor an amended plan named CSAC or Educational Credit and neither plan identified specific student loans. The plan was confirmed by the bankruptcy court in 1999 and, about one year later, the Wheltons borrowed money and paid the full amount due under the plan. Educational Credit accepted payment under the plan of $4,997 and the Wheltons received their discharge in July 2000. Educational Credit then attempted to garnish Whelton’s wages in an attempt to collect the student loan. When a U.S. Department of Education hearing officer said the department could not permit a wage garnishment in light of the confirmation order, the company filed an adversary proceeding in the bankruptcy court in Vermont, where a judge found that the “discharge-by-declaration provision in the Whelton’s plan is inconsistent with the Bankruptcy Code, is outside the scope of relief that may be effected by a Chapter 13 plan, and should not have been confirmed.” Because the bankruptcy rules require a debtor to file an adversary proceeding to discharge a student loan debt, Bankruptcy Judge Colleen Brown, said the “inclusion of such a provision in the plan, where it has no legitimacy, constitutes … ‘practice by ambush.’” STATUTORY PRESUMPTION At the 2nd Circuit, Murtha said Title 11 U.S.C. �523(a)(8) creates a statutory presumption against the discharge of student loans. It states that a discharge under �1328(b) “does not discharge an individual debtor from any debt … for an educational benefit overpayment or loan made, insured or guaranteed by a governmental unit … unless excepting such debt from discharge … will impose an undue hardship on the debtor.” Murtha said the 9th and the 10th Circuits, while acknowledging that such a discharge procedure violates both the Bankruptcy Code and Rules, have nevertheless “upheld such discharges where a student loan creditor had notice of the declaration’s placement in the plan and failed to object.” But more recently, he said, the 4th, 6th and 7th Circuits have ruled that a discharge by declaration is unenforceable against a student loan creditor. The 7th Circuit, in In re Hanson, 397 F.3d 482 (2005), found that allowing a discharge without an adversary proceeding to establish undue hardship runs plainly “contrary to the express language of the Bankruptcy Code and Rules,” and therefore the intent of Congress and the Judicial Conference. “This is an ineluctable conclusion, which we hereby adopt as the rule in this Circuit,” Murtha said, noting that the 10th Circuit and a bankruptcy appellate panel of the 9th Circuit “have apparently retreated somewhat from their former contrary view.” Therefore, he said, “we reject Whelton’s argument that the Bankruptcy Court approval of his Plan serves to preclude challenge such as” Educational Credit’s. Whelton cannot invoke the theory of res judicata to preclude the company’s challenge, he said, because the company lacked proper notice. Bernard M. Lewis of Randolph, Vt., represented Christopher Whelton. Julie K. Swedback of St. Paul, Minn., represented the Educational Credit Management Corp.

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