§ 88.9 — Long-Term Debts
Revised: June 3, 2004
11 U.S.C. § 1322(b)(5) permits a Chapter 13 plan to “provide for the curing of any default within a reasonable time and maintenance of payments while the case is pending on any unsecured claim or secured claim on which the last payment is due after the date on which the final payment under the plan is due.”1 This power to cure default and maintain payments on long-term debt is coupled with an exception to discharge in § 1328(a)(1).2 Long-term debts provided for under § 1322(b)(5) are nondischargeable claims that are often separately classified by a Chapter 13 debtor.
For example, if a Chapter 13 debtor proposes to cure default and maintain payments on a long-term home mortgage,3 the balance of the mortgage at the completion of payments to other creditors will be excepted from discharge by § 1328(a)(1). This treatment of the mortgage is a separate classification for purposes of § 1322(b)(1).4 This separate classification survives the unfair-discrimination test for three reasons: (1) the separate classification of each secured claim is a widely accepted fair discrimination;5 (2) most home mortgages are protected from modification by § 1322(b)(2)6 and are too large to be managed through a Chapter 13 plan except by long-term treatment under § 1322(b)(5); (3) because § 1322(b)(5) authorizes curing default and maintaining payments on long-term debt during the plan, and because § 1328(a)(1) excepts from discharge the balance remaining on a long-term debt after completion of payments to other creditors, it is reasonable debtor behavior to use § 1322(b)(5) and “suffer” § 1328(a)(1). Similar logic supports the separate classification of priority claims based on § 1322(a)(2)7—when Congress provides special treatment for a claim in the Code itself, complying with that requirement in the plan is more likely to be fair discrimination for purposes of § 1322(b)(1).
However, it does not follow that every separate classification of a long-term claim under § 1322(b)(5) is necessarily a fair discrimination. Section 1322(b)(5) also permits curing default and maintaining payments with respect to any unsecured claim on which the last payment is due after the last payment under the plan.8 If there are other unsecured claims, any plan proposal to cure default and maintain payments on a long-term unsecured debt under § 1322(b)(5) will be a separate classification tested against the unfair-discrimination standard in § 1322(b)(1).9
Curing default and maintaining payments on a long-term unsecured claim can generate difficult fairness questions. The typical context in the reported cases is a long-term educational loan. After the 1990 amendments rendered most student loans nondischargeable in Chapter 13 cases,10 debtors financially unable to pay all unsecured debt in full during the plan separately classify the student loans to cure default and maintain the original contract, with the balance surviving discharge under § 1328(a)(1).
This use of § 1322(b)(5) necessarily includes curing default and maintaining payments on the interest portion of the unsecured educational loan. Debtors like this because the nondischargeable postpetition interest gets paid through the plan rather than accumulating to be a personal liability of the debtor after discharge of other debts.11 Other unsecured creditors are disallowed interest on their claims12 and will justifiably complain that the separate classification of a student loan for treatment under § 1322(b)(5) unfairly discriminates.
It is curious that there has been a veritable stampede in the case law to approve the fairness of separate classification of long-term student loans for treatment under § 1322(b)(5).13 Several courts have held “as a matter of law” that treating a student loan under § 1322(b)(5) satisfies the unfair-discrimination test.14 In one case, the bankruptcy court instructed a Chapter 13 debtor to separately classify a student loan to cure arrearages and pay the regular monthly payments during the plan under § 1322(b)(5).15 Several courts have cited § 1322(b)(5) as a reason for refusing other classifications of student loans:
Debtor need only formulate a plan which treats her student loans as long term indebtedness under § 1322(b)(5). Even though such treatment may require treating student loans differently than other unsecured debt, it cannot be said that it would unfairly discriminate because the treatment would be in full accordance with Code provisions. . . . Any other treatment that discriminates in favor of student loan creditors at the expense of the other unsecured creditors where the final scheduled student loan payment falls due after the date of the plan is unfairly discriminatory.16
Although § 1322(b)(5) is an available plan provision for long-term student loans in Chapter 13 cases, it is not obvious that this treatment will always be fair discrimination. Curing default and making regular contract payments under § 1322(b)(5) may pay a greater percentage of the unsecured student loan than the plan pays to other unsecured claims. Absent separate classification, a student loan creditor with a nondischargeable claim would share pro rata with other unsecured claim holders without postpetition interest unless all unsecured claim holders were entitled to interest.17 Using § 1322(b)(5) to pay postpetition interest to an unsecured educational loan when other unsecureds are not receiving interest stretches the concept of fair discrimination in § 1322(b)(1). That the debt and the accumulating postpetition interest are nondischargeable is one factor in the fair-discrimination calculus; it is not outcome determinative.
Because student loans are rarely secured only by real property that is the debtor’s principal residence, the debtor can modify an educational loan under § 1322(b)(2).18 Chapter 13 debtors typically can propose a plan that would pay the student loan the same percentage as other unsecured claims during the plan. There usually is a Chapter 13 plan that can be confirmed without paying interest to only the student loan. Long-term treatment of a nondischargeable student loan is permitted but not required by § 1322(b)(5); curing default and maintaining payments has some advantages for debtors but is not necessarily fair discrimination with respect to other unsecured claims. Applying the usual § 1322(b)(1) tests for unfair discrimination, several reported decisions condition, question or refuse separate classification of a student loan for long-term treatment under § 1322(b)(5).19
Sometimes treatment of a long-term unsecured claim under § 1322(b)(5), even when it has the effect of paying postpetition interest, actually advantages other unsecured claims by increasing the percentage of payment under the plan.20 This will be true when the long-term unsecured claim is large relative to other unsecured claims and maintenance of the regular contract payment leaves more money for other unsecured creditors than would be available if the large claim were included in pro rata distributions under the plan. In this situation, strong arguments can be made that separate classification and treatment under § 1322(b)(5) is fair discrimination.
For example, in In re Ford,21 the debtor was involved in a prepetition automobile accident, and an insurance company paid damages of $9,819. To regain driving privileges, the debtor contracted to reimburse the insurance company with monthly installments of $50, with the last payment due in April of 2012. The debtor filed a Chapter 13 case in 1998 and classified the insurance reimbursement for treatment under § 1322(b)(5). The bankruptcy court approved this separate classification, explaining as follows:
The practical result of this classification is to reduce the total amount of Shelter’s claim under the plan by over $6100.00. This reduction, in turn, reduces Ford’s total unsecured debt . . . . With plan payments of approximately $900/month, the debtor should have no problem paying 100% to his unsecured creditors. If Ford did not classify the Shelter debt pursuant to § 1322(b)(5), the optimum unsecured percentage would be around 75%. It is difficult for the Court to see how a 25% increase in payments to unsecured creditors results in any discrimination against the creditors at all.22
Although not used as an example in In re Crawford,23 the outcome in Ford probably fits the Seventh Circuit’s model for an allowable separate classification. As explained in Crawford, there will be situations when classification is a “win-win outcome”—when, “without classification the debtor is unlikely to be able to fulfill a Chapter 13 plan and the result will be to make his creditors as a whole worse off than they would be with classification.”24 In Ford, the debtor could have confirmed and probably “fulfilled” a Chapter 13 plan without the separate classification—a 75 percent plan paying all unsecured creditors pro rata. Separate classification of the student loan for long-term treatment actually increased the payment of other unsecured claim holders to 100 percent, an outcome that Judge Posner would surely approve.
Ironically, it is the student loan creditor that is separately classified and receiving the short end of the stick in Ford. The student loan creditor might object to its separate classification on the ground that a pro rata plan would pay the student loan 75 percent along with all other unsecured claim holders—a higher percentage of its total debt than will be paid if the debtor cures default and maintains payment consistent with the student loan contract. The student loan creditor would then have to concoct a definition of “unfair” discrimination that would preclude curing default and continuing payments consistent with its original contract rights. Chances are the student loan creditor would have the good sense to accept contract payments and save the fight.
1 See §§ 115.1 [ Curing Default, Waiving Default, Maintaining Payments and Combinations ] § 78.4 Curing Default, Waiving Default, Maintaining Payments and Combinations and 171.1 [ Curing Default and Maintaining Payments on Unsecured Debt ] § 101.4 Curing Default and Maintaining Payments on Unsecured Debt.
2 11 U.S.C. § 1328(a)(1) excepts from discharge after completion of payments under the plan any debt “provided for under § 1322(b)(5) . . . .” See § 351.1 [ Long-Term Debts ] § 158.7 Long-Term Debts.
3 See discussion beginning at § 81.1 Overview: General Rules for Saving Debtor’s Home.
4 If the mortgage is fully secured, there is an argument that § 1322(b)(1) does not apply. See § 74.7 Classification of Secured Claims. If the mortgage is partially secured, curing default and maintaining payments under § 1322(b)(5) creates a separate class for at least the unsecured portion of the mortgage, which is then paid with interest that is not allowed to other unsecured claim holders. See also § 83.5 Undersecured Mortgage and Interest to Cure Default.
5 See § 103.1 [ Classification of Secured Claims ] § 74.7 Classification of Secured Claims.
6 See § 118.1 [ Most Home Mortgages Cannot Be Modified: § 1322(b)(2) and Nobelman ] § 79.1 Most Home Mortgages Cannot Be Modified: § 1322(b)(2) and Nobelman.
7 See § 151.1 [ Priority Claims ] § 87.4 Priority Claims.
8 See, e.g., In re Saulter, 133 B.R. 148 (Bankr. W.D. Mo. 1991); In re Bradley, 109 B.R. 182 (Bankr. E.D. Va. 1990). See also §§ 115.1 [ Curing Default, Waiving Default, Maintaining Payments and Combinations ] § 78.4 Curing Default, Waiving Default, Maintaining Payments and Combinations and 171.1 [ Curing Default and Maintaining Payments on Unsecured Debt ] § 101.4 Curing Default and Maintaining Payments on Unsecured Debt.
9 See § 149.1 [ Power to Classify Unsecured Claims: Tests for Unfair Discrimination ] § 87.1 Power to Classify Unsecured Claims: Tests for Unfair Discrimination.
10 See §§ 153.1 [ Student Loans ] § 88.6 Student Loans and 346.1 [ Student Loans ] § 158.2 Student Loans. Long-term treatment of a student loan under § 1322(b)(5) may be a bad idea for debtors because it interferes with the debtor’s right to seek discharge of the loan for “undue hardship” under § 523(a)(8)(B). See §§ 346.1 [ Student Loans ] § 158.2 Student Loans and 351.1 [ Long-Term Debts ] § 158.7 Long-Term Debts.
11 See Leeper v. Pennsylvania Higher Educ. Assistance Agency, 49 F.3d 98 (3d Cir. 1995) (Applying Bruning v. United States, 376 U.S. 358, 84 S. Ct. 906, 11 L. Ed. 2d 772 (1964), unmatured postpetition interest on a nondischargeable student loan is not allowable, continues to accrue as a personal liability of the debtor, and is excepted from discharge in a Chapter 13 case.); In re Shelbayah, 165 B.R. 332, 337 (Bankr. N.D. Ga. 1994) (Unmatured postpetition interest on a student loan is not allowable under § 502(b)(2); such interest continues to accrue during the Chapter 13 case and has the same nondischargeable character as the underlying student loan under § 1328(a). The unmatured postpetition interest is not allowable “to insure that creditors other than [the student loan] receive their fair share of the estate.”).
12 See 11 U.S.C. § 502(b)(2), which excepts from allowance “unmatured interest.”
13 See § 153.1 [ Student Loans ] § 88.6 Student Loans.
14 See In re Sullivan, 195 B.R. 649, 658 (Bankr. W.D. Tex. 1996) (Debtor cannot separately classify student loan for 100% payment and 3% to other unsecured claims, but debtor can use § 1322(b)(5) to treat the student loan as a long-term debt. “As a matter of law, the maintenance of long-term debt obligations according to their terms does not result in ‘unfair discrimination,’ in no small part because such obligations are not being satisfied out of the plan payment (with the possible exception of the ‘cure’ of arrearages) but out of the debtor’s income. . . . The payment of long-term obligations on a current basis also does not run afoul of section 1325(b), with its requirement that all of a debtor’s net disposable income be devoted to ‘plan payments.’ Maintaining the current payments on a long-term obligation is one of the provisions permitted to be contained in the debtor’s plan. . . . Thus, if a student loan also qualifies as a long-term obligation under section 1322(b)(5), a debtor’s plan may provide for the cure of any arrearages and the maintenance of payments without running afoul of the ‘unfair discrimination’ limitations of section 1322(b)(1).” In a note, the court offers “one caveat: the payout of the arrearages over time, in competition with other creditors, must be done in a fashion which does not ‘unfairly discriminate.’”). Accord In re Chandler, 210 B.R. 898, 904 (Bankr. D.N.H. 1997) (“Reviewing section 1322(b)(1), the Court finds that it does not prevent discrimination. Rather, section 1322(b)(1) prevents ‘unfair’ discrimination. The Court holds that placing unsecured creditors, like those holding student loans, into a separate class and permitting debtors to maintain their payments to them at the full contract rate, as expressly permitted by section 1322(b)(5), is not ‘unfair’ discrimination. This must be the result intended by Congress; otherwise, how could a debtor’s plan provide for the ‘maintenance of payments’ on ‘unsecured’ claims under section 1322(b)(5) if it were considered ‘unfair discrimination’ under section 1322(b)(1).”); In re Cox, 186 B.R. 744, 746–47 (Bankr. N.D. Fla. 1995) (Plan can separately classify a student loan for payment directly by the debtor consistent with § 1322(b)(5) notwithstanding that the effect is to pay 42.3% of the student loan over the life of a plan that only pays 18% to other unsecured claim holders. The proposed treatment “may be tolerated in this situation because section 1322(b)(5) proves that ‘a form of discrimination is sometimes possible in bankruptcy, even if creditors can correctly view it as most unfair.’ . . . [Section] 1322(b)(5) prevents a finding of unfair discrimination in this case as a matter of law.”); In re Benner, 156 B.R. 631 (Bankr. D. Minn. 1993) (Student loan debt can be treated “outside” the plan in accordance with § 1322(b)(5) without resulting in unfair discrimination in violation of § 1322(b)(1).); In re Dodds, 140 B.R. 542 (Bankr. D. Mont. 1992).
15 In re Geehan, 59 B.R. 600 (Bankr. S.D. Ohio 1986).
16 In re Saulter, 133 B.R. 148, 150 (Bankr. W.D. Mo. 1991). Accord Groves v. LaBarge (In re Groves), 39 F.3d 212 (8th Cir. 1994); McCullough v. Brown (In re Brown), 162 B.R. 506 (N.D. Ill. 1993).
17 See discussion of best-interests-of-creditors test in 11 U.S.C. § 1325(a)(4) in § 162.2 [ Discount Rates and Interest If Liquidation Would Produce Dividend ] § 90.5 Discount Rates and Interest If Liquidation Would Produce Dividend.
18 See § 104.1 [ The Power to Modify ] § 74.11 The Power to Modify.
19 See § 153.1 [ Student Loans ] § 88.6 Student Loans. See, e.g., Labib-Kiyarash v. McDonald (In re Labib-Kiyarash), 271 B.R. 189, 195 (B.A.P. 9th Cir. 2001) (Direct payment of long-term student loans at contract rates is subject to the unfair-discrimination test. “[W]e adopt the majority view and hold that a debtor may use § 1322(b)(5) to maintain long-term student loan payments at the contract rate while curing any arrearage through the plan, provided that the debtor’s plan satisfies the [AMFAC Distribution Corp. v. Wolff (In re Wolff), 22 B.R. 510 (B.A.P. 9th Cir. 1982),] test for unfair discrimination under § 1322(b)(1).”); In re Simmons, 288 B.R. 737, 749 (Bankr. N.D. Tex. 2003) (Unfair discrimination to treat student loans as long-term debts under § 1322(b)(5). “The court does not find the argument based on section 1322(b)(5) persuasive. . . . [I]t would be absurd to permit preferential treatment of a debt solely on the basis that its original term extended beyond the term of the plan.”); In re Edwards, 263 B.R. 690, 691 (Bankr. D.R.I. 2001) (Unfair-discrimination test applies to separate classification of student loan for payment directly by the debtor. Plan would pay unsecured creditors nothing and $140 per month to a long-term student loan. If the student loan payment was added to the payments to the trustee, unsecured creditors would be paid 25% of their claims. “[Section] 1322(b)(5) must be applied consistently with section 1322(b)(1) . . . . [E]ven though a plan calls for the continuation of payments on long term unsecured debts in accordance with Section 1322(b)(5), it must also provide that such treatment does not unfairly discriminate against other unsecured creditors under Section 1322(b)(1).”); In re Colley, 260 B.R. 532, 538–41 (Bankr. M.D. Fla. 2000) (Long-term treatment of student loan for 36% payment unfairly discriminates against general unsecureds that would be paid 2% in pro rata distributions. “Student loan debts that qualify for § 1322(b)(5) treatment must nonetheless pass § 1322(b)(1) ‘unfair discrimination’ muster. The Court will not allow student loan debtors to make an end run around § 1322(b)(1) by using § 1322(b)(5) as a pretense for classification where nondischargeability must be the true motivation for discrimination. . . . [I]f a Chapter 13 Plan provides for full contractual payments that amount to a certain percentage of the student loan creditor’s claim while providing for a lower percentage of other unsecured creditor’s claims to be paid off through pro rata distribution, then the plan discriminates unfairly under § 1322(b)(1) and may not be confirmed. . . . There are situations wherein a debtor’s use of § 1322(b)(5) to pay contractual student loan payments may not injure the disfavored creditors or may even benefit them.”); In re Williams, 253 B.R. 220, 227–28 (Bankr. W.D. Tenn. 2000) (With respect to student loans that qualify for long-term treatment under § 1322(b)(5): “[T]he Bankruptcy Code itself provides one approved method of preferring student loan claims over other unsecured claims. Section 1322(b)(5) provides for the curing of any default within a reasonable time and maintenance of payments on unsecured claims on which the last payment is due after the final payment under the plan is due. Many student loan claims will have remaining terms that extend beyond a three- to five-year plan. The maintenance of ongoing payments necessarily involves the payment of post-petition interest. Pre-petition interest will be included in the creditor’s proof of claim consisting of the arrearage to be paid (cured) within a reasonable time. Through this method, a debtor should be able to fully repay student loan arrearages during the plan, and reestablish the original loan repayment schedule. This type of discrimination is specifically contemplated and sanctioned by the Bankruptcy Code. . . . Because the Bankruptcy Code contemplates the curing of any default within a reasonable time, a debtor may pay 100% of a student loan arrearage while paying less than 100% of other unsecured claims, so long as the degree of discrimination is necessary to the debtor’s success under the plan.”); In re Thibodeau, 248 B.R. 699 (Bankr. D. Mass. 2000) (Long-term treatment of student loan under § 1322(b)(5) is not automatically fair discrimination under § 1322(b)(1). Applying four-part test, full payment of student loan arrearages as part of long-term treatment under § 1322(b)(5) fails unfair-discrimination test when other unsecured claim holders will receive only 27%, debtor failed to account for some income, extension of the plan to 60 months would pay 71% of unsecured debt, the student loans are one-third of total debt but are receiving two-thirds of available payment and the debtor could pay all creditors 29% in a three-year plan and then extend the plan for two years to pay the student loans.); In re Coonce, 213 B.R. 344, 346–49 (Bankr. S.D. Ill. 1997) (Separate classification of student loan for long-term treatment under § 1322(b)(5) fails unfair-discrimination test in § 1322(b)(1). Long-term treatment would pay student loan creditor 33.1%, and other unsecured creditors would receive 10.56%. Absent separate classification, all unsecured creditors would receive 16.88%. “[D]iscrimination in favor of educational loans based on their nondischargeable nature is unfair and, therefore, violates § 1322(b)(1). . . . [F]rom the perspective of unsecured creditors holding dischargeable claims, it would be patently unfair for creditors holding nondischargeable claims—who may thus pursue post-bankruptcy collection efforts against the debtor—to be preferred not only after the bankruptcy case is completed but also during the time payments are being made to creditors. . . . [Section] 1322(b)(1) does apply to obligations designated as long-term debts under § 1322(b)(5). However, it cannot conclude that every such classification satisfies the § 1322(b)(1) test of ‘fair discrimination’ as a matter of law. . . . A careful examination of § 1322(b) reveals that its provisions are cumulative unless otherwise provided. An interpretation allowing preferential treatment of student loan debts so long as they are classified as long-term indebtedness under § 1322(b)(5) would render subsection (b)(1) superfluous. Taken to its logical conclusion, such an interpretation would require that any designation or plan provision made pursuant to a subsection of § 1322(b) would be per se exempt from the ‘fair discrimination’ requirement of § 1322(b)(1). . . . [A]llowing the debtors to discriminate in favor of student loan creditors would, in effect, create an artificial priority scheme not provided for in § 507(a). . . . Because of the nature of student loan debts, a debtor will often have a ‘mixed’ motive for classifying these obligations as long-term indebtedness, with the real incentive being the reduction of his nondischargeable debt burden following bankruptcy. This Court will not permit such an ‘end run’ around § 1322(b)(1) and specifically finds that § 1322(b)(1) prohibits unfair discrimination even when it appears in the guise of treatment of long-term debt under § 1322(b)(5). . . . [I]t may be possible for the debtors to formulate a nondiscriminatory plan. . . . Discrimination of this magnitude is unnecessary . . . . [T]he debtors could extend the duration of their plan . . . . [A] ‘non-bankruptcy’ alternative would be for the debtors to seek a deferral of their educational loans.”).
20 See also §§ 153.1 [ Student Loans ] § 88.6 Student Loans and 171.1 [ Curing Default and Maintaining Payments on Unsecured Debt ] § 101.4 Curing Default and Maintaining Payments on Unsecured Debt.
21 221 B.R. 749 (Bankr. W.D. Tenn. 1998).
22 221 B.R. at 754–55. Accord In re Delauder, 189 B.R. 639, 645–47 (Bankr. E.D. Va. 1995) (Direct payment of undersecured car lender separately classifies by silently providing payment in full with interest of the unsecured portion of the claim. “First, Hyundai will receive a greater percentage payment on account of its unsecured claim than do other unsecured creditors. Second, both the secured and unsecured portions of Hyundai’s claim will be paid directly by the debtor, while other unsecured creditors must wait for disbursement by the trustee.” Car loan was a long-term debt on which the last installment was due after the last payment under the plan. Applying the five-factor test in In re Husted, 142 B.R. 72 (Bankr. W.D.N.Y. 1992), there is no evidence that the debtor could not pay the car lender through the plan. Debtor did not propose direct payment solely to avoid trustee’s fees. If the long-term debt were paid through the Chapter 13 trustee, the percentage distribution to all unsecured claim holders would actually fall from 25% to approximately 18% because the unsecured portion of the car lender’s claim is small and accelerating long-term car loan for payment in full during the life of the plan would reduce the money available to unsecured claim holders. In other words, the discrimination in favor of the car lender actually worked to the advantage of other unsecured claim holders. “[A]lthough this court would not, as a routine matter, permit an undersecured automobile loan to be paid directly by a debtor outside the plan, such treatment is not improper in this case. Here, the last payment on the automobile loan is due after the last payment under the plan, the direct payment does not reduce the dividend to unsecured creditors and does not appear to be motivated primarily by a desire to avoid the trustee’s commission, and the plan otherwise complies with all the requirements for confirmation. For these reasons, the court cannot find that the plan unfairly discriminates against general unsecured creditors.”).
23 324 F.3d 539 (7th Cir. 2003). See § 152.2 [ Alimony, Maintenance and Support ] § 88.4 Alimony, Maintenance and Support.
24 324 F.3d at 543.