The Bankruptcy Code Has its Day in Court

On December 1, the United States Supreme Court was in session to listen to a couple of arguments about bankruptcy.

The first case concerned student loans, specifically in reference to their ability to be discharged under the confines of a Chapter 13 bankruptcy. The other case, however, had larger implications on the industry as a whole, as it challenged the bankruptcy code itself.

Bankruptcy attorneys are not allowed to encourage clients to take on more debt if they have communicated to the attorney that they are considering filing for bankruptcy. To no surprise, the provision was put in place in 2005 as part of the Bankruptcy Abuse Prevention and Consumer Protection Act. The problem with this provision is that essentially, it prevents an attorney from providing a full scope of legal advice. A law firm from Minnesota is challenging that the provision violates the first amendment.

The firm is also challenging the act's provision that states law firms must identify themselves as "debt-relief agencies." Justices Scalia and Roberts both seemed to agree that the provisions were problematic, leaving the challengers quite optimistic after the hearing.

The other case on the docket involved the bankruptcy of an airline ramp agent from Phoenix and his subsequent discharge of more than $13,000 in student loans he was unable to pay. Francisco Espinosa took out the loan to pay for a trade school he wanted to attend but never finished the program and remained employed with the airline.

Currently, federal law does not treat student loans quite like other types of debt. The debtor must prove an undue hardship in court as reason for non-payment. For a number of debt types, the bankruptcy becomes that proof of hardship and is then subject to discharge. Not so with student loans, they require additional evidence of a person's inability to pay.

Those arguing on behalf Espinosa's creditors cite the fact that undue hardship was not proven and that like child support, student loans need to be held to a higher standard because without those added protections, secondary education funding would become increasingly difficult to obtain.

Lawyers working on behalf of Espinosa are citing the fact that once a bankruptcy ruling is decided, it cannot be undone on the grounds of a judge's error.

In a previous ruling from a lower U.S. appeals court favored Espinosa's argument, stating that when the bankruptcy petition was submitted and the creditor's notified, they did not object. It was this decision that the student loan industry and the lawyers present in the Supreme Court yesterday are worried about, as it may pave the way for student loans to be easier to discharge.

If yesterday's hearings are any indication, the court may come down on Espinosa's side when a ruling is issued, as a couple of judges, Kennedy and Ginsburg specifically, voiced concern that perhaps a new balance can be found between the need for a hardship hearing and some leniency in regard to discharging student loan debt.

Both cases heard in court this week could have impact on the bankruptcy code, one in favor of debtors and the other in favor of the attorneys who help debtors. All in all, it wasn't a bad day in court.