1. The grounds for discharge for a student loan are very narrow — debtor must establish that failure to discharge would impose an “undue hardship” on debtor or his/her dependents; and
2. The bankruptcy court must make the finding of undue hardship in an adversary proceeding;

Adversarial notice was not served on the creditor, United Student Aid Funds (USA Funds), but the creditor did receive notice from the bankruptcy court of the proceedings and of Espinosa’s plan. The bankruptcy court approved the plan without neither a finding of undue hardship nor the required adversarial proceeding. Once Espinosa repaid the principal, the court discharged the interest obligation. A few years later, the Department of Education (DOE) tried to collect the discharged interest, Espinosa asked the bankruptcy court to enforce the confirmation of discharge against USA Funds and DOE. USA Funds replied with a cross-motion seeking to set aside the confirmation because the plan was inconsistent with the undue hardship and adversarial proceedings requirements discussed above, and because the plan violated USA Funds rights of due process because it was never served with the required notice of adversarial proceeding. The bankruptcy court granted Espinosa’s motion in relevant part and denied USA Funds cross-motion. The District Court reversed on the basis that USA Funds was entitled to its due process, but the Ninth Circuit reversed the district court, holding that

The Supreme Court found error at all three prior levels. The student loan discharge rules are “self-executing,” meaning that the bankruptcy court must make the finding of undue hardship only after an adversarial proceeding, whether or not requested by the creditor. But the Court also held that failure to follow the procedure was legal error, but the confirmation order was binding because USA Funds had adequate notice and failed to object or appeal within the required time limits. Thus the District Court erred in reversing the bankruptcy court on due process grounds and the Ninth Circuit also erred in its holding that a bankruptcy court must confirm a plan proposing discharge of a student loan debt without the finding of undue hardship in an adversarial proceeding unless the creditor makes a timely objection. Remember, the undue hardship and adversarial proceedings are “self-executing,” and the bankruptcy court should have followed the procedure with or without object of the creditor.

So although Espinosa prevailed and had his loans discharged without the finding of undue hardship after an adversarial proceeding, the effect of this ruling is extremely limited. The bankruptcy court should have required the adversarial proceeding, but USA Funds did not object or appeal this legal error within the time limits allowed. There was no due process violation because USA Funds had actual notice of both the proceeding and the plan for discharge.

It is highly unlikely that this decision will serve as a basis for discharge of additional debtors student loans without the finding of undue hardship after an adversarial proceeding.