Amicus Curiae Brief — United Student Aid Funds, Inc. v. Espinosa

Supreme Court brief2010

Ask Donna

What actually matters in this document.

Text

= — = ==")

~ Ld

\o1 wold

In the Supreme Court sep s- 08 -

of the United States —-. ~ ----~

_— ”

“*

UNITED STUDENT AID FUNDS, INC.,

Petitioner,

Vv.

FRANCISCO J. ESPINOSA,

Respondent.

On Writ of Certiorari to the

United States Court of Appeals for the Ninth Circuit

Brief of the States of Oregon, Alabama, Alaska,

Arizona, Colorado, Connecticut, Delaware, Florida,

Hawaii, Idaho, Illinois, lowa, Louisiana, Maine,

Maryland, Massachusetts, Michigan, Missouri,

Montana, Nebraska, Nevada, New Hampshire,

New Mexico, Ohio, Oklahoma, Pennsylvania, South

Dakota, Tennessee, Texas, Utah, Virginia,

Washington, Wyoming, and the

National League of Cities

JOHN R. KROGER

Attorney General of Oregon

MARY H. WILLIAMS

Deputy Attorney General

*JEROME LIDZ

Solicitor General

CAROLYN G. WADE

Assistant Attorney General

400 Justice Building

Salem, Oregon 97301-4096

. “xp Phone: (503) 378-4402

fay.” wal } Counsel for State of

ae Oregon

*Counsel of Record

WILSON-EPES PRINTING Co. INC - (202) 789-0096 — WASHINGTON, D C 20002

ag \

7% -

QUESTIONS PRESENTED

Section 523(a)(8) of the Bankruptcy Code pro-

vides that student loans are nondischargeable

unless the debtor affirmatively shows that re-

payment of the loan would impose an undue

hardship. In turn, Rule 7001(6) of the Federal

Rules of Bankruptcy Procedure (“Bankruptcy

Rule”) provides that the determination of dis-

chargeability of a debt must be established in an

adversary proceeding (a separate proceeding

within a bankruptcy case that is litigated directly

between the debtor and the other party). Finally,

Bankruptcy Rule 7004 provides that an adver-

sary proceeding, like a standard civil proceeding

in federal court, is initiated by service of a sum-

mons and complaint on the defendant party. The

questions presented are:

1. If a debtor ignores the requirements of

Bankruptcy Rules 7001(6) and 7004 and purports

to discharge a student debt through a Chapter 13

plan, rather than by an adversary proceeding,

has the debtor satisfied the due process require-

ments of Mullane v. Cent. Hanover Bank & Trust

Co., 339 U.S. 306 (1950) - that a party must pro-

vide “notice reasonably ca!culated, under all the

circumstances, to apprise interested parties of

the pendency of the action and afford them an

opportunity to present their objections?”

2. If a debtor fails to satisfy those due process

requirements, is the plan confirmation order void

with respect to the purported discharge or are its

terms binding, under principles of res judicata,

on a party that does not object to the proposed

plan?

3. Does the bankruptcy court have authority to

disapprove a plan that provides for actions that

the Bankruptcy Rules state must be taken by ad-

versary proceeding?

TABLE OF CONTENTS

Page

QUESTIONS PRESENTED........................ceccceeeess l

STATEMENT OF AMICI INTEREST .................. 1

a a anc seaicinapecenions 7

REST ALES NRECE Sete tc we ROR oT aE 8

”

I. The Use of a Plan Provision to “Discharge

this Debt Violates the Code and the Rules

II. Bankruptcy’s Unique Nature Demands a

Consistent Application of the Rules.......... 14

II]. Failure to Provide a Party with the Notice

Required by the Rules Denies That Party

I ciicctci nica cidbinansiiinaibenscsanimebaninnes 22

IV. A Creditor’s Failure to Object to a Plan

Provision Does Not Bar the Bankruptcy

Court From Acting Sua Sponte to Review

ERS Ls he BEN Res 5 lek RRR 36

V. Debtors Seeking the Equitable Remedy of a

Discharge Must Act Equitably Towards

I on cid cul chetnbasabidasnadehenimnns 40

IIT Uhicinnnscesniiniisiessnscscanninianivinheiegsaiaiteed 4]

TABLE OF AUTHORITIES

Page

Cases Cited

Ashcroft v. Iqbal,

racic etgccieneetid 25

Banks v. Sallie Mae Servicing Corp..,

299 F.3d 296 (4th Cir. 2002) ............0000000... 22, 26

Bell Atlantic v. Twombly,

I I io ics csconsensntecscenevncensses 25

Black v. Educational Credit Mgmt. Corp.,

459 F.3d 796 (7th Cir. 2006).............................. 5

Cen-Pen Corp. v. Hanson,

56 F.5G GO (4th Cir. 1986) ....................00..0000005. 23

City of New York v. New York,

New Haven & Hartford R.R.,

BY EP I I osc cccnasicsscecssccsencensseses 26, 35

Educ. Credit. Mgmt. Corp. v. Mersmann

(In re Mersmann),

505 F.3d 1033 (10 Cir., 2007)....... 22, 23, 26, 38

GMAC Mortgage Corp. v. Salisbury

(In re Loloee),

241 B.R. 655 (9th Cir. BAP 1999)...00000 000. 29

Hamlett v. Amsouth Bank (In re Hamlett),

eee © ae SO (GER CP. BO) onc cc ceccccccccccccccccccessedh

In re Barnes,

32 F.3d 406 (Sth Cir. 1994) ..........................00.. 39

In re Bateman,

SB FBS GBl (1 Rtas Ci. BOB) .....cccvccecscccccccccees 23

In re Brawders,

503 F.3d 856

GE NE, MPT Picccesenccnssccussven 23, 24, 28, 29, 34, 35

In re Enewally,

368 F.3d 1165 (9th Cir. 2004) ...................000000. 24

In re Espinosa,

553 F.3d 1193 (9th Cir. 2008) .......... 8, 13, 22, 32

In re Evans,

242 B.R. 407 (Bankr. S.D. Ohio 1999)............... 6

In re E-Z Serve Convenience Stores, Inc.

et al.(CIT Group/ Business Credit, Inc.,

vs. Official Committee of Unsecured

Creditors of E-Z Serve Convenience Stores,

Inc., et. al),

318 B.R. 631 (Bankr. M.D.N.C. 2004)............. 32

In re Hanson,

397 F.3d 482 (7th Cir. 2005) .......0.00. 13, 22

In re Hensley,

249 B.R. 318 (Bankr. W.D. Okla. 2000) ............ 6

In re Lemons,

285 B.R. 327 (Bankr. W.D. Okla. 2002) ............ 6

In re Mammel,

221 B.R. 238 (Bankr. N.D. lowa 1998).............. 6

In re Mansaray-Ruffin,

630 F.3a 230 (Sed Cir. ZO068)...................... 23, 39

In re Metzger,

346 B.R. 806 (Bankr. N.D. Cal. 2006) ............. 27

In re Repp,

307 B.R. 144 (9th Cir. BAP 2004)............000.... 22

In re Ruehle,

412 F.3d 679 (6th Cir. 2004) 0.00... 22, 26

In re Szostek,

886 F.2d 1405 (3d Cir. 1989)...................c000ccee 39

In re Wright,

279 B.R. 886 (Bankr. D. Kan. 2002).................. 6

In the Matter of McMahon (Miller v.

Homecomings Fin. Network, Inc.,

2008 Bankr. LEXIS 3635

| 31

Katchen v. Landy,

a sacs ccssmescnnneii 40

Marshall v. Belda (In re Belda),

A 5 | | ere 21

Mullane v. Cent. Hanover Bank

& Trust Co.,

339 U.S. 306 (1950) .......... i, 9, 13, 26, 33, 34, 35

Schwab v. Reilly,

No. 08-538, 129 S.Ct. 2049 (2009) ............. 19, 40

Shaw v. Aurgroup Financial Credit Union,

ee re 38

Taylor v. Freeland & Kronz,

a caieas 6, 19

Tennessee Student Assistance Corp. v. Hood,

gg 8 Ms RT ERI ean ree 12,13

Travelers Indemnity Co. v. Bailey,

as easiseioiaeboind 9

UNIPAC-NEBHELP (In re Andersen),

179 F.3d 1253 (10th Cir. 1999) ............0....... 7, 23

United States v. Cardinal Mine Supply,

916 F.2d 1087 (6th Cir.1990) ....................cccccee0 4

United States v. Hairopoulos (In re Hairopoulos,

138 P.3a 12460 (SER Cir. 1G87) ........0c.cccccccccessees. 4

Varela v. Dynamic Brokers, Inc. (In re Dynamic

Brokers, Inc.),

293 B.R. 489 (9th Cir. BAP 2008).................... 29

Whelton v. Educ. Credit Mgmt. Corp..,

432 FBG 160 (2nd Cir. BOGB)....0.cccccccsccccccccssssess 22

Constitutional and Statutory Provisions

Be I ooo cs cosautesicctuniistekhideiuatinanatauss 37, 39

4 SERED eae elie nbs aaa Ne RK Nawab ei catrpee SENS Or 18

eee es Oe oh ss ddeamacindainnnsabanians 24

tet Soy f — | | ees

A ESR nes Ps aire eee mere 18

|g) dg 5 SERRE RITIOD SSeS ee eunee nea ont = 38, 39

ae es Oe I ee eee 39

ee ED asic sdsintstpsiienicidacntasiiapenbichaneiian 38

Be ee Oe I iididiitndndniascnnsndelnesisncessusauiiil 38

SAREE SEAR EADIE me me eK 38

| 8 STE OT ee ODE SS 19

I cc sceeeptuciinniaseitensiinlanticandeaitenionialatiaias 19

FE ERSTE ee nS er NE Do 1}

a I i insss cdoeciciecasoineunenesneiiniaaidadeiias 11

I cineca 11

ee oo saids csmtahdatnioeenisniennninnanentil 11

BE WFR. FB oecccccccssccesescccssecesss i, 11, 12, 38

TRE SEA EP RIS eee As eR eae S 1

Be I Ciierican ac cctsdietalds icdersacsionieaeardpaaniannniaiie 1

‘Bankruptcy Abuse Prevention and Consumer

Protection Act of 2005, Pub. L. No. 109-8......... 2

Ps ls Ms Be BION vincccivcvesrscecnssotmserecsoscsieee 18

I occas ssscdencuieoiumedbiedadenmaten 29

es I i, SE goons voccnnatendeusectalauseniogs 18

i A Ee. RE Een EY 24

re cnc succsssinesasiaeuabaenene 37

i es i ID ac nnrcctnceesconsescanine 4, 23

i, me a ey | | nee i, 8, 12, 13

POG. Te. BOGUT. EF. TOUTING) ....cccccnccqcsccsccssccessccsee 31

Vill

Fed.

Dm Dm mW mw Www ww

. Bankr.

Bankr.

. Bankr.

Bankr.

. Bankr.

ITT Siti nc eninicdcinsnenienentanenotneniincniiil

SIT siciusiiisddainiounptaciibenmeibinsies

SI cs etiisl, cdindaieiianponeneneeadigae

Nees 7,

SN iasienseaccisdlintspisalasilbaieniancdiae

suv yy yt

a canibaetinuinia

I i cnsubsnaeihied

Sn ahneuninie

SE ee

Other Authorities

U.S. DEPT. OF EDUC., FINANCIAL AND

PERFORMANCE QUARTERLY UPDATE,

Issue 2008-2 (Sept. 30, 2008)......:..........0 ce.

STATEMENT OF AMICI INTEREST’

The Amici States frequently appear as credi-

tors in bankruptcy cases and are often charged

with collecting student loans, which are not dis-

charged in bankruptcy unless a debtor success-

fully prosecutes an adversary proceeding. They

hold other claims that are automatically excepted

from discharge in Chapter 13;’ the logic of the

Ninth Circuit’s analysis would also make those

debts susceptible to discharge without the adver-

sary proceedings required by the Bankruptcy

Code and Rules.* Among those debts are claims

arising from late or non-filed tax returns or taxes

1 The parties to the case received timely notice and

have consented to the filing of this brief and the join-

der of the National League of Cities (“NLC”) to this

brief; the consents have been filed with the Clerk of

the Court. No counsel for a party authored this brief,

and no person, other than the amici curiae, their

members, or their counsel, made any monetary con-

tribution to the preparation or submission of this

brief. For purposes of this brief, NLC is included

within the term “Amici States.”

2 Chapter 13 of the Bankruptcy Code, 11 U.S.C.

1301 et seq. Citations herein will be to the provisions

of the Bankruptcy Code, 11 U.S.C. 101 et. seq., (“the

Code”) unless noted otherwise.

* All citations to a “Rule” or “Bankruptcy Rule” are

to the Federal Rules of Bankruptcy Procedure.

a debtor sought to fraudulently evade, fraud, un-

scheduled debts, domestic support obligations,

drunk driving judgments, and criminal sentences

— many of which were recently added by Congress

when it expanded the scope of discharge excep-

tions in Chapter 13 in 2005 in the Bankruptcy

Abuse Prevention and Consumer Protection Act

(the “BAPCPA”).* The Amici States have a sub-

stantial interest in ensuring that debtors’ plans

are not allowed to circumvent Congress’s clear

intent.

Taken together, the Bankruptcy Code and

Rules provide that the bankruptcy court’s author-

ity to determine whether a particular debt fits

into an exception from discharge must be exer-

cised through an adversary proceeding — a sepa-

rate action directed at and naming a single credi-

tor. The proceeding must be initiated by a com-

plaint that is served with a summons on an offi-

cer or other agent authorized to receive service of

process for the creditor. That method of proceed-

ing is distinct from that required to confirm a

plan and provides notice of the proposed dis-

charge with far greater force and clarity to a per-

son who can reascnably be expected to under-

stand the significance of that notice. Under the

Ninth Circuit’s analysis, however, those debts

could be discharged by the mere inclusion of a

* Pub. L. No. 109-8.

sentence in a Chapter 13 plan, sidestepping pro-

tections that creditors otherwise have.

The Ninth Circuit’s analysis condones actions

that contravene fundamental provisions of the

Bankruptcy Code and Rules, creates a chaotic

process in Chapter 13° that lays traps for the

unwary, requires prudent parties (especially al-

ready financially stressed state agencies, schools,

colleges, and universities) to incur unnecessary

costs, and burdens courts and Chapter 13 trus-

tees with reviewing plans multiple times — once

when a plan with an improper provision is filed

and again after a vigilant creditor demands its

removal. The debtor’s approach here — often re-

ferred to as “discharge by declaration” or “dis-

charge by ambush” -— is antithetical to his obliga-

tion to deal equitably with his creditors when

seeking the benefit of a discharge and violates

° The discussion herein primarily focuses on Chap-

ter 13 because the vast majority of plans filed by in-

dividuals (for which the discharge exceptions are ap-

plicable) occur in Chapter 13 cases (as opposed to

Chapters 11 and 12). Further, as discussed below, the

financial stakes in the former cases are so much

smaller that creditors cannot afford the same degree

of scrutiny of hundreds of thousands of plans in such

cases, compared to the relatively minute number of

cases in the other chapters. The Rules, though, apply

across the board in all chapters.

due process.°

The Amici States also appear in Chapter 13

cases to protect their secured claims and are con-

cerned that debtors will use Chapter 13 plans to

invalidate security interests, even though Bank-

ruptcy Rule 7001(2) provides that actions to “de-

termine the extent, priority, and validity” of liens

must also be brought by adversary proceedings.

The Amici States seek to ensure that their prior-

ity claims and liens — for taxes, for costs of envi-

ronmental cleanups, and for a myriad of other

purposes —are not lost in future ambushes by

debtors.

The practical impact of the decision below is

that creditors must presume that debtors will in-

clude unlawful provisions in their plans and omit

legally-required notices. Even if large institu-

tional creditors, such as petitioner, can adapt to

this abu ive tactic, the result will be increased

collection costs that must be passed on to all bor-

®° While the Amici States, as governmental enti-

ties, are not entitled to due process under the Fifth

Amendment, they stil] must receive notice which sat-

isfies the requirement of fundamental fairness. See

United States v. Hatropoulos (In re Hairopoulos), 118

F.3d 1240, 1244 n. 3 (8th Cir.1997); United States v.

Cardinal Mine Supply, 916 F.2d 1087, 1089 n. 3 (6th

Cir.1990). Discharge by declaration violates that re-

quirement.

rowers. This is particularly harmful in the stu-

dent loan area because the costs of collection are

not allocated to the specific debtors who force

such costs to be incurred, but rather are imposed

pro rata on all other student debtors.’ Similarly,

the taxpayers of the Amici States will be forced to

assume the added burdens of forcing debtors to

play by the rules of the bankruptcy system they

have chosen to invoke. Finally, the Amici States’

citizens who hold nondischargeable judgments

may find that the debtor has eliminated their

rights through the simple expedient of a plan

provision.

The added costs imposed by the decision below

will be increased even further by virtue of the

Ninth Circuit’s final ruling in the case — namely,

that bankruptcy courts may not act sua sponte to

bar confirmation of abusive plans or to police the

actions of debtors and their counsel. The original

outbreak of “discharge by ambush” cases ended in

large part because bankruptcy courts, acting un-

der their own authority, warned practitioners of

their disapproval and of the possibility that such

' See Black v. Educational Credit Mgmt. Corp.,

459 F.3d 796, 800-01 (7th Cir. 2006) (upholding impo-

sition of collection costs as uniform percentage of debt

owed).

provisions could lead to sanctions.* By barring

such review, the Ninth Circuit’s holding immu-

nizes practitioners and suggests that a debtor’s

attorney should always take the chance of seeing

if such a provision will go unnoticed. In an era of

unprecedented budget shortfalls, the Amici

States are deeply concerned that they not be

forced to shoulder unnecessary costs to protect

themselves from debtors who refuse to abide by

the Code and Rules.

5 See, e.g., In re Mammel, 221 B.R. 238, 242

(Bankr. N.D. lowa 1998) (denying confirmation of

plan with discharge provision, and describing practice

as "trap for unwary creditors" that "trivializes the en-

tire process and reduces it to a game of chance”); Jn re

Evans, 242 B.R. 407, 411-13 (Bankr. S.D. Ohio 1999)

(ordering debtor’s counsel to show cause why provi-

sion did not violate Bankruptcy Rule 9011); Jn re

Hensley, 249 B.R. 318, 323-24 (Bankr. W.D. Okla.

2000) (deeming counsel's intentional inclusion of dis-

charge language unethical and sanctionable)); Jn re

Lemons, 285 B.R. 327, 333 (Bankr. W.D. Okla. 2002)

(imposing sanctions for use of discharge language and

admonishing counsel); and Jn re Wright, 279 B.R.

886, 889 (Bankr. D. Kan. 2002) (noting that absent

good-faith basis, inclusion of discharge provision in

hope of trapping unwary student loan creditor should

result in sanctions). Cf. Taylor v. Freeland & Kronz,

503 U.S. 638, 644 (1992) (explaining that while frivo-

lous exemptions were binding if not objected to, result

would not immunize debtor’s counsel from sanctions).

STATEMENT OF CASE

In 1988-89, Espinosa obtained various student

loans. In 1992, he filed a Chapter 13 case that

listed his student loans as his only debts, pro-

posed to pay only the principal, and stated that

any unpaid amounts would be discharged. He did

not file an adversary proceeding nor did his plan

assert that payment of the interest would be an

“undue hardship.”®

Further, instead of serving an officer, manag-

ing or general agent, or other agent authorized to

receive service of process with a summons and

complaint as required by Bankruptcy Rule

7004(a) and (b)(3), Espinosa only mailed a copy of

his plan to a post office box where payments on

his loans were sent. The guarantor (the petitioner

herein) did not object to the plan. After it was

confirmed and Espinosa completed his payments,

a standard discharge order was entered in 1997,

providing that student loan debts were excepted

from discharge. Espinosa did not object to the en-

try of that order or seek to have it corrected. In

2000, the Education Department began collection

efforts and caused Espinosa’s income tax refunds

* Compare Andersen v. UNIPAC-NEBHELP (In re

Andersen), 179 F.3d 1253 (10th Cir. 1999) in which

the debtor asserted that payment of additional

amounts beyond that set out in the plan would consti.

tute an “undue hardship.”

to be intercepted. Three years later, he filed a

motion alleging that those actions violated the

discharge injunction. The guarantor moved, un-

der Federal Rule of Civil Procedure 60(b)(4), for

relief from the confirmation order (which had ap-

proved the plan with the discharge language).

The bankruptcy court ruled for Espinosa, though,

finding that the confirmation order’s terms con-

trolled over the contrary language in the dis-

charge order.

The district court reversed, holding that the

confirmation order was void for lack of due proc-

ess because of the absence of an adversary pro-

ceeding. On further appeal, after the bankruptcy

court corrected the discharge order as a clerical

error, pursuant to Bankruptcy Rule 9024 (the

counterpart to Federal Rule of Civil Procedure

60(a)), the Ninth Circuit reversed the district

court and entered the order at issue here, uphold-

ing the bankruptcy court’s ruling that res judi-

cata barred any attack on the plan’s terms. Jn re

Espinosa, 553 F.3d 1193 (9th Cir. 2008). The

guarantor’s petition followed.

ARGUMENT

The Ninth Circuit’s analysis reduces to a few

basic — but fallacious - propositions. First, de-

spite Bankruptcy Rule /001(6), which requires an

adversary proceeding and proof of undue hard-

ship to discharge a student loan debt, a debtor's

plan may simply provide that the debt will be

discharged. Second, despite the requirement in

Bankruptcy Rule 7004 that an adversary pro-

ceeding must be brought by means of a complaint

and summons served upon specified parties at a

specified address, the debtor may mail a copy of

the plan to a different, generic address and not

name those parties. Third, the creditor cannot as-

sume that legal requirements for notice will be

complied with, and fourth, violation of the Rules

has no relevance to whether due process has been

accorded to litigants pursuant to Mullane.

Rather, due process merely requires some generic

degree of notice, even if that form of notice vio-

lates a rule or statute and even if a creditor could

be misled by the absence of the required notice.

At the outset, it is important to clarify that the

Amici States fully understand this Court’s deci-

sions concerning the general finality of confirma-

tion orders. In particular, they are mindful of this

Court’s recent holding in Travelers Indemnity Co.

v. Bailey, 129 S.Ct. 2195 (2009), that principles of

res judicata, in general, protect plan provisions

from collateral attack. However, as this Court

noted, res judicata does not protect an order that

was entered in violation of due process. Jd. at

2207. It is that lack of due process that distin-

guishes this situation from that in Travelers and

similar cases.

Five other circuits have correctly reasoned

that the use of a plan provision to create a “dis-

charge by declaration” violates due process. It is

not simply that the provision in the Espinosa

plan substantively violated the Bankruptcy Code

(although it plainly did); it is also the fact that

the discharge of a nondischargeable debt was ob-

tained by means of plan confirmation, even

though the Bankruptcy Rules undeniably man-

date a different and more demanding process

with neightened notice. It is the combination of

those violations that sets the dividing line be-

tween the issues the Amici States concede are

governed by res judicata and those that are not.

If a matter may lawfully be decided in the plan

confirmation process, the fact that a proposed

provision violates the Code is not necessarily

enough to eliminate the application of res judi-

cata. But, if the Code and the Rules make clear

that the proper procedure is an adversary pro-

ceeding, the right of the creditor to wait until it is

sued in that manner before deciding whether or

not to defend the action against it, cannot, consis-

tent with due process and fundamental fairness,

be extinguished by some other method of proceed-

ing.

I. The Use of a Plan Provision to “Dis-

charge” this Debt Violates the Code and

the Rules

The Amici States adopt the discussion in the

petitioners brief of the structure under the

Bankruptcy Code and Rules for processing a

claim that a particular debt should be discharged.

They describe briefly this structure solely to show

how widely the process used in this case missed

the mark.

Section 523 specifies the debts that are ex-

cepted from discharge and the procedural re-

quirements for dealing with those exceptions.

Some types of debts are non-dischargeable only if

the creditor timely brings an adversary proceed-

ing to except the debt from the general discharge

granted the debtor.'® All other discharge excep-

tions, though, including the student loan excep-

tion set out at 11 U.S.C. § 523(a)(8), are self-

executing and the creditor need do nothing.

If the debtor seeks to determine whether a

particular debt fits within a discharge exception,

he may file an adversary proceeding with the

bankruptcy court or he can wait to be sued by the

creditor and assert the discharge as a defense. In

either case, the determination plays out in a for-

mal litigation setting, between the only two par-

ties that have any stake in it — the debtor and the

creditor holding the claim.

Because discharge determinations are likely to

be a critical issue for most creditors, the Bank-

523(a\(2), (4), and (6).

ruptcy Code and Rules impose notice require-

ments that distinguish them from the vast mass

of other paper work that flows through the bank-

ruptcy system. Those special requirements give

proper deference to the fact that Congress has

specifically determined that certain debts should

either not be discharged at all or should be dis-

charged only if the debtor satisfies a stringent

standard. Finally, as a practical matter, address-

ing discharge exceptions in an adversary proceed-

ing ensures that the plan confirmation process is

not burdened by one-creditor issues that do not

affect other creditors or what the debtor must pay

under the plan.

This Court recognized those principles in Ten-

nessee Student Assistance Corp. v. Hood, 541 US.

440, 449-452 (2004), in which it described Section

523(a)X(8) as “self-executing;” stated that the

debtor must “affirmatively secure[{] a hardship

determination” to discharge a student loan debt;

added that creditors are given “greater proce-

dural protection” before such debts can be dis-

charged; and held that an adversary proceeding

must be filed to discharge the debt. This Court

did, to be sure, state that “absent Rule 7001(6), a

debtor could proceed by motion . . . which would

raise no constitutional concern,” 541 U.S. at 453

(emphasis added), but Rule 7001(6) does exist

and it does impose affirmative obligations on a

debtor. The suggestion that Hood allows courts to

disregard Rule 7001(6) was rightfully rejected by

In re Hanson, 397 F.3d 482, 487 (7th Cir. 2005).

Hood states that Congress has discretion to de-

cide when to give parties more than minimal due

process; it certainly does not authorize courts to

arbitrarily disregard the choice that Congress has

made.

In any event, Espinosa’s position is that the

confirmation order is valid even if its entry vio-

lated the Code or the Rules, because some mini-

mal form of notice was provided. Under that

analysis, no due process violation could ever oc-

cur even if a creditor is misled by the debtor’s

failure to comply with the prescribed notice re-

quirements. Indeed, according to the Ninth Cir-

cuit it would be “wrong and dangerous’ to allow

Congress to define what due process requires.

Espinosa, 553 F.3d at 1204.

The Amici States assert, to the contrary, that,

while Congress cannot approve a procedure that

falls below the Constitutional minimum for due

process, it certainly may determine in certain

cases that due process requires that parties re-

ceive more than that constitutional minimum.

And, Congress having done so, those parties are

entitled to rely on that grant of rights and act ac-

cordingly. Denying those rights violates due proc-

ess under Mullane because one of the “circum-

stances” that must be considered is the collection

of rights parties have been informed that they

possess and can rely on having. That is true in

any civil proceeding; it is critical in the unique

scenario posed by bankruptcy proceedings.

II]. Bankruptcy’s Unique Nature Demands a

Consistent Application of the Rules.

Bankruptcy is quantitatively different from

any other federal litigation and that fact explains

the many differences in the way cases are han-

dled. Bankruptcy filings are far more numerous

than all other federal cases combined — and the

ratio between the two has increased dramatically

during the last twenty years. In 1988, when

Espinosa took out his loans, there were 549,612

nonbusiness bankruptcies. By 1992, when he

filed his petition, that number had soared to

900,874, and by 1997, when he received a dis-

charge, the number had grown by another 50 per-

cent to 1,350,118. From 1998 to 2004, the number

varied between a low of 1,217,972 in 2000 and a

high of 1,625,208 in 2003."!

While it was frequently suggested that enact-

ment of the BAPCPA would lead to a reduction in

"| All filing rates taken from charts maintained by

American Bankruptcy Institute:

http://www.abiworld.org/AM/AM Template.cfm ?Sec-

tion= Home& TEMPLATE=/CM/Content Dis-

play.cfm& CONTENTID =56822. All websites were

viewed on April 7, 2009, unless otherwise stated.

case filings, and while that did initially occur af-

ter its enactment in 2005, filings have increased

every year since then. '* For 2009, they are likely

to return to the roughly 1.4-1.5 million average

that predated the BAPCPA. As of the second

quarter of 2009, filings totaled 1.3 million for the

prior twelve months, but the June 2009 quarter

alone had 381,000 filings. On an annualized ba-

sis, the June rate translates into 1.524 million fil-

ings.'°

By contrast, in 1988, there were 43,670 federal

criminal and 240,232 federal civil cases filed, or

about 1 for every 2 bankruptcy filings.'* In 1993,

there were 46,786 federal criminal and 229,850

12 620,000 petitions were filed in October 2005 to

beat the BAPCPA’s effective date, resulting in a total

of more than two million cases in 2005. See

http://www.abiworld.org /AM/Template.cfm? Section=

Home& TEMPLATE=/CM/ContentDisplay.cfm

&CONTENTID=42631. Case filings dropped to

600,000 in 2006, then rose to 800,000 in 2007 and to

more than one million in 2008.

8 See http://www.uscourts.gov/Press_Releases/200

9/BankruptcyFilings Jun2009.cfm, issued by Admin-

istrative Office of the U.S. Courts, viewed on August

19, 2009.

‘4 Federal Judicial Workload Statistics, ‘lables C,

D, F-2, issued by Administrative Office of the US.

Courts, December, 1988.

federal civil cases filed, for a total of 276,636

cases,’° still less than one for every three of the

almost 900,000 bankruptcy filings. By 1997,

though, other federal filings had risen only to

322,390, compared to 1.37 million bankruptcy fil-

ings — now a 1 to 4.2 ratio. Nonbankruptcy filings

have varied little in recent years, averaging

about 340,000 cases a year from 2004 to 2008,*°

as compared to bankruptcy filings which have re-

turned to the 1.5 million range and the 1 to 4.2

ratio.

The reality is that bankruptcy, at least for

consumer debtors, is a high volume, highly stan-

dardized practice in which lawyers and the courts

use software packages, form pleadings, standard

plans, “no look” fee approvals, and the like to

handle the wholesale business of processing hun-

dreds of thousands of petitions each year. Unlike

a typical two-party dispute in civil or criminal

litigation, bankruptcy almost inevitably involves

unrelated claims by many different parties

against the debtor. Those claims may arise under

'® See http://www.uscourts.gov/judicial busi-

ness/judbus.pdf p. 12, issued by Administrative Office

of the U.S. Courts, viewed on August 28, 2009. (Sta-

tistics are for FY 93, beginning October 1992).

‘© See http://www.uscourts.gov/judbus2008/content

s.cfm for statistics for 2004-2008, Tables S-7 and D-2,

viewed on August 19, 2009.

state law, federal nonbankruptcy law, or the

Code, and the debtor (or trustee) must decide

whether to accept or dispute them, in addition to

contesting liens, defending challenges to exemp-

tions, and administering property of the estate.

Further, in Chapter 11, 12, and 13 cases, debtors

have broad leeway to propose plan terms, and

creditors may vote on or object to those proposed

plans. Finally, the debtor and his creditors may

litigate either his right to a general discharge or

request that specific debts be discharged.

In this high-volume . reia, creditors need to be

able to rely on the rules. That need in-reases

geometrically when a single defendant, such as a

student loan creditor — or a taxing authority of

the Amici States — is faced with literally thou-

sands or tens of thousands of cases a year.’’ To

cope with those filings in an economically realis-

tic fashion, creditors must set up automated sys-

tems, delegate work to paralegals, and train sec-

retarial staff as to which matters must be

brought to counsel’s attention and which do not

As noted by the petitioner, the feder: | student

loan programs service more than $500 billion of

loans. The petitioner states it received notice of

24,411 bankruptcies in 2008 alone. U.S. DEPT. OF

EDUC., FINANCIAL AND PERFORMANCE

QUARTFRLY UPDATE, Issue 2008-2, at 7 (Sept. 30,

2008).

require further action.

This cacophony of actions would produce chaos

absent the carefully-orchestrated provisions of

the Code and the Rules which create detailed

procedural mechanisms with specific notice, tim-

ing, and objection provisions for cach type of ac-

tion. There are 86 Federal Rules of Civil Proce-

dure for district court litigation. By contrast,

those rules are largely subsumed in only one

chapter of the Bankruptcy Rules. There are an

additional eight chapters of bankruptcy rules,

spelling out how the case is to proceed. Virtually

every bankruptcy court also has detailed local

rules to further help guide, channel, and control

the thousands of cases they handle each year.

That multitude of proceedings, moreover,

takes place on a highly compressed schedule

compared to normal federal litigation, especially

in Chapter 13.'* Moreover, the Bankruptcy Code

‘8 Chapter 13 plans must be filed no later than 15

days after the petition date. Bankruptcy Rule

3015\a). The confirmation hearing must be at least 20

days after the Section 341 meeting of creditors, which

in turn, under Bankruptcy Rule 2003(a) and Section

1324(b), is to be held between 20 and 50 days after

the case is filed. Thus, the plan confirmation hearing

could be as early as the 40th day of the case and only

25 days after the plan is filed. Before 2005, no mini-

mum period existed between the petition date and the

confirmation hearing.

and the Rules are far more stringent in many re-

spects about challenges to decisions than the

rules that govern other federal litigation. Section

363(m), for instance, precludes a sale to a good

faith purchaser from being overturned unless a

stay has been obtained. Notices of appeal must be

filed within 10 days rather than 30 (compare

Bankruptcy Rule 8002(a) to Federal Rule of Ap-

pellate Procedure 4(a)(1)). Confirmation orders in

Chapter 13 can only be overturned for fraud and

only for six months.!®

And, in yet another example of the stringent

application of the Rules in bankruptcy, even a

frivolous claim of exemption can be enforced

unless the trustee challenges the claim within

the required deadline. See Taylor v. Freeland &

Kronz, 503 U.S. 638 (1992). The Court is cur-

rently scheduled to hear a case this term, Schwab

v. Reilly, No. 08-538, 129 S.Ct. 2049 (2009), in

which the Third Circuit held that a trustee had to

challenge not only facially invalid exemptions,

but also those that implicitly could be read to as-

sert an improper claim. Failing to do so, the

Third Circuit held, barred the trustee from later

contesting the debtor’s ability to claim the im-

proper amounts that it had impliedly exempted.

In short, in light of the severe consequences the

Bankruptcy Code and Rules visit upon parties

"8 $1330(a).

that fail to take a required step, it becomes even

more critical for notice requirements to be fol-

lowed and consistently enforced.

That is particularly true when a third signifi-

cant reality of Chapter 13 cases is considered,

namely, that despite the large amount of litiga-

tion that may arise in any given case, these are,

on average, very low-dollar proceedings. In fiscal

year 2008, for instance, payments made through

Chapter 13 cases totaled some $5.2 billion, of

which only $1.2 billion dollars went to pay the

claims of all unsecured creditors.*° Divided by the

roughly 353,000 Chapter 13 cases filed in 2008,*!

that resulted in an average payout to all unse-

cured creditors of only $3400 per case. When po-

tential recoveries are so small, unsecured credi-

tors like student loan guarantors generally can

expect little from the plan itself. Rather, their

primary hope of return is for their debt not to be

discharged so they can resume collection activi-

ties after competing obligations are discharged.

A creditor with a nondischargeable claim will

2° See http://www.usdoj.gov/ust/eo/private_trustee/|

ibrary/chapter13; Chart chl3ar08AARpt.xls — FY-

2008 Chapter 13 Trustee Audited Annual Reports.

Viewed on August 19, 2009.

*! See http://Awww.uscourts.gov/Press_Releases/200

8/BankruptcyFilings Dec2008.cfm.

have little reason to fear the plan’s treatment of

its claim, if the plan cannot discharge the debt.

Rather, the debtor has every incentive to pay as

much as possible on the nondischargeable debt

during the case and, indeed, to give such debts

preferential treatment to reduce the amount he

will need to pay after the bankruptcy. Courts dif-

fer on whether such treatment is allowed;”’ the

salient point is that, if the plan cannot discharge

the debt, the debtor has no reason to underpay

that creditor. The creditor, in turn then, can di-

rect its limited resources to defending bona fide

challenges brought via adversary proceedings.

On the other hand, if debtors may ignore both

substantive and procedural requirements, they

have every reason to seek approval of plans that

discharge debts improperly. If, as the Ninth Cir-

cuit ruled, such plans are absolutely protected if

the creditor does not object, and if bankruptcy

courts are precluded from policing them sua

sponte, then debtors, at least initially, will be

successful in gaining unwarranted benefits.

While large creditors with many cases presuma-

bly will learn to adapt their actions to this new

regimen (albeit at substantial, unnecessary cost

and burden to all parties), occasional creditors

*2 See discussion of contrasting lines of cases in

Marshall v. Belda (In re Belda), 315 B.R. 477, 482-86

(N.D. Ill. 2004).

may not learn until too late that they were foolish

to have assumed that the Rules applied to debt-

ors too.

III. Failure to Provide a Party with the No-

tice Required by the Rules Denies That

Party Due Process

The Ninth Circuit’s ruling puts it squarely in

conflict with five other circuits*® — a fact that it

readily conceded. Moreover, it was forced to over-

rule both the district court in this case and the

Ninth Circuit Bankruptcy Appellate Panel

(“BAP”) in Jn re Repp, 307 B.R. 144 (9th Cir. BAP

2004), reversed by Espinosa, 553 F.3d at 1204, n.

6. In each of those cases, the creditor did not ob-

ject to the plan or appeal from confirmation, but

sought to collect the debt after the plan ended,

only to be met by the contention that the con-

*3 Whelton v. Educ. Credit Mgmt. Corp., 432 F.3d

150, 154-55, 156, n.2 (2nd Cir. 2005) (using plan

process makes discharge provision “void ab initio”);

Banks v. Sallie Mae Servicing Corp., 299 F.3d 296,

300 (4th Cir. 2002); In re Ruehle, 412 F.3d 679, 682-

83 (6th Cir. 2004); In re Hanson, 397 F.3d 482, 486

(7th Cir. 2005); Educ. Credit. Mgmt. Corp. v. Mers-

mann (In re Mersmann), 505 F.3d 1033 (10“ Cir.,

2007) (“§ 1325(a)(1) .. . permits the confirmation of a

plan only if it is consistent with the rest of the Code’;

“bankruptcy court lacks authority to confirm” plan

that does not use adversary proceeding).

firmed plan was res judicata. In each case, the

Court of Appeals held that res judicata did not

apply because the orders were void because the

debtor had violated due process requirements by

failing to initiate an adversary proceeding or to

provide proper notice. Because of those violations,

it was impossible to satisfy one of the conditions

for the application of res judicata, namely that

the defendant had received a full and adequate

opportunity to litigate the issues. Compare the

Tenth Circuit’s decisions in Andersen v. UNIPAC-

NEBHELP (In re Anderson), 179 F.3d 1253 (10th

Cir. 1999), which utilized the res judicata ap-

proach, with its en banc decision in Mersmann,

505 F.3d at 1049, where it reversed its earlier po-

sition once the due process argument was pre-

sented.

The same analysis has also been applied to the

use of plans to purportedly invalidate liens in cir-

cumstances where Bankruptcy Rule 7001(2) re-

quires an adversary proceeding. Three circuits

have held that doing so violates due process and

have invalidated provisions in plans that at-

tempted to avoid liens. See In re Mansaray-

Ruffin, 530 F.3d 230, 235-36 (3rd Cir. 2008); In re

Bateman, 331 F.3d 821, 830-833 (11th Cir. 2003);

Cen-Pen Corp. v. Hanson, 58 F.3d 89 (4th Cir.

1995). Indeed, in both Jn re Brawders, 503 F.3d

856, 869-870 (9th Cir. 2007) (affirming decision

by BAP), and Jn re Enewally, 368 F.3d 1165, 1173

(9th Cir. 2004), the Ninth Circuit had, until the

decision below, been consistent with its sister cir-

cuits, confirming that due process requires that

matters that must be raised in an adversary pro-

ceeding cannot be determined by a plan. The de-

cision in this case has left that court at odds not

only with the other circuits, but even itself.

The distinction between using an adversary

proceeding versus plan language to discharge a

debt is not merely semantics. Plan language is a

short and simple statement of the debtor’s inten-

tions; it requires neither explanation nor justifi-

cation. That is particularly true in Chapter 13

cases in which plans are often form documents,

prepared in a “fill in the blanks” format, compris-

ing only a few pages. Moreover, the debtor need

not even serve the full Chapter 13 plan on credi-

tors, but is permitted to provide a mere sum-

mary. See Bankruptcy Rule 3015(d), Section

521(e)(3) (full plan must be provided to a creditor

only if it requests the plan and pays for the copy

it receives).

Adversary proceedings, by contrast, are com-

** The decision below purported to distinguish the

language in Enewally as being mere dicta — but the

Bankruptcy Appellate Panel's decision in Brawders,

which was affirmed by the Ninth Circuit, was clearly

based on a reading of Enewally consistent with the

petitioner's view here.

menced by filing a complaint that must, under

Bankruptcy Rules 7004 and 7008, show “that the

[debtor] is entitled to relief’ and describe the spe-

cific relief sought. Thus, unlike a debtor’s bare

assertion in a plan that a student loan debt

should be discharged, a complaint must assert

facts that demonstrate undue hardship. Bell At-

lantic v. Twombly, 550 U.S. 544 (2006) and

Ashcroft v. Iqbal, 129 S.Ct. 1937 (2009). More-

over, the complaint must name the specific party

in interest and be served with a summons on a

high-level official or person designated to receive

service. The combination of the formal structure

of a complaint, coupled with heightened notice

provisions, ensures that a responsible person at

the creditor will be alerted in a clear and direct

fashion that the creditor’s specific interests are

being challenged and that it must take heed of

those interests or suffer a default. That process is

surely more likely to ensure that the creditor will

respond to the challenge than merely sending a

copy of the plan to a post office drop box.

Congress has every right to protect creditors

with nondischargeable debts by granting them

that added level of notice. It is not difficult to un-

derstand why Congress would have made that

choice in light of the practical realities of bank-

ruptcy cited above. Large creditors, like USA

Funds, receive “tidal waves of mail. . . . The

quantity ‘of notice’ that is issued by the bank-

ruptcy system is so overwhelming that it is nec-

essary to have clear rules in order for creditors to

know what notices to notice as opposed to the no-

tices that are deafening legal background noise.

The Code and the Rules set forth those clear

standards and it is up to the courts to ensure that

the lines are not blurred.” Jn re Ruehle, 412 F.3d

679, 684 (6th Cir. 2004).

As this Court stated in Mullane, due process

requires “notice reasonably calculated, under all

the circumstances, to apprise interested parties of

the pendency of the action and afford them an

opportunity to present their objections.” Mullane

339 U.S. at 314 (emphasis added). The other Cir-

cuits have concluded that, at a minimum, those

“circumstances” include the fact that parties have

been promised a specific level and form of pro-

ceeding and of notice. See, e.g., Banks, 299 F.3d

at 302 (“due process generally entitles a party to

receive the notice specified before an order bind-

ing the party will be afforded preclusive effect”);

Ruehle, 412 F.3d at 684-85 (parties are “entitled

to the prescribed level of notice for the process to

be due”); Mersmann, 505 F.3d at 1049 (“creditor

has a right to assume that he will receive all of

the notices required by statute before his claim is

forever barred” (emphasis by Mersmann court).

This Court took the same view in City of New

York v. New York, New Haven & Hartford R.R.,

344 U.S. 293 (1953), where it considered whether

a party could be bound by a confirmation order

when it knew of the case but had not been mailed

notice of the hearing on the plan as required by

the Bankruptcy Act and rules. This Court re-

jected the argument that knowledge of the case

would put a party on inquiry notice so that it

would be obligated to take steps to learn of the

hearing, stating that “even creditors who have

knowledge of a reorganization have a right to as-

sume that the statutory ‘reasonable notice’ will be

given them before their claims are forever

barred.” (Emphasis added).*°

The same is true here — the creditors have

been told that any attempt to discharge their

debt will take place in an adversary proceeding

and that they will receive a particular form of

“reasonable notice” of the commencement of that

proceeding. The debtor, though, brought a differ-

*° Under other circumstances (i.e., in Chapter 7

and 13 cases where the Rules are far more specific

about the timing and sequence of bar dates in the

case), parties may be required to inquire. See In re

Metzger, 346 B.R. 806, 817-19 (Bankr. N.D. Cal.

2006), explaining the differences and noting the effect

of varying statutory provisions in the different chap-

ters. Thus, it is clear that there is no one single-size

notice that satisfies all constitutional duties; plainly,

though, the decision by Congress to specify a particu-

lar form of notice and proceeding is entitled to defer-

ence.

ent form of action and provided a different,

lesser, form of notice, but argues that the alter-

nalives were “good enough.” The Ninth Circuit

agreed, holding that mailing a plan to a post of-

fice box would have been minimally adequate no-

tice in a constitutional sense, in the absence of

any specified provisions in the statute or Rule. It

was immaterial to the Ninth Circuit’s due process

analysis, therefore, that what was done was not

the form of service and proceeding that was re-

quired by an existing Rule for this particular cir-

cumstance.

That conclusion, though, ignores the critical

distinction between being told nothing about

what is required, and being promised that mat-

ters would proceed in a particular way. If nothing

had been said in the Code or Rules about how

undue hardship would be decided, the creditor

would have no alternative but to examine each

paper it received with care to determine if a dis-

charge action was lurking within. But, because

the Code and Rules specify a particular form of

proceeding and notice, creditors have a right to

rely on those specifications and to adjust their

monitoring efforts accordingly. They should not

have to assume that the party providing notice

will ignore the Rules and the Code and substitute

its own procedures.

Indeed, as noted by the Ninth Circuit Bank-

ruptcy Appellate Panel in Brawders (in a decision

affirmed by the Ninth Circuit), it had previously

held that “the greater the deviation from the

process set out in the rules, ‘the greater the qual-

ity and amount of notice needed in order to com-

ply with due process.” Brawders, 503 F.3d at

870-71 (BAP decision citing GMAC Mortgage

Corp. v. Salisbury (In re Loloee), 241 B.R. 655,

662 (9th Cir. BAP 1999)). It further noted that it

had held, in Varela v. Dynamic Brokers, Inc. (In

re Dynamic Brokers, Inc.), 293 B.R. 489, 497 (9th

Cir. BAP 2003), that to include a claims objection

in a Chapter 11 plan,

considerations of due process mandate

great caution and require that the creditor

receive specific notice (not buried in a dis-

closure statement or plan provision) of at

least the quality of specificity, and be af-

forded the same opportunity to litigate one-

on-one, as would be provided with a

straightforward claim objection under Rule

3007.76

In short, the more one decides to ignore the re-

2° Indeed, Bankruptcy Rule 3007 was amended, as

of December 1, 2007, to limit the number and types of

objections in a single pleading and to bar inclusion of

adversary matters in a claims objection. Thus, it is

clear that the Rules drafters and Congress have re-

cently opted to require more notice to creditors, not

less, in contrast to the Ninth Circuit.

quirements established by the Code and the

Rules, the more likely it is that parties will be

misled in a way that is fundamentally unfair and

that violates the due process rights of those who

justifiably relied on those provisions.

The decision below brushes aside these con-

siderations and suggests that a party risks waiv-

ing its rights when it does not respond to any

form of information that it receives that might

implicate its claims. That is simply not the case,

though. A party that receives by regular mail a

civil complaint, without personal service, has no

duty to respond, despite his full knowledge of its

contents. It is only when proper personal service

is obtained under Federal Rule of Civil Procedure

4 that the defendant has’an obligation to defend |

the suit. *’

The Bankruptcy Rules provide for service of a

complaint by mail in Rule 7004(b) in addition to

personal service, but Rule 7004(b)(3) nonetheless

requires service on an “officer, managing or gen-

eral agent, or {) any other agent authorized by

appointment or by law to receiver service of proc-

ess.” Mailing a plan notice to a lockbox does not

27 Of course, a plaintiff could include a request to

waive service under Fed. R. Civ. Proc. 4(d)(1). To ac-

tually waive the right to formal service, though, a

proper party must sign the waiver, thus ensuring the

equivalent of personal service.

satisfy that obligation, much less the require-

ment that the document at issue must be an ad-

versary complaint. Even assuming the plan

document here ever came to the attention of a re-

sponsible official of petitioner (an assumption for

which the Ninth Circuit cites no evidentiary sup-

port), the fact remains that a party receiving a

plan with a provision that cannot lawfully be de-

cided in that context is not required to object

thereto.

That principle is part of the bedrock of juris-

diction in and outside of bankruptcy; there is

nothing about the discharge or Chapter 13 plan

process that dictates a different result. See, e.g.,

Hamlett v. Amsouth Bank (In re Hamlett), 322

F.3d 342, 345-46 (4th Cir. 2003) (default judg-

ment vacated because service made on registered

agent of depository institution, not “officer,” as

required in Rule 7004(h)); In the Matter of

McMahon (Miller v. Homecomings Fin. Network,

Inc., 2008 Bankr. LEXIS 3635, *9-10 (Bankr.

N.D. Ind. 11/18/08) (failure to address summons

to attention of corporate officer, as opposed to

merely corporation, as required by Rule

7003(b)\(3), made service defective and allowed for

lifting of default judgment); Jn re E-Z Serve Con-

venience Stores, Inc. et al.(CIT Group/ Business

Credit, Inc., vs. Official Committee of Unsecured

Creditors of E-Z Serve Convenience Stores, Inc.,

et. al), 318 B.R. 631, 635-36 (Bankr. M.D.N.C.

2004) (reconsidering order avoiding creditor's lien

because relief sought by motion rather than ad-

versary proceeding).

Espinosa’s position here stands that principle

on its head by asserting that he is not bound by

the Rules; rather, he may devise whatever forms

of proceeding and service he chooses and, if the

court believes those efforts are minimally likely

to bring the matter at issue to the creditor’s at-

tention, the creditor is bound. That cannot be the

law because it leaves every other party in the

case unsure of what it must do to protect its

rights, particularly in the high-volume, low-

payment reality of Chapter 13 cases.

If the Rules had said, “no action can be taken

to discharge a debt unless the notice is sent in a

blue envelope,” a creditor could reasonably judge

that it need not read mail in white envelopes if it

is only concerned with discharge actions. The re-

sult should be no different here. The Ninth Cir- »

cuit considered the violation of the Rules to be

wholly irrelevant, stating that the guarantor was

sophisticated and that it was “highly unlikely”

that it was misled by “customary bankruptcy pro-

cedure,” Espinosa, 553 F.3d at 1205. That would

be true, though, only if is “customary” for debtors

to ignore the Code and the Rules. Indeed, it is

more likely that a “sophisticated creditor” — that

is, one conversant with the pertinent statute and

rules — would be misled because of its reliance

thereon. A bankruptcy novice with only a single

case might not read the Rules and — unlike larger

creditors — might have time to read every single

piece of paper with which it was served.

A comparison of the facts in Mullane to those

here shows how far the Ninth Circuit’s method of

analysis strays from that required by this Court.

In Mullane, a trustee sought to settle his ac-

counts in a situation where thousands of parties

were involved, there was no reason to assume he

had done anything wrong, and he could not ascer-

tain names and addresses for many of those par-

ties. He sought to proceed under a state law that

explicitly allowed publication notice to all parties

in such circumstances. Even though this was the

only action involving those beneficiaries, and

even though they might be thought responsible

for learning the state law and gauging their

monitoring accordingly, this Court held that pub-

lication notice was not sufficient. It could be used

for unknown creditors, because no better method

was available, but known creditors were entitled

to actual service. Due process, this Court held, is

not a mere gesture, but is measured by the steps

a person takes who truly wants to communicate

with another.

The Ninth Circuit’s holding below, by contrast,

applies even when a debtor violates the Rules and

the Code, the plan takes away the creditor's

rights, the debtor can expect opposition from the

creditor, there is a manageable number of credi-

tors to notify, and the debtor can readily obtain

information to effectuate proper service. In the

world of Chapter 13, debtors know that creditors

managing large case loads will rely on the Rules

and the Code to determine the level of their

monitoring efforts. Allowing debtors to exploit

that reliance by violating the Rules and the Code

does not satisfy Mullane’s requirements; it is the

antithesis of Mullane. Mullane does not dictate a

“one size fits all” form of notice for due process

purposes; it requires a consideration of “all of the

circumstances.” The fact that, in some circum-

stances, due process may not require that the

party receive actual notice at all (for example,

when publication notice is the only possible

means to attempt service), surely does not dictate

the Ninth Circuit’s opposite conclusion that any

form of actual notice will automatically satisfy

due process. In its amendatory opinion, reported

at 553 F.3d 1193, the Ninth Circuit held that it

was “bizarre” to assume that the Constitution

might require anything more than actual notice.

In fact, what is bizarre is the court’s implicit

conclusion that parties should be penalized for

relying on notice requirements mandated by

Congress.*®

“8 Indeed, the Ninth Circuit in its original opinion

had overruled the BAP’s decision in Brawders, which

It is clear, as the other five circuits have held,

that adherence to the principles enunciated in

Mullane and City of New York means that a

debtor may not obtain a binding order discharg-

ing a debt unless the debtor complies with the re-

quirements Congress has established for obtain-

ing that order. Failing to follow those procedures

means that the creditor has been denied due

process and that the confirmation order is void

with respect to that provision. Accordingly, the

actions of petitioner here did not violate the dis-

charge injunction.

By contrast, the Ninth Circuit’s opinion rein-

vigorates the concept of discharge by ambush. It

creates uncertainty and leaves parties to grapple

with an amorphous balancing process despite the

fact that Congress has prescribed the proper

process with complete clarity. Under the Rules,

the result is simple — either a summons and com-

plaint are prepared and served on a proper party,

or they are not. But under the Ninth Circuit’s ap-

proach, courts must decide whether some other,

explicitly held that greater degrees of notice had to be

given if a party violated the Rules. In the revised

opinion, though, it reversed its position and left

Brawders intact, thus retaining a decision whose

holding directly contradicted this statement. Thus,

again, the Ninth Circuit’s holdings contradict each

other as well as those of other circuits.

lesser form of process is adequate under the cir-

cumstances of each particular case. The Ninth

Circuit’s approach imposes added costs and bur-

dens on an already overcrowded bankruptcy sys-

tem and provides no countervailing benefits.

Those difficulties will increase in light of the new

exceptions to the Chapter 13 discharge, which

will give debtors even greater incentives to evade

the Rules than before the passage of the

BAPCPA. It is critical that this Court reverse this

holding before it spurs another round of abuse.

IV. A Creditor’s Failure to Object to a Plan

Provision Does Not Bar the Bankruptcy

Court From Acting Sua Sponte to Re-

view the Plan

Perhaps the most troubling aspects of the

opinion are the Ninth Circuit’s twin assertions:

first, that a creditor’s failure to file an objection

suggests its affirmative consent to the discharge

of the debt owed to it, and second, that such pur-

ported “consent” made it improper for the bank-

ruptcy court to raise a sua sponte challenge to the

plan’s terms.

First, there is no apparent evidentiary basis

for the Ninth Circuit’s suggestion that the guar-

antor here, or a creditor in general, that does not

object to a plan in which its claim is purportedly

discharged actually agrees to that discharge. Be-

cause a creditor may both receive partial pay-

ment under a plan and have the balance excepted

from discharge, it is unclear why it would ever

agree to accept the payment and allow the dis-

charge. But, assuming a creditor was willing for

its debt to be discharged, it can always state that

consent affirmatively to the debtor, or it can de-

fault on its response to the adversary complaint

when filed. The assumption that silence, in the

face of unlawful provisions, implies actual con-

sent will only increase the procedural! free-for-all

occasioned by this ruling.

The other aspect of the ruling — that bank-

ruptcy courts are not allowed to challenge illegal

provisions sua sponte — ignores the broad policing

powers granted to bankruptcy courts by Section

105(a). That section states:

The court may issue any order, process, or

judgment that is necessary or appropriate

to carry out the provisions of this title. No

provision of this title providing for the rais-

ing of an issue by a party in interest shall

be construed to preclude the court from,

sua sponte, taking any action or making

any determination necessary or appropriate

to enforce or implement court orders or

rules, or to prevent an abuse of process.

Courts have relied on that authority to enforce

Rule 7001 and the substantive provisions of the

Code that determine how student loans may be

discharged. The Ninth Circuit now holds that

they may not independently do so. ‘t erred in so

holding.

Section 1322(b)(11) provides that a Chapter 13

plan may contain any provision “not inconsistent

with this title.” Section 1325(a)(1) provides that

the court “shall confirm a plan if... (1) the plan

complies with the provisions of this chapter and

with the other applicable provisions of this title.”

And, finally, Section 1325(a)(3) states that the

court shall confirm a plan if “. . . (3) the plan has

been proposed in good faith and not by any

means forbidden by law.” Thus, Congress has

thrice stated that plans must only contain lawful

provisions and that courts are to confirm lawful

plans. A plan that discharges a student loan debt

with no showing of hardship violates Section

523(a)(8) and Section 1328(a)(2).

Numerous circuits have concluded that the

provisions of Section 1325 are binding obligations

that the debtors must follow — and that courts are

to enforce in deciding whether to confirm a plan.

See, e.g., the extensive discussion in Shaw ov.

Aurgroup Financial Credit Union, 552 F.3d 447,

452-58 (6th Cir. 2009) (citing, inter alia, three de-

cisions of this Court referring to Section 1325 as

requirements a plan must satisfy to be confirmed)

and Mersmann, 505 F.3d at 1048, 1049 (“§

1325(a)(1)... permits the confirmation of a plan

only if it is consistent with the rest of the Code”;

“bankruptcy court lacks authority to confirm”

plan that does not use adversary proceeding). The

Third Circuit in Jn re Szostek, 886 F.2d 1405 (3d

Cir. 1989), did use broad language suggesting in

dicta that those provisions were not mandatory.

Notably, the Ninth Circuit, in Jn re Barnes, 32

F.3d 405, 407 (9th Cir. 1994), was among the cir-

cuits that rejected the Third Circuit’s approach

and deemed the requirements of Section 1325(a)

mandatory. Moreover, even the Third Circuit has

held, in Mansaray-Ruffin, 530 F.3d at 237-38,

that general res judicata provisions do not allow

a debtor to avoid a lien through a plan provision

where the Rules require an adversary proceeding

— a situation precisely analogous to the discharge

provision at issue here.

It is plainly inconsistent then for the Ninth

Circuit to hold that a bankruptcy court is forbid-

den from enforcing the provisions of Section 1325

under its own authority, as Section 105(a) allows.

If, in fact, the debtor can prove undue hardship

and the creditor does not dispute the debtor’s

right to a discharge, the parties can easily stipu-

late to that effect to resolve the matter if the is-

sue is raised by the bankruptcy court. (Notably,

there is no evidence that the debtor here has ever

indicated a willingness or ability to make such a

showing.) If a debtor cannot satisfy the Code’s re-

quirements, the bankruptcy system is far better

served by allowing bankruptcy courts to police

their dockets and cut off these abusive tactics at

an early stage, rather than requiring them to

preside over the duplicative, wasteful, and expen-

sive system the Ninth Circuit’s opinion envisions.

V. Debtors Seeking the Equitable Remedy of

a Discharge Must Act Equitably Towards

Their Creditors

It has often been held that bankruptcy courts

are essentially courts of equity. See, e.g., Katchen

v. Landy, 382 U.S. 323, 327 (1966). It is an estab-

lished maxim that those who seek equity must

behave equitably in turn to those dealing with

them. When debtors seek the enormous equitable

benefit of a discharge, it is not too much to ask

that they afford their creditors the notice rights

that Congress has required. Bankruptcy should

not be a game of “gotcha,” of debtors violating the

Rules and attempting to slip provisions past

creditors that are following the Rules. Instead, it

should be a process by which each party obtains

what it is due — nothing more and nothing less.

As noted above, this Court is also considering

the case of Schwab v. Reilly. In that case, the

debtor similarly argues that it managed to slip an

unlawful provision past the other parties and is,

therefore, entitled to retain a benefit to which it

was plainly not entitled. Regardless of how the

Court rules on whether the trustee should have

understood that the debtor was asserting an

unlawful exemption, it is clear that accepting the

debtor’s position will require trustees to file ob-

jections that would be wholly unnecessary if

debtors did not seek to obtain more than the law

allows. By the same token, the debtor’s approach

and that of the Ninth Circuit in this case will also

impose added costs and burdens for all parties

(including the debtors) to no useful purpose. This

Court should ensure that this large and complex

system that provides great benefit and relief to

those honest but unfortunate citizens suffering

from financial stress should not be undermined

by the actions of those who seek more than that

which they have been granted.

CONCLUSION

For the foregoing reasons, this Court should

reverse the decision below.

Respectfully submitted,

JOHN R. KROGER

Attorney General of Oregon

MARY H. WILLIAMS

Deputy. Attorney General

JEROME LIDZ

Solicitor General

CAROLYN G. WADE

Assistant Attorney General

Counsel for Amicus Curiae

State of Oregon

September 4, 2009

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.