Bankruptcy Payments Permitted to be Directed Toward Principal During Plan

Faced with a nearly impossible standard to discharge federal student loan debt in bankruptcy due to undue hardship, creative debtors’ attorneys and the bankruptcy courts are continuing to create pockets of relief wherever possible.

Finding that “non-dischargeability does not immunize the student loan claim from modification,”a bankruptcy court confirmed the debtors’ plan under which their payments would go to the principal on their student loan debt with accumulated post-petition interest to be paid post-discharge. In re Duensing, No. 18-10201 (Bankr. D. Kans. Feb. 22, 2019).

The guarantor of the loans, ECMC, objected to the debtors’ proposed treatment of the student loan debt arguing that, because the reduction of principal would result in declining post-petition interest, the proposed plan effectively discharged her student loan without a finding of undue hardship.

The court looked to federal regulations addressing how student loans that are not in default are treated. 34 C.F.R. Part 682.209(b)(1) provides that the lender may apply payments to fees and interest before applying them to principal. Part 682.209(b)(2)(i) and (ii), however, permit a borrower to prepay the debts and direct those prepayments to principal. The court read these regulations in conjunction with the Bankruptcy Code, section 1222(b)(2), which permits a debtor to modify the rights of an unsecured creditor, and section 1225 which provides for confirmation of a plan that conforms to the Code’s requirements.

The court found that the debtor’s plan harmonized with the relevant regulatory and statutory provisions. It disagreed with ECMC’s characterization of the resulting decline of post-petition interest as a de facto discharge, finding that a debt that has not yet accrued cannot be discharged.

Furthermore, section 1222(b)(11) [comparable to section 1322(b)(10)] provides for payment of post-petition interest on a non-dischargeable debt only when the debtor has sufficient disposable income to pay that interest after all other debts are paid in full. That was not the case here. Finally, section 1222(b)(5) permits curing and maintaining a debt that exceeds the five-year plan term.

Finding that nothing in the regulations or Code prohibit the Duensings’ treatment of the student loan debt, the court confirmed the plan.

If the Middle District of Florida will follow this case and apply the real “power” of 524i, we may be able to craft a Chapter 13 Plan with non-standard provisions with respect to how payments are made in different situations for student loans or even IRS debt.