In re: Nelson Quiles Santana and Maria de los Angeles Alves Ruiz

• Court: United States Bankruptcy Court, D. Puerto Rico
• Decided: October 18, 2012
• Docket: 10-11210
• Status: Unknown

Opinion

1 IN THE UNITED STATES BANKRUPTCY COURT FOR THE DISTRICT OF PUERTO RICO 2 IN RE: : 3 : CASE NO. 10-11210 (ESL) NELSON QUILES SANTANA : 4 MARIA DE LOS ANGELES ALVES RUIZ : : CHAPTER 13 5 Debtors : ____________________________________: 6 7 OPINION AND ORDER 8 This case came before the Court on March 21, 2012 for a hearing on confirmation of the 9 Debtors’ Amended Plan filed on May 5, 2011 (the “Amended Plan II”, Docket No. 40), the Chapter 10 13 Trustee’s Objection to Plan Confirmation and Memorandum of Law in Support Thereof (the 11 “Objection to Plan Confirmation”, Docket No. 42) alleging that the Amended Plan II includes a 12 provision in favor of Citibank N.A. (“Citibank”) for his son’s student loans that unfairly 13 discriminates against other unsecured creditors and the Debtors’ Response to [the] Trustee’s 14 Objection to Plan Confirmation (Docket No. 52). After hearing the arguments of the parties at the 15 confirmation hearing and considering the parties’ supplemental briefs, the Court took the matter 16 under advisement. For the reasons stated herein, the confirmation of the Debtors’ Amended Plan 17 II is hereby denied. 18 Background 19 The Debtors filed their Chapter 13 bankruptcy petition on November 30, 2010 (Docket No. 20 1). In Schedule F, the Debtors listed a student loan with Citibank as a co-debtor debt in the amount 21 of $100,400 (Docket No. 1, p. 37). On December 1, 2010, the Debtors filed a Chapter 13 Plan 22 (Docket No. 5)1. On December 17, 2010, Citibank filed an unsecured Proof of Claim in the amount 23 of $99,787.59 (Claims Register No. 7-1), as amended on January 21, 2011 to claim $100,077.84 24 (Claims Register No. 7-2). 25 On April 6, 2011, the Debtors filed a Motion of Amended Plan and Notice of Opportunity 26 to Object and for a Hearing (Docket No. 32). The Amended Plan dated April 6, 2011 (the 27 “Amended Plan I”) proposed a total plan base of $73,000.00 and the following schedule of 28 1 From December 1, 2010 through March 4, 2011, the Debtors amended their Chapter 13 plan twice on grounds unrelated to the one at hand. See Docket Nos. 5, 20, 23, 24, 27 and 28. 1 payments: 3 monthly payments of $840 each, one monthly payment of $1,040, and 56 monthly 2 payments of $1,240 (Docket No. 32, p. 3). The Debtors also included a section of unsecured 3 preferred claims, which provides for the payment of 50% of each of the consumer co-debtor claims 4 filed by Caribe Federal Credit Union (Claims Register Nos. 5 and 6 for the amounts of $9,391.33 5 and $4,363.00, respectively) and Citibank (Claims Register No. 7). See Docket No. 32, p. 4. 6 A confirmation hearing was held on April 26, 2011 to discuss the Amended Plan I. During 7 the hearing, the Trustee objected the confirmation of the plan, arguing that by including Citibank’s 8 claim (Claims Register No. 7) in a class with co-debtor claims, the Debtors were unfairly 9 discriminating against the other unsecured creditors in violation of 11 U.S.C. §1322(b)(1) because 10 unlike the co-debtor claims filed by Caribe Federal Credit Union (Claims Register Nos. 5 and 6), 11 Debtor Quiles Lasanta was not the actual debtor of Citibank’s claim, but a co-signer of his son’s 12 loan. The Court ordered the Trustee to review the co-debtors’ claims filed in this case and submit 13 his position in writing on or before May 24, 2011. See Docket No. 37. On May 5, 2011, the 14 Debtors filed another Motion of Amended Plan and Notice of Opportunity to Object and for a 15 Hearing to increase the base of the plan through a lump sum payment of $326.91 obtained from their 16 2010 tax refund. See the Amended Plan II (Docket No. 40). The provision regarding Citibank’s 17 classification as an unsecured preferred co-debtor claim remained unaltered. 18 On May 24, 2011, the Trustee filed his Objection to Plan Confirmation (Docket No. 42) 19 restating his prior objection and claiming that the Amended Plans I and II should be denied 20 confirmation because, by providing for the payment of 50% of Citibank’s claim, it unfairly 21 discriminates against other unsecured creditors and that such discrimination is not permitted by 22 Section 1322 of the Bankruptcy Code. The Trustee does not object that the co-debtor claims filed 23 by Caribe Federal Credit Union (Claims Register Nos. 5 and 6) be separately classified and 24 preferred. 25 After several procedural events (Docket Nos. 46, 48, 50 and 51), including an unfavorable 26 report for confirmation by the Trustee (Docket No. 45), on December 22, 2011, the Debtors filed 27 their Response to Trustee’s Objection to Plan Confirmation and Memorandum of Law in Support 28 Thereof (the “Response”, Docket No. 52). They contend that the plain language of Section 2 1 1322(b)(1) reveals that “Congress held the favored treatment of co-signed debt to be fair 2 discrimination” (Docket No. 52, p. 7, ¶ 20). They did not allege having derived any benefit 3 whatsoever from the co-signed debt with Citibank. 4 On March 21, 2012, the Court held another confirmation hearing to entertain the Trustee’s 5 Objection and Debtors’ Response. See Docket Nos. 58 and 60. During the hearing, the Trustee 6 acknowledged that this case meets the liquidation analysis. The parties were granted 14 days to 7 supplement their briefs. 8 On April 18, 2012, the Trustee and the Debtors filed their supplemental briefs (Docket Nos. 9 64 and 65). On May 3, 2012, the Debtors filed a sur-reply to the Trustee’s supplemental brief 10 (Docket No. 69) and on May 30, 2012, the Trustee filed his sur-reply (Docket No. 72). 11 Legal Analysis and Discussion 12 (A) Unfair Discrimination under Section 1322 and Co-signed Claims 13 The Bankruptcy Court shall confirm a Chapter 13 plan that meets the requirements of 14 Sections 1322 (contents of the plan) and 1325 (confirmation of the plan) of the Bankruptcy Code. 15 Section 1322(b)(1) provides that a Chapter 13 plan may “designate a class or classes of unsecured 16 claims, as provided in Section 1122 of [the Code], but may not discriminate unfairly against any 17 class so designated”. 11 U.S.C. § 1322(b)(1). The prohibition of “unfair” discrimination suggests 18 that the Code does allow discrimination that is fair. See William L. Norton, Jr. & William L. Norton 19 III, Norton Bankruptcy Law and Practice, 3rd ed. § 149:6 (2012). “[T]he reason for a debtor to have 20 separate classes of nonpriority unsecured claims in Chapter 13 is to prefer one class over another 21 in terms of how much the members of each class are paid.” William D. Warren, Daniel J. Bussel 22 & David A. Skeel, Jr., Bankruptcy, Foundation Press, 9th ed. 2012, p. 548. As originally enacted in 23 1978, Section 1322(b) permitted a Chapter 13 debtor to designate classes of unsecured claims if two 24 conditions were satisfied: that the classification be “as provided in Section 1122” and that the 25 classification “not discriminate unfairly”. 26 The origins of this “unfair discrimination standard” provide little guidance of its meaning. 27 See Bruce A. Markell, A New Perspective on Unfair Discrimination in Chapter 11, 72 Am. Bankr. 28 L.J. 227, 228-239 (1998), for the legislative history of the standard. “[I]t seems fairly clear that the 3 1 || unfair discrimination standard is intended to maintain equity among creditors of the same priority, 2 | muchas the fair and equitable requirement preserves equity among creditors of different priorities. 3 || Beyond that level of generality, however, the origins and legislative history of the unfair 4 || discrimination rule are not much help. To discern the details of this portrait of equity, courts ... must 5 || look elsewhere.” Stephen L. Sepinuck, Rethinking Unfair Discrimination in Chapter 13, 74 Am. 6 || Bankr. L.J. 341, 347 (2000). The lack of specificity in Section 1322 led to a wide array of decisions 7 || by courts over the years, most of them dramatically split, on whether separate classification of co- 8 || signed unsecured claims was permitted or not in Chapter 13 cases. Keith M. Lundin & William H. 9 || Brown, Chapter 13 Bankruptcy, 4" Edition, §150.1 at § 14 (2004), www.Ch13online.com. 10 In 1984 Congress enacted the Bankruptcy Amendments and Federal Judgeship Act, Pub. L. 11 || No. 98-353, 98 Stat. 333 (1984) (“BAFJA”), which amended Section 1322(b)(1) to explicitly 12 || authorize the separate classification of co-debts as follows: 13 Subject to subsections (a) and (c) of this section, the plan may — 14 (1) designate a class or classes of unsecured claims, as provided in Section 1122 of this title, but may not discriminate unfairly against any class so designated; however, such 15 plan may treat claims for a consumer debt of the debtor if an individual is liable on such consumer debt with the debtor differently than other unsecured claims. 16 11 U.S.C. § 1322(b)(1) (emphasis added on the commonly known “However Clause’). 17 || “The use of the introductory word ‘however’ signals that the power to separately classify consumer 18 || debts intended to be an exception to the classification power immediately preceding it in Section 19 || 1322(b)(1). Because the preceding grant is broad, subject only to the statutory proscription against 20 || unfair discrimination, it is not clear as a matter of sentence construction what the word ‘however’ 21 || is intended to convey.” Keith M. Lundin & William H. Brown, Chapter 13 Bankruptcy, 4" Edition, 22 |] $150.1 at § 2 (2004), www.Ch/ 3online.com. Since the sentence construction in Section 1322(b)(1) 23 || is not clear, the legislative history of the 1984 amendment must be considered to analyze its 24 || conveyance. See U.S. v. Great Northern Railway Co., 287 U.S. 144, 154-155 (1932) (“In aid of the 25 || process of construction we are at liberty, if the meaning be uncertain, to have recourse to the 26 || legislative history of the measure and the statements by those in charge of it during its consideration 27 || by the Congress.”); Perez-Olivo v. Chavez, 394 F.3d 45, 49-50 (1* Cir. 2007), citing Summit Inv. 28 || & Dev. Corp. v. Leroux, 69 F.3d 608, 610 (1* Cir. 1995) (“The congressional intendment conveyed

1 by unclear statutory language may be discernible from its legislative history.”) 2 The Senate and House reports for BAFJA do not contain a reference to Section 1322(b). 3 Rather, this portion of the amendment derives from a prior bill whose language was partially 4 incorporated into BAFJA. The only legislative history is the one in the Senate report for that earlier 5 bill, the Omnibus Bankruptcy Improvements Act of 1983, S. 445, 98th Cong., 1st Sess. (1983). See 6 In re McKown, 227 B.R. 487, 491-492 (Bankr. N.D. Ohio 1998) (explaining the legislative history 7 of the amendment). That Senate report states as follows: 8 Although there may be no theoretical differences between co-debtor claims and others, there are important practical differences. Often, the co-debtor will be a relative or a 9 friend, and the debtor feels compelled to pay the claim. If the debtor is going to pay this debt anyway, it is important that this fact be considered in determining the 10 feasibility of the plan. Sometimes, the co-debtor will have posted collateral, and the debtor will feel obligated to make the payment to avoid repossession of the collateral. 11 In still other cases, the co-debtor cannot make the payment, and the effect of nonpayment will be to trigger a Chapter 7 or Chapter 13 petition by the co-debtor, 12 which may have a ripple effect on other parties as well. For these reasons, separate classification is often practically necessary. S. Rep. No. 65, 98th Cong., 1st Sess., 17-18 13 (1983)[S. 445]. 14 The foregoing reveals that “permitting favored treatment of co-debtor claims is intended to help 15 prevent the debtor’s bankruptcy from prompting a filing by the co-debtor, and then perhaps in 16 domino fashion the bankruptcy of others.” Rethinking Unfair Discrimination in Chapter 13, 74 Am. 17 Bankr. L.J. at 369. The “However Clause” is also premised on the concern that the debtor may feel 18 a moral obligation to pay co-debtor claims beyond the extent provided for in the plan, and that such 19 payments might jeopardize the success of the plan. Id. at 369. 20 In In re Martinez-Rivera, — B.R. —, 2012 Bankr. LEXIS 4211 at *6, 2012 WL 3930367 at 21 *2 (Bankr. D.P.R. September 10, 2012)2, the Bankruptcy Court for the District of Puerto Rico 22 recently ruled that “the unfair discrimination test does not apply to co-debtor claims [in virtue of the 23 However Clause] where the obligation is entered into for debtors’ benefit” (emphasis added). 24 In that case, the Court found that the obligation was entered into for the debtor’s benefit, and 25 consequently ruled that the unfair discrimination test was inapplicable to the co-signed debt. This 26 27 2 The decision in In re Martinez-Rivera (Godoy, Bankruptcy Judge) was appealed to the Bankruptcy 28 Appellate Panel for the First Circuit (“BAP”) on September 21, 2012. As of this date, the BAP has not ruled on the appeal. 5 1 || Court agrees with the decision in In re Martinez-Rivera. Just as the co-debtor stay does not apply 2 || to debts incurred for the benefit of the co-debtor under 11 U.S.C. § 1301(c)(1), favored treatment 3 || of a co-debtor claim is only available if the debtor --not the co-debtor-- was the one who benefitted 4 || from the loan. In re Janssen, 220 B.R. 639, 642 (Bankr. N.D. Iowa 1998). As explained in Spokane 5 || Ry. Credit Union v. Gonzales (In re Gonzales), 172 B.R. 320, 330 (E.D.Wash. 1994): 6 Underlying the assumption that a debtor will feel a great need to pay in full a co-signed debt between the debtor and a friend or relative is the additional assumption that the 7 co-debt benefitted the debtor, not the friend or relative. The obligation to repay arises because the friend or relative extended his or her credit to help the debtor acquire 8 credit. In return for the help, a debtor will feel a moral obligation to repay the loan in full to protect the co-signer. 9 However, the same is not true where the debtor extends his or her credit to help 10 the co-signer. No moral obligation exists to repay the loan since no help was given to the debtor. On the contrary, it was the debtor that helped the co-signer. Without the 11 moral obligation to repay the loan in full, irrespective of the plan, there is little chance this type of co-debt will impede completion of the plan. Therefore, no reason justifies 12 the classification of unsecured co-signed debt, acquired for the benefit of the co-signer, separately from other general unsecured debt. To do so would be unfair to the general 13 unsecured creditors. Accordingly, this court finds that Section 1322(b)(1) is limited to co-signed debt acquired for the benefit of the debtor, not the co-signer. 14 (Emphasis added.) 15 || Also see In re McKown, 227 B.R. at 492 (“debtor [must] establish that the co-signed obligations 16 || were incurred for her benefit as opposed to the benefit of the co-signer in order to separately classify 17 || co-signed debt”); In re Battista,180 B.R. 355, 358 (Bankr. D.N.H. 1995) (the debtor must establish 18 || that the co-signed claim falls within the Section 322(b)(1) exception and was incurred for debtor’s 19 || benefit as opposed to the benefit of the co-signer); Rethinking Unfair Discrimination in Chapter 13, 20 || 74 Am. Bankr. L.J. at 369. 21 || (B) ~= Student Loans Co-Signed by Debtors under Section 1322(b)(1): who do they benefit? 22 “There is neither legislative history nor clear congressional intent concerning the separate 23 || classification of student loan debts.” Seth J. Gerson, Separate Classification of Student Loans in 24 || Chapter 13, 73 Wash. U. L. Q. 269, 283 (1995). Caselaw has found, however, that student loans co- 25 || signed by debtors for their children generally benefit the children only, who would be ordinarily be 26 || expected to pay the obligations anyway. See In re Beauchamp, 283 B.R. 287, 289 (Bankr. D.Minn. 27 || 2002). “There is no legitimate purpose in allowing the debtors to pay the obligations of their 28 || children, who received the benefits of the loans, at the expense of the debtors’ other unsecured

1 creditors.” Id. at 289. Courts have also distinguished between student loan debts from general child 2 support obligations, which have been found to justify more favorable treatment than general 3 unsecured debts. For instance, in In re Scheiber, 129 B.R. 604, 606 (Bankr. D. Minn. 1991), the 4 Court reasoned as follows: 5 In [In re] Sotrberg, [94 B.R. 144, 147 (Bankr. D. Minn. 1988)], the strong public policy of ensuring the support of children was the major focus. The opinion cites to examples 6 of statutory special treatment for child support obligations. Public policy ensuring repayment of student loans is not as significant. In this case, the debtors argue “the 7 entire educational system in the United States hinges on student loan availability which in turn requires the repayment of student loans.” To the extent this is true, Congress 8 has remedied the situation by amending 11 U.S.C. § 1328. The fact that Congress amended Section 1328(a)(2) to except from discharge educational loans as specified 9 in 11 U.S.C. § 523(a)(8) indicates that Congress insists that debtors repay their student loans but this does not evidence a position as favored in public policy as are alimony 10 and child support payments. 11 The facts considered in In re Hamilton, 102 B.R. 498 (Bankr. W.D.Va. 1989), are similar to 12 the ones before this Court. The debtors in In re Hamilton separately classified in their Chapter 13 13 plan the educational loans for their children, which the debtors had co-signed, from the general 14 unsecured claims under 11 U.S.C. § 1322(b)(1). The debtors offered no evidence at the 15 confirmation hearing as to their reasons for requesting the separate classification of the co-signed 16 educational loans, although their counsel argued that the debtors’ desire was to protect their children 17 from the claims of these creditors by paying as much to the creditors as is possible. No evidence 18 was offered of an agreement between the debtors and the educational lenders that the proposed plan 19 payments would result in deferral of legal action against the children for collection of the balance 20 owed. Thus, the debtors proposed to pay 14% of the educational loans and approximately 5% of the 21 remaining unsecured claims. The debtors also claimed that their benefit in that proposed 22 classification was to protect their children from the claims of the educational lenders while they 23 finished their college education. The Hamilton Court ruled that the protection of one’s children 24 from claims of creditors who funded their higher education is not the type of legitimate interest of 25 the debtor that Congress intended to protect when they enacted the However Clause in 1984. 102 26 B.R. at 501. It further held that “the desire of parents to protect their children from the claims of 27 creditors for debts incurred solely for the benefit of the children does not, by itself, constitute a 28 legitimate interest of the debtor which should be protected by permitting discriminatory treatment 7 1 || under 11 U.S.C. § 1322(b)(1). Accordingly, the plan ... [could not] be confirmed under 11 U.S.C. 2 | § 1325.” Id. at 502. This Court adopts that same reasoning. 3 The Trustee has also brought to the attention of the Court the case of In re Lilley, 2010 4 || Bankr. LEXIS 4867, 2010 WL 5462519 (Bankr. N.D. Iowa 2010), where the debtor co-signed a 5 | student loan with his daughter. The debtor proposed to pay the student loan outside the Chapter 13 6 || plan under Section 1322(b)(1) over the general unsecured creditors. The Court held that the debtor’s 7 || plan could not separately classify and make payments outside of the plan on the co-signed unsecured 8 || student loan debt at a higher rate than the general unsecured creditors could receive under the plan. 9 || The Lilley Court followed the reasoning earlier discussed: “co-signed consumer debt under Section 10 || 1322(b)(1) is only eligible for separate classification and treatment when the co-debt was acquired 11 || for the benefit of the debtor.” 2010 Bankr. LEXIS 4867 at *5, 2010 WL 5462519 at *2, citing In 12 re Janssen, 220 B.R. at 642. Thus, the Court in that case determined that because the student loan 13 || co-signed by the debtor only benefitted his daughter, its proposed classification and treatment 14 || unfairly discriminated against other general unsecured creditors and therefore confirmation was 15 || denied’. 16 || (C) — Burden of Proof 17 “As a general rule, ... Chapter 13 requires equality of distribution among nonpriority 18 || unsecured creditors, and the burden of justification is on those who propose plans to the contrary.” 19 || Bentley v. Boyajian (In re Bentley), 266 B.R. 229, 240 (B.A.P. 1* Cir. 2001). The Debtors have not 20 || met that burden in the instant case. The Debtors’ only argument is a legal one: “Section 1322(b)(1) 21 || makes no distinction over who is the subject of the co-signed debt and that a Debtor may 22 || discriminate in favor of all co-signed debt without recourse to any unfair discrimination test. The 23 || plain language of the statute is unambiguous in that all categories (as opposed to some categories) 24 25 * In Lilley, the Court went one step further stating that “even if there was some theoretical benefit to the 76 || Debtor in co-signing the loan, and that it could fall under to co-signor provision of Section 1322(b)(1), the Debtor here still must satisfy the ... test [established in In re Leser, 939 F.2d 669, 671 (8" Cir.1991) to] show there was no 97 || ‘unfair’ discrimination”, 2010 Bankr, LEXIS 4867 at *6, 2010 WL 5462519 at *3. This Court declines to take that further step in the present case as its ruling that the “However Clause” of Section 1322(b)(1) is not applicable when 2g || the co-signed debt was not entered into for the debtor’s benefit is dispositive of the controversy before its consideration.

1 || of co-signed debt can be preferred in a Chapter 13 plan over other unsecured debt without the 2 || restraints of unfair discrimination tests.” Debtors’ Supplement to Brief (Docket No. 65, p. 2, 42). 3 || The Debtors have not made allegations that would move this Court to find that the co-signed student 4 }| loan with Citibank was for their benefit, or that there is a legitimate purpose for Citibank’s co-signed 5 || claims to be given a favorable classification at the expense of the general unsecured creditors. This 6 || Court concludes, as did the Court in In re Martinez-Rivera, that the co-signed debt exception (the 7 || “However Clause”) in Section 1322(b)(1) applies only when the loan was given for the debtor’s 8 || benefit. 9 Conclusion 10 For the reasons stated herein, the Trustee’s Objection to Plan Confirmation is hereby 11 || sustained and the Debtors’ Response thereto is hereby denied. Therefore, confirmation of the 12 || proposed Amended Plan IT (Docket No. 40) is hereby denied. 13 In San Juan, Puerto Rico, this 18" day of October , 2012. 14 SO ORDERED. 15 16 17 18 Atparguille 20 21 22 23 24 25 26 27 28