Functionally Illiterate, Disabled Debtor Succeeds in Discharging Student Loans

Building on existing Sixth Circuit authority, Bankruptcy Judge Mary Ann Whipple of Toledo, Ohio, held that eligibility for an income-based repayment program does not preclude an indigent debtor from discharging student loans.

Judge Whipple’s October 4 opinion is a template for any judge tasked with discharging student loans owed by a debtor living below the poverty line. She analyzes and rejects most of the arguments a lender could make under similar circumstances.

Functionally illiterate, the debtor suffered from bipolar disorder and had spent part of his life living out of a car. Employed part time, he earned about $14,000 a year, which Judge Whipple described as “living in poverty.” Married with a teenage step daughter, the debtor lived in a mobile home lacking a furnace and operable stove. His wife earned about $230 a month cleaning houses.

In prior years, the debtor made some payments toward the $15,000 in student loans he incurred in 1996-1997 while studying car mechanics. He did not graduate and did not work as a mechanic.

Currently, the 47-year-old debtor was eligible for an income-based repayment program where he would not be required to make payments toward the student loans given his low income. Assuming his income were not to rise, the loans would be forgiven in about 22 years, but the forgiveness might become taxable income.

Judge Whipple analyzed the debtor’s circumstances under the so-called Brunner test adopted in the Sixth Circuit. In 2007, the Sixth Circuit had held that a debtor’s failure to apply for an income-based repayment program did not constitute a prima facie showing of bad faith resulting in failure under the third prong of the three-part Brunner test. Barrett v. Educational Credit Management Corp., 487 F.3d 353 (6th Cir. 2007).

So, the lender took a different tack in opposing the debtor’s adversary proceeding to declare that his student loans imposed an “undue hardship” and were dischargeable under Section 523(a)(8).

Brunner’s first test inquires as to whether the debtor can maintain a “minimal” standard of living if required to repay the student loans. Because the debtor could pay nothing under an income-based repayment program, the lender contended under the first prong of Brunner that the student loans imposed no undue hardship because no payment was required.

Judge Whipple observed that the repayment program is “neither automatic nor permanent.” It requires continual reapplication, which could be beyond the capacity of some debtors. If eligibility for the program precluded the discharge of student loans, she said that “the hardship discharge provision for student loans would be effectively eliminated for those most likely to be entitled to it.”

Citing cases coming down on both sides of the issue, Judge Whipple concluded that the debtor satisfied the first prong of the Brunner test, even though he was eligible to pay nothing.

On the second and third prongs, the lender argued that the debtor should move to another town in pursuit of higher income. Judge Whipple rejected the argument, noting the debtor’s statement that he would lose his wife if he moved. Moreover, his support system was in Toledo, where he lived.

Judge Whipple concluded that the debtor was “not acting unreasonably or unfairly to his student loan holder by continuing to make and try to build a life in Toledo.”

The debtor had shown good faith by having made some payments on the loans, although the payments were never enough to reduce principal, Judge Whipple said. Even if he were to obtain a second part-time job, his poverty would continue because the increased income would end his eligibility for food stamps and leave him with no more net disposable income.

Deciding to discharge the student loans, Judge Whipple found an additional basis for finding good faith. The student loans were not the precipitating factor in the debtor’s decision to file bankruptcy. He had been saddled with an $8,000 judgment in favor of a former landlord who was garnishing his wages.

Judge Whipple therefore found that the debtor met the second and third parts of the Brunner test, requiring a showing of a good faith attempt to repay the student loans and a demonstration that his impecunious circumstances were likely to persist.

Observation: We indeed have a curious system when a judge is compelled to conduct a trial and write a 13-page opinion to justify discharging student loans owed by an individual who is functionally disabled and living well below the poverty line. (The observation is the writer’s opinion and does not represent the policy or opinion of ABI.)