Are Bankruptcy Courts Loosening Standards for Student Loan Discharge?

       Student loan debt has now grown to over $1.5 trillion. Despite a relatively strong economy, more than 8 million borrowers are delinquent or are in default under their loans. Of particular concern to lenders is that these figures will only worsen if economists’ predictions for a slowing economy ring true. Lenders can no longer expect with certainty that a student loan will be virtually impossible to discharge.

The Brunner Test

        Section 523(a)(8) of the Bankruptcy code allows for the discharge of student loan debt if “excepting such debt from discharge … would impose an undue hardship on the debtor and the debtor’s dependents.…”[1] Although the term “undue hardship” is not defined by the Bankruptcy Code, the majority of courts have adopted the test set forth in Brunner v. New York State Higher Education Services Corp., 831 F.2d 395, 396 (2d Cir. 1987). To prove an undue hardship, the debtor must prove three elements: (1) that the debtor cannot maintain a minimal standard of living if forced to repay the loans; (2) that the current state of affairs is likely to persist for the majority of the repayment period; and (3) that the debtor has made a good-faith effort to repay the loan.[2]

       Although traditionally a very difficult standard to meet, two recent bankruptcy court decisions highlight a growing trend by bankruptcy courts to loosen restrictions limiting the discharge of student loan debt.

In re Metz, 589 B.R. 750 (Bankr. D. Kan. 2018)

       The debtor filed for chapter 13 bankruptcy protection.[3] It was the debtor’s third chapter 13 filing, having previously received a chapter 7 discharge (case was converted after filing) and chapter 13 discharge in her prior bankruptcies.[4] Approximately 20 years prior to the current bankruptcy filing, the debtor attended community college and incurred student loan debt in the amount of $16,613.73.[5] By the time the debtor filed her third bankruptcy, the student loan debt had ballooned to $67,277.88, and the debtor sought to have the student loan debt discharged pursuant to § 523(a)(8).[6]

       Applying the Brunner test, the court focused on the first prong: whether the debtor could maintain a minimal standard of living if forced to repay the debt.[7] The debtor was enjoying a standard of living above the bare minimum, which included regularly eating out, buying alcohol and cigarettes, and gambling at a nearby casino.[8] Despite this, the court found that the debtor could not maintain a minimal standard of living if forced to repay her student loans.[9] First, the court considered whether the debtor could make monthly payments in the amount of $564.60 that would allow for the complete repayment of the loan.[10] The court found that payments in that amount were simply not feasible given the debtor’s current financial condition.[11] Second, the court examined whether the debtor could enter into an income-based repayment plan.[12] Under this plan, the debtor would be required to pay $203 per month to service the loan, with the reaming balance being forgiven after 25 years of payments.[13] Despite the fact that the debtor could afford these payments in the amount of $203 per month and still maintain a minimal standard of living, the court still found that the debtor had met her burden and satisfied the first prong of the Brunner test.[14] The court stated that the debtor should be able to reduce the debt, not simply service it, and found that the continuing accrual of interest and the tax implications caused by the forgiveness of debt would not provide the debtor with a fresh start.[15] The bankruptcy court, in a compromise, discharged the interest portion of the debt and instructed the debtor to repay the remaining principal balance over a period of 5-10 years.[16]

In re Pierson, No. 17-31687, 2018 WL 4849658 (Bankr. N.D. Ohio Oct. 4, 2018)

       The debtor, who suffered from learning disabilities that caused him to struggle to read and write, sought to discharge student loan debt in the amount of $15,053.06 through a chapter 7 bankruptcy.[17] Although the debtor had previously earned as much as $36,000 per year while working in property management in California, his current income totaled only $215 per week (after taxes).[18] Together with his wife, the couple had a household income of approximately $1,161 per month.[19] The debtor and his wife lived in a mobile home that had been purchased for $1.00 and that had no functioning furnace or stove.[20]

       In analyzing the first prong under the Brunner test, the court found that the debtor could not make payments on his student loans and maintain a minimal standard of living.[21] The lender questioned how it was possible that the student loans could be an undue burden on the debtor when he was currently eligible for a repayment plan that would require monthly payments of $0.[22] The court rejected the lender’s argument under similar reasoning as in the Metz case — i.e., that the accruing interest and tax liability at the conclusion of a 25-year payment plan would impose an undue hardship on the debtor.[23] The court further stated “that qualifying for a zero repayment amount ‘certainly indicates difficult financial conditions for an individual debtor’ and that ‘accepting the concept of a zero payment as constituting repayment effectively eliminates the hardship discharge provision for student loans for those most likely to be entitled to it.’”[24] Notwithstanding the debtor’s zero-dollar monthly payment, the court found that the debtor had proven an undue hardship and therefore discharged the entire student loan balance.

Conclusion

These two recent cases present a number of important takeaways for lenders as the number of borrower defaults continues to rise:

1. Debtor participation in an income-based repayment plan does not always provide the debtor with a fresh start. Courts may want to see a reduction in the overall debt, not just an ability to service a nominal monthly payment.
2. As evidenced by the Metz case, a debtor is not always required to live a life of destitution in order to discharge student loan debt.
3. Courts do not always see discharge of student loan debt as an all-or-nothing proposition and may be willing to discharge a portion of the loan balance.
4. In determining whether an undue hardship exists, courts not only consider current monthly payments, but also potential tax consequences caused from loan forgiveness, sometimes 25 years in the future.