District Court Upholds Discharge of a Portion of Student Loan Debt

A district judge in Kansas upheld a decision handed down last year by Bankruptcy Judge Robert E. Nugent of Wichita, Kan., who ruled that a bankruptcy court has authority to discharge interest on a student loan while leaving the principal intact.

In his May 2 opinion, District Judge John W. Broomes also held that a discharge under Section 523(a)(8) is not an “all or nothing” proposition. If the court decides that payment of part of a student loan results in undue hardship, the judge is not required to discharge the entire loan.

The debtor was a 59-year-old single woman with no dependents. Her gross annual income had ranged between $40,000 and $43,000, with little chance of substantial increase. Judge Nugent found that her standard of living was “spartan.”

The debtor presented an attractive case for discharging student loans. She had borrowed about $16,000 between 1989 and 1991 to attend college for two years. She had paid about $14,000 toward the loans, almost all in a succession of three chapter 13 cases. Because her payments did not cover interest, the outstanding balance had grown to more than $67,000.

Having completed payments in her most third and most recent chapter 13 plan, the debtor sought to discharge the student loans under Section 523(a)(8).

Under three payment plans offered by the government, the only one she could afford was the smallest at $203 a month. If she made all the payments over the succeeding 25 years, Judge Nugent calculated that she would have ended up at age 84 owing more than $152,000, because $203 a month would be $301 a month short of paying current interest. If the remainder were forgiven at the end of the repayment program, she faced the possibility of incurring a nondischargeable tax liability for forgiveness of indebtedness income.

On the other hand, Judge Nugent calculated that she could pay off the $16,000 principal balance in about 10 years if she were to pay $203 a month.

Judge Nugent therefore ruled that everything in excess of the $16,000 principal balance would be discharged.

Both sides appealed. The lender argued that the debtor failed the so-called Brunner test and was not entitled to discharge anything. The debtor contended that the bankruptcy court should have discharged the entire debt, arguing that the statute does not permit a partial discharge if the court finds an undue hardship.

The issues were well presented on appeal. The National Association of Bankruptcy Attorneys, the National Consumer Bankruptcy Rights Center, and the National Consumer Law Center submitted an amicus brief authored by Jill A. Michaux, William R. Fossey, and Tara Twomey. District Judge Broomes overruled the lender’s opposition to the filing of the amicus brief.

Judge Broomes affirmed Judge Nugent right down the line. He began by explaining how the Tenth Circuit had adopted Brunner and its three-prong test. Brunner v. New York State Higher Education Services Corp., 831 F.2d 395, 396 (2d Cir. 1987). Nonetheless, he said the Tenth Circuit had “cautioned” that the test “must not be applied such that debtors who truly cannot afford to pay their loans may have their loans discharged,” quoting Education Credit Management Corp. v. Polleys, 356 F.3d 1302, 1309 (10th Cir. 2004).

On the first test — whether the debtor can maintain a minimal standard of living while repaying the debt — Judge Broomes cited Judge Nugent’s finding that the debtor could only afford about $200 a month.

Because the debtor could pay something, the lender contended that the debtor failed the first test, making the entire loan nondischargeable. Judge Broomes disagreed. He cited the Tenth Circuit for holding that a debtor is not required to participate in one of the repayment programs to qualify for discharge. That, he said, is considered to be part of the good faith test.

Judge Broomes said that the lender had failed to make a “colorable argument that [the debtor] could ever truly repay her loan.” He ruled that the debtor had therefore satisfied the first test, because participating in one of the repayment programs “would thwart the fresh start policy.”

The second test asks whether the debtor’s circumstances are likely to persist. Judge Broomes upheld Judge Nugent’s finding that her financial condition was “likely to persist.”

The third test deals with the debtor’s good faith. On that topic, Judge Broomes upheld Judge Nugent’s finding that the debtor had made a good faith effort to repay her loans.

Finally, Judge Broomes turned to the debtor’s cross appeal, where she contended the court must discharge the entire loan once the debtor proves that paying the entire debt is impossible. The debtor cited Skaggs v. Great Lakes Higher Education Corp. (In re Skaggs), 196 B.R. 865, 866-67 (Bankr. W.D. Okla. 1996), for the notion that discharging student loans is an all-or-nothing proposition under Section 523(a)(8).

According to Judge Broomes, the Tenth Circuit rejected the all-or-nothing approach in dicta, as do the “majority of courts.” Requiring courts to discharge student loans entirely, he said, would run counter to the bankruptcy court’s equitable authority to enforce bankruptcy laws.

Judge Broomes therefore ruled that the bankruptcy court has “equitable powers . . . to grant a partial discharge of student loan debt upon a finding of undue hardship.”

Question: Where is the power in the statute allowing the bankruptcy court to impose a payment program on a lender long after the plan expires?

Answer: The bankruptcy court could tell the lender, “Agree to accept $203 a month without interest, or I will discharge the entire debt.”

Observation: Creative uses of equitable powers, such as this, strike this writer as similar to the development of asbestos channeling injunctions before the adoption of Section 524(g).