There are two and perhaps three tests among the circuit courts for deciding when the repayment of a student loan amounts to an “undue hardship,” enabling the court to discharge the debt under Section 523(a)(8).
Discharging a student loan is conceivable under the Eighth Circuit’s somewhat lenient “totality of the circumstances” test. In the majority of circuits employing the so-called Brunner test, discharging a student loan is exceedingly difficult. Although professing to follow Brunner, the Fifth Circuit’s new test means that student loans are essentially impossible to discharge.
Decisions in late July by the Fifth Circuit and the First Circuit Bankruptcy Appellate Panel underscore the need for the Supreme Court to grant certiorari and resolve the circuit split.
The Three Tests
The Brunner test emanated from the Second Circuit in 1987, 18 years before Congress adopted the current iteration of Section 523(a)(8). Brunner v. New York State Higher Education Service Corp., 831 F.2d 395 (2d Cir. 1987).
To discharge a student loan under Brunner, the debtor must prove that (1) she cannot maintain a “minimal standard of living” if forced to repay the loan, (2) additional circumstances show that the state of affairs is likely to persist for a significant portion of the repayment period, and (3) the debtor has made a good faith effort to repay the loans. Brunner is followed in the Second, Third, Fourth, Fifth, Sixth, Seventh, Ninth and Eleventh Circuits.
Standing alone, the Eighth Circuit developed the so-called totality of the circumstances test, where the court must consider (1) the debtor’s future financial condition, (2) the debtor’s and dependents’ reasonable and necessary living expenses, and (3) “other relevant facts and circumstances surrounding each particular bankruptcy case.” Long v. Educ. Credit Mgmt. Corp. (In re Long), 322 F.3d 549, 554 (8th Cir. 2003). Rejecting Brunner, the Eighth Circuit said it preferred a “less restrictive approach.” Id.
Although professing to follow Brunner, the Fifth Circuit seemed to tighten its already higher standard by ruling on July 30 that a debtor may not discharge a student loan unless “repayment would impose intolerable difficulties on the debtor.” Thomas v. Department of Education (In re Thomas), 18-11091, 2019 BL 282170, 2019 US App Lexis 22584 (5th Cir. July 30, 2019). To read ABI’s discussion of Thomas, click here.
If nothing more, the Supreme Court should grant certiorari to decide whether the Fifth Circuit’s requirement of showing “intolerable difficulties” is tougher than the “undue hardship” standard in the statute.
The Facts in the First Circuit BAP
The First Circuit has not definitively decided whether to follow Brunner or the “totality of the circumstances” test. However, most of the bankruptcy judges in the First Circuit and the circuit’s BAP employ Long from the Eighth Circuit. Although invoking Long, a bankruptcy court in Massachusetts refused to discharge student loans owned by a debtor who was virtually destitute in terms of current income.
The debtor was in her mid-60s and lived alone in a home she purchased in 1998. She provided some support for her adopted child who was in his early 20s and attending college.
The debtor earned an undergraduate degree in 1997 and enrolled later in law school, emerging with a JD degree in 2009. In the process, she amassed $110,000 in student loans. Although she passed the bar and sought a law job for two years, she received no offers of employment and only had one interview after filing 100 job applications.
Suffering from a long list of medical ailments, she worked only sporadically as a solo practitioner and for a not-for-profit legal clinic where she earned minimal income. In three years before attempting to discharge the student loans, her annual income was no greater than $14,800.
More recently, her monthly income was less than $1,500 and her monthly expenses resulted in a deficit of $76 a month.
But here’s the kicker: The debtor estimated that she had an equity of $125,000 in her home. The home was encumbered by a $59,000 mortgage.
The debtor claimed an exemption in the home. No one objected. The maximum homestead exemption in Massachusetts is $500,000, meaning that her exemption was one-quarter of what the state allows.
Although finding that the debtor lived “a spartan lifestyle not susceptible to further expense reduction,” the bankruptcy court refused to discharge the student loans. According to the BAP, the bankruptcy judge said that the equity in the home by itself was “dispositive” and “negates any claim that payment of the loan imposes an undue hardship.”
While the bankruptcy court did not require the debtor to sell the home, the bankruptcy judge said that the “substantial equity . . . can be used to pay these student loans in full.”
The Remand by the BAP
The debtor appealed and won a remand in a July 26 opinion for the BAP written by Bankruptcy Judge Diane Finkle.
Judge Finkle emphasized two factor: Section 522(c) and Law v. Siegel, 571 U.S. 415 (2014). Section 522(c) says that exempt property “is not liable during or after the case for any debt of the debtor that arose . . . before the commencement of the case.” Law v. Segal teaches that the court may not employ equitable considerations to override a debtor’s statutory homestead exemption.
Judge Finkle therefore held that the debtor’s “home equity is protected from liability for her student loans.” She went on to say that Section 522(c)(3) does not permit invading an exempt asset to repay a student loan unless the loan was obtained through fraud.
Turning to Long, Judge Finkle said that the existence of exempt assets is not one of the factors in the “totality” test. By relying solely on the home equity, she said that the bankruptcy court “sidestepped the necessary evaluation of whether in the foreseeable future [the debtor] could increase her income and pay” part of all of the loans.
Judge Finkle ruled that the bankruptcy court committed error by overlooking the policy articulated in Law v. Segal and by “not fully evaluating other relevant factors” such as the debtor’s future earning capacity and the impact of her health “on her future financial prospects.”
Judge Finkle remanded the case for the bankruptcy judge to make the findings outlined in her opinion for the BAP. Unless facts come to light not evident from the BAP decision, the debtor would seem to be eligible in the First Circuit to discharge her student loans on remand.
However, the same debtor would not seem eligible to discharge the loans in the Fifth Circuit under the new Thomas standard.
The Need for High Court Review
Except in the Eighth Circuit, discharging student loans is exceptionally difficult. In the Fifth Circuit after Thomas, it appears that a debtor must be both disabled and unemployable to discharge student loans.
At a minimum, the Supreme Court should decide whether Brunner or the Eighth Circuit’s “totality” test is proper. More fundamentally, the high court should decide whether all of the circuits have adopted standards that are higher than the statutory standard of “undue hardship.” In other words, the Supreme Court needs to specify the degree of hardship a debtor is required to endure before discharging student loans.
There are two and perhaps three tests among the circuit courts for deciding when the repayment of a student loan amounts to an “undue hardship,” enabling the court to discharge the debt under Section 523(a)(8).
Discharging a student loan is conceivable under the Eighth Circuit’s somewhat lenient “totality of the circumstances” test. In the majority of circuits employing the so-called Brunner test, discharging a student loan is exceedingly difficult. Although professing to follow Brunner, the Fifth Circuit’s new test means that student loans are essentially impossible to discharge.
Decisions in late July by the Fifth Circuit and the First Circuit Bankruptcy Appellate Panel underscore the need for the Supreme Court to grant certiorari and resolve the circuit split.