DISCHARGING STUDENT LOANS

Student loan debt can be discharged in bankruptcy under certain circumstances.

Bankruptcy Code section 523(a)(8)(B) prohibits discharge of certain educational loans except in cases where prohibiting the discharge would impose “undue hardship” on the debtor.  Specifically, Bankruptcy Code section 523(a)(8) provides:

(a) A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title [11 USCS § 727, 1141, 1228(a), 1228(b), or 1328(b)] does not discharge an individual debtor from any debt–

   (8) unless excepting such debt from discharge under this paragraph would impose an undue hardship on the debtor and the debtor’s dependents, for–
      (A) (i) an educational benefit overpayment or loan made, insured, or guaranteed by a governmental unit, or made under any program funded in whole or in part by a governmental unit or nonprofit institution; or
         (ii) an obligation to repay funds received as an educational benefit, scholarship, or stipend; or
      (B) any other educational loan that is a qualified education loan, as defined in section 221(d)(1) of the Internal Revenue Code of 1986 [26 USCS § 221(d)(1)], incurred by a debtor who is an individual;

  1. U.S.C. § 523(a)(8).

Legislative Purpose Behind the Enactment of § 523(a)(8)(B)

The government has established an educational loan program that attempts to provide educational opportunities to as many students as possible.  The entire system is designed so that those students borrowing money today will pay back the borrowed funds to permit future students to have access to such fund.  Congress enacted 11 U.S.C. § 523(a)(8)(B) ultimately to protect this system. 

In re Kuznicki, Bankr. No. 11-20563-BM, Adv. No. 11-02076-BM, 2012 Bankr. LEXIS 605 at *4-5 (Bankr. W.D. Pa. February 21, 2012).  In other words, the enactment of section 523(a)(8)(B) “was an attempt to satisfy the twin goals of rescuing the student loan program and preventing abuse of the bankruptcy process by undeserving debtors.”  Id. citing In re Faish, 72 F.3d 298, 302 (3rd Cir. 1995).

The Brunner Test

In determining when the “undue hardship” exception has been satisfied and when educational loans should be discharged, the Third Circuit has adopted the test set forth in the second circuit decision, In re BrunnerSee In re Faish, 72 F.3d 298, 306 (3rd Cir. 1995) (“We therefore hold that the Brunner “undue hardship” test must now be applied by bankruptcy courts within the Third Circuit.”). 

The Brunner test for undue hardship involves three prongs that must each be satisfied by the debtor in order to prove “undue hardship” for purposes of the exception.  The debtor bears the burden of proof with regard to each prong of the test by a preponderance of the evidence.  The three prongs of the Brunner test are as follows:

(1) that the debtor cannot maintain, based on current income and expenses, a “minimal” standard of living for herself and her dependents if forced to repay the loans; (2) that additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period for student loans; and (3) that the debtor has made good faith efforts to repay the loans.

In re Kuznicki, Bankr. No. 11-20563-BM, Adv. No. 11-02076-BM, 2012 Bankr. LEXIS 605 at *6 (Bankr. W.D. Pa. February 21, 2012) (internal citations omitted);  See also In re Faish, 72 F.3d 298, 306 (3rd Cir. 1995) (If one of the requirements of the Brunner test is not met, the bankruptcy court’s inquiry must end there, with a finding of no dischargeability.”) (internal citations omitted).

“The ‘undue hardship’ exception provided for by Congress is a narrow exception and is only to be granted in the exceptional case to the deserving and honest debtor.”  In re Kuznicki, Bankr. No. 11-20563-BM, Adv. No. 11-02076-BM, 2012 Bankr. LEXIS 605 at *13 (Bankr. W.D. Pa. February 21, 2012).  “Equitable concerns or other extraneous factors not contemplated by the Brunner framework may not be imported into the court’s analysis to support a finding of dischargeability.”  In re Faish, 72 F.3d 298, 306 (3rd Cir. 1995);  See also In re Kuznicki, Bankr. No. 11-20563-BM, Adv. No. 11-02076-BM, 2012 Bankr. LEXIS 605 at *13 (Bankr. W.D. Pa. February 21, 2012) (“[T]he Brunner test explicitly excludes considerations of extraneous factors and equitable considerations.”).

First Prong – That the Debtor Cannot Maintain, Based on Current Income and Expenses, a “Minimal” Standard of Living for Herself and Her Dependents if Forced to Repay the Loans

The first prong of the Brunner test requires the debtor to prove by a preponderance of the evidence that he/she cannot maintain, based on current income and expenses, a minimal standard of living for himself/herself and his/her dependents if forced to repay the loans.  This “requires an examination of the debtor’s current financial condition to see if payment of the loans would cause his standard of living to fall below that minimally necessary.”  In re Roberson, 999 F.2d 1132, 1135 (7th Cir. 1993).

A minimal standard of living requires more than a showing of tight finances.  The “minimal” standard of living does not require the debtor to live in a state of poverty.  The upper limits of the standard permit the debtor to purchase basic necessities such as food, clothing, housing, and medical treatment.  However, it does not allow for “luxury-type expenses”.  Once the debtor has provided for his basic necessities, excess financial resources should be used to satisfy student loan debt in lieu of discretionary expenditures.  We agree with other courts that “basic needs” include more than just those necessities stated above.  A minimal standard of living includes transportation expenses, food and hygiene expenses, as well as modest recreation expenses.  Also the first prong will not be deemed satisfied if proof that a little “belt-tightening” on the debtor’ part would have resulted in an ability to repay the loans.

In re Kuznicki, Bankr. No. 11-20563-BM, Adv. No. 11-02076-BM, 2012 Bankr. LEXIS 605 at *7-9 (Bankr. W.D. Pa. February 21, 2012) (internal citations omitted); Cf. Matthews v. Pineo, 19 F.3d 121, 124 (3rd Cir.  1994) (NHSC scholarship recipient’s “current income and … expenses should [not] be regarded as unalterable.  Instead, the property inquiry is whether it would be ‘unconscionable’ to require [the debtor] to take any available steps to earn more income or to reduce her expenses.”).

Second Prong – That Additional Circumstances Exist Indicating That This State of Affairs is Likely to Persist for a Significant Portion of the Repayment Period for Student Loans

The second prong of the Brunner test requires the debtor to prove by a preponderance of the evidence that he/she will be unable to maintain a minimal standard of living given the additional circumstances that will continue to exist through the loan repayment period.  The standard for this prong has been deemed quite high.  It is not enough to prove current financial difficulties, rather the debtor must prove a total incapacity in the future to pay her debts for reasons not within her control. 

In re Kuznicki, Bankr. No. 11-20563-BM, Adv. No. 11-02076-BM, 2012 Bankr. LEXIS 605 at *10-11 (Bankr. W.D. Pa. February 21, 2012) (internal citations omitted).  As the Second Circuit explained in Brunner, “[r]equiring evidence not only of current inability to pay but also of additional, exceptional circumstances, strongly suggestive of continuing inability to repay over an extended period of time, more reliably guarantees that the hardship presented is ‘undue.’”  In re Brunner, 831 F.2d 395, 396 (2nd Cir. 1987);  See also In re Roberson, 999 F.2d 1132, 1135 (7th Cir. 1993) (explaining that the second prong “properly recognizes the potential continuing benefit of an education, and imputes to the meaning of ‘undue hardship’ a requirement that the debtor show his dire financial condition is likely to exists for a significant portion of the repayment period.”).

Third Prong – That the Debtor has Made Good Faith Efforts to Repay the Loans

The third prong of the Brunner test requires that the Debtor show [by a preponderance of the evidence] that he has made good faith efforts to repay his loan… The Third Circuit has traditionally looked to two considerations to determine the satisfaction of this prong.  Courts have considered whether the Debtor incurred substantial expenses beyond those of basic necessities and whether the Debtor made efforts to restructure his loan before filing his petition in bankruptcy.

In re Kuznicki, Bankr. No. 11-20563-BM, Adv. No. 11-02076-BM, 2012 Bankr. LEXIS 605 at *12 (Bankr. W.D. Pa. February 21, 2012) (internal citations omitted).  “The good faith inquiry is to be guided by the understanding that undue hardship encompasses a notion that the debtor may not willfully or negligently cause his own default, but rather his condition must result from factors beyond his reasonable control.” In re Faish, 72 F.3d 298, 305 (3rd Cir. 1995) (internal quotations and citations omitted).

In Pellicia, the Third Circuit held that:

[A] court inquiring whether a debtor has made a good faith effort to repay a student loan must consider the following factors: (1) whether the debtor incurred substantial expenses beyond those required to pay for basic necessities and (2) whether the debtor made efforts to restructure his loan before filing his petition in bankruptcy.

Pelliccia v. United States Dep’t of Educ., 67 Fed. Appx. 88, 91 (3d Cir. Pa. 2003). 

The Court went on to explain that:

[A] debtor seeking to discharge a student loan obligation on the ground that barring him from doing so would result in undue hardship must prove that he or she made good faith efforts to repay the loan over the entire time period between the date on which the first loan payment became due and the date on which the debtor filed for bankruptcy.

Pelliccia v. United States Dep’t of Educ., 67 Fed. Appx. 88, 90 (3d Cir. Pa. 2003).

Devos v. Price – A Case Study

The issue on appeal addressed in Devos v. Price centers around the second prong of the Brunner test – whether the debtor’s inability to maintain a minimal standard of living is likely to continue, and to exists for a significant portion of the repayment period. 

By way of background, the debtor filed a chapter 7 in the Eastern District of Pennsylvania in 2015, and thereafter pursued an adversary action against the United States Department of Education seeking to discharge her student loans.  The debtor had five (5) years remaining on her student loan repayment contract.  In the adversary, the debtor presented evidence that she: (i) has negative monthly disposable income; (ii) has a bachelor’s degree in Radiological Science; (iii) works part-time as a vascular sonographer for Main Line Health; (iv) is separated from her husband; (v) receives certain voluntary support from her husband, including health insurance through her husband’s employer; (vi) has three children living with her full time, two of whom are not yet of school age and require childcare while she works.

The Department of Education conceded that the first and third prongs of the Brunner test were met. And, the Bankruptcy Court ultimately held that the debtor met her burden of satisfying the second prong of Brunner – the debtor’s inability to maintain a minimal standard of living is likely to continue, and to exists for a significant portion of the repayment period. 

The following three (3) facts served as the basis for both the Bankruptcy Court’s ruling and the District Court’s reversal on appeal:

  • The debtor’s unintended and involuntary underemployment – The debtor testified that the vascular sonography employment market is currently saturated, and full-time sonographers at Main Line Health are not set to retire for eight (8) years.

The District Court held that the debtor’s testimony was not enough to prove that her current employment circumstances were likely to persist.  The debtor did not offer any expert testimony on the level of saturation in the market, or the likelihood that it would persist.  The debtor also did not offer any details about the type and number of positions she applied, where she applied or when she applied.

  • The debtor’s childcare squeeze – The debtor testified that she would not be able to significantly improve her financial situation by finding additional hours of employment in another field, because any additional income earned would be offset by the additional childcare expenses she would incur.

The District Court held that the debtor failed to prove that her childcare squeeze would persist for five (5) years, because in 2019 all three (3) of her children would be in full time public school and her childcare costs would then diminish significantly.

  • The debtor’s likely divorce – The debtor argued that her likely divorce would hurt her financial situation, not improve it, as she may no longer receive voluntary support from her estranged husband, including health insurance coverage.

The District Court held that the debtor failed to offer sufficient evidence to prove the foregoing.

Rosenberg v. N.Y. State Higher Educ. Serv. Corp. – A Case Study

In Rosenberg v. N.Y. State Higher Educ. Serv. Corp., the Bankruptcy Court held that a debtor’s schedules showing negative income each month satisfied the first prong of Brunner –  that the debtor cannot maintain, based on current income and expenses, a “minimal” standard of living for herself and her Dependents if forced to repay the loans.

The Court also held that where the repayment period had ended, and the loan was accelerated and due and payable in its full amount of $221,385.49, the debtor satisfied the second prong of Brunner – that additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period for student loans.

The Court also held that a Court should only consider the debtor’s past (i.e. prepetition) behavior in repaying the loans in determining satisfaction of the third prong of Brunner – that the debtor has made good faith efforts to repay the loans

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