Student Loan Debt Discharged in Bankruptcy
In a highly publicized decision, a New York bankruptcy court ruled that a debtor’s $221,385 student loan debt could be discharged in his Chapter 7 bankruptcy case under Section 523(a)(8) of the Bankruptcy Code. Under that section, most student loan debts cannot be discharged unless the debtor proves that payment of the loan imposes an “undue hardship.”
To establish undue hardship, the debtor is required to meet the Brunner test, which the U.S. Court of Appeals for the Second Circuit established in 1987. Under the Brunner test, the debtor must demonstrate the following standards:
(1) That the debtor is unable to meet, based on the debtor’s current income and expenses, a “minimal standard of living” for the debtor and dependents if forced to repay the loan;
(2) That the debtor likely will be unable to repay the loan for a significant portion of the repayment period; and
(3) That the debtor has made a good faith effort to repay the loan.
The U.S. Court of Appeals for the Fourth Circuit, which covers Maryland, has adopted the Brunner test.
In the New York case, the debtor received a law degree in 2004 but was not practicing law at the time of his bankruptcy. Prior to law school, the debtor served in the military for five years. The original principal amount of his student loan was $116,475 and the debtor had a history of making payments on the loan. At the time of bankruptcy, the debtor’s income was $37,635 and he had a monthly net income of a negative $1,549. The student loan went into default and was accelerated before bankruptcy was filed.
While acknowledging that the Brunner test was binding, the judge noted that some have criticized Brunner for creating “too high a burden” for a debtor to meet and that the courts’ application of the test has produced “harsh results.” She attributed this trend to the courts’ misapplication of the test and stated that she would not “participate in perpetuating these myths.”
Her ruling based on the Brunner test is as follows:
(1) As to the test’s first prong, the court found that the debtor would not be able to pay the accelerated amount of $221,385 from his current income and maintain a minimal standard of living.
(2) As to its second prong, the court rejected the lender’s argument that the test cannot be met by a debtor who created his financial condition by choice. Rather, this prong only requires a court to determine if the debtor’s current state is likely to continue for a significant portion of the payment period of the loan. Since the loan had been accelerated and was due immediately, the court found that the second prong was met.
(3) As to its third prong, the court found that the debtor’s payment history showed that he had made “good faith efforts” to repay the loan.
Practice Pointer: This decision has been appealed. Ironically, the lender’s prebankruptcy acceleration of the loan appears to have helped the debtor. It is unknown whether other courts will similarly reward a debtor whose loan was accelerated before bankruptcy. While the problem of mounting student loan debt has received a great deal of attention in the media and political arena, courts remain limited in their ability to discharge a student loan by the “undue hardship” standard of Section 523(a)(8), regardless of how it is interpreted.
Please contact Lawrence D. Coppel for further information concerning this topic.