Bankruptcy: Dischargeability of Student Loans

     In recent posts I reviewed the first case examining the application of Bankruptcy Code §523(a)(8) concerning the dischargeability of student loans.

     The second case is Jones v. National Payment Center, which was heard by the United States Bankruptcy Court in Richmond. In Jones the Court held that the debtor had the ability to repay $13,000 of her $16,000 in student loans, and $3,000 was thus determined to be dischargeable in bankruptcy under Bankruptcy Code §523(a)(8)(b), because of the “undue hardship” arising from debtor’s medical condition of chronic fatigue. This was the Court’s second decision in this case - the first decision in favor of full discharge was overturned on the creditor’s appeal. In this remanded trial, the creditor argued that all of the debt was non-dischargeable. However, the Court allowed a partial discharge.

     The Court ruled that simply because the debtor earned a higher wage ($5 per hour more than at the time of the Court’s earlier opinion), and had a higher net income than she did when she first came before the Court, did not mean that she was not entitled to a partial hardship discharge. While it was true that she had over $700 left over each month after paying for necessary expenses, the Bankruptcy Court found that this was largely due to the fact that she was dependent at that time upon her parents. In considering whether a debtor could maintain a minimal standard of living based on current income and expenses, courts differ as to how they treat the fact that a debtor relies on parental support. The Court found that it would be inappropriate to treat all of the savings the debtor realized by living with her parents as available to pay her student loan debt. The debtor testified that she planned to move out of her parents’ home sometime in the coming year, at which time her expenses would increase drastically. More of her net income would be needed to maintain a minimal standard of living as her parents would no longer be providing her with shelter and transportation. The Court found that there was no reason not to consider these facts in the minimal standard of living calculus.

     The Court ruled that to hold the debtor’s student loan nondischargeable would penalize her for simply doing the best she could under the circumstances. The debtor’s parents were retired and on a fixed income and they could not support her indefinitely. It was therefore prudent for the debtor to build her savings and prepare for the day when she would no longer be able to live with her parents.

     The Bankruptcy Court allowed the debtor to continue building her savings so that she would become self-sufficient by discharging all but $13,000 of her student loans and giving her approximately six years to repay this amount with interest on the unpaid balance of 8.25 percent.

     The third case is Commonwealth of Va., State Educ. Assistance Auth. v. Gibson. In Gibson the Court ruled that under Bankruptcy Code §523(a)(8)(A), a student loan is not dischargeable in bankruptcy unless the loan became due more than seven years (exclusive of any applicable suspension of the repayment period) before the date of the filing of the petition. Therefore, the seven-year nondischargeability period is calculated by determining the amount of time between the date the loan became due and the date the borrower filed bankruptcy, then subtracting the amount of time during which any "applicable suspension" periods were in effect.

     In Gibson the debtor filed her current Chapter 13, slightly more than seven years after the loan became due. However, during the debtor's previous Chapter 7 bankruptcy, an automatic stay was in effect and prevented the Commonwealth from taking any action to collect the student loan, and the debtor did not make any payments on the loan during the period. The Court held that the previous automatic stay was an "applicable suspension of the repayment period" that tolled the nondischargeability period. Accordingly, upon applying the formula listed above, the debtor did not have the equivalent of seven years payments on her loans, and therefore, the loans were not dischargeable.

Bankruptcy: Dischargeability of Student Loans

     Student loans generally are non-dischargeable debts and pass through the bankruptcy process unaffected. Congress has provided that government-guaranteed student loans are nondischargeable in bankruptcy unless the debtor can demonstrate that the repayment of such student loans would constitute an undue hardship under Bankruptcy Code 523(a)(8).  However, there are exceptions that allow for dischargeability.  In this blog and a December blog, I will review three cases to examine the application of Bankruptcy Code §523(a)(8) concerning the dischargeability of student loans.

      The first case is Murphy v. CEO/Manager, Sallie Mae, heard by the United States Bankruptcy Court at Norfolk, Virginia.  In Murphy the court found as fact that the debtor’s nine year old daughter was permanently disabled, as she suffered from Pfeiffer syndrome.  This disability caused the debtor to discontinue her medical education.  It also impeded the debtor’s ability to work.  The loans in question totaled $58,000.00, on which no payments were ever made.  However, the debtor’s husband earned $82,000.00 annually.  Further, the debtor’s evidence illustrated a monthly family disposable income of $400.00.  The debtor argued that the family’s net disposable income was not available to repay her student loans because she and her husband had a savings account in the event that he was laid off.  At the time of the bankruptcy, the account had $2,500.00.  The court further noted that based upon the debtor’s testimony that her son was changing from private school to public school, it was logical to presume that there was an additional $507.00 per month available from the savings in private school tuition plus an extra $109.00 per month paid on an automobile that would be available for student loans.  Eliminating these household expenses and adding these to the $400.00 already noted as per month disposable net income to pay toward the student loan debt.

     The Court stated that it was doubtless that the debtor’s burden of caring for her disabled child was immeasurable, and her disappointment in her inability to complete her medical education immense. However, discharge of a student loan must be founded on more than notions of fairness or sympathy. Because of the debtor’s husband’s successful employment, the debtor and her dependents enjoyed an income well in excess of nearly all who seek undue hardship discharge, and a substantially more comfortable lifestyle than the minimal one contemplated by the criteria for a hardship discharge. Accordingly, the court found that the student loans were non-dischargeable, and thus denied the debtor’s motion to discharge her student loans due to hardship under Bankruptcy Code §523(a)(8).

Bankruptcy: Debtor's Chapter 13 Plan Cannot Favor Student Loans

     The U.S. District Court in Alexandria, in the case of Gorman v. Birts, while approving the bankruptcy court’s test to consider the debtor’s chapter 13 plan, reversed its decision to confirm the plan because it unfairly discriminated against unsecured creditors by proposing to pay the debtor’s student loans outside of the plan.
     Bankruptcy Code Section 1322(b)(5) permits a plan to provide for the curing of any default within a reasonable time and maintenance of payments while the case is pending on any unsecured claim or secured claim on which the last payment is due after the date on which the final plan is due. In Gorman the debtor’s student loans would qualify as this type of long term debt.
     The parties in Gorman agreed that Bankruptcy Code Section 1322(b)(5) is subject to the unfair discrimination limitation described in subsection (b)(1). By proposing to pay her student loan outside of the plan the debtor in Gorman designated a separate class of unsecured claims. As a result of the proposal, the student loan lender would be paid more than three times as much in dollar amounts as the other unsecured creditors, even though the student loan debt constituted only one-third of the total unsecured debt. Accordingly, the question presented was whether the differential treatment constituted “unfair” discrimination under Bankruptcy Code Section 1322(b)(5).
     As the bankruptcy court in Gorman recognized, courts across the country have not settled on a uniform test to assess whether a classification unfairly discriminates within the meaning of the statute. Courts have developed two primary tests to evaluate what constitutes unfair discrimination, neither of which has been adopted by the 4th Circuit (our local circuit). The 8th Circuit’s test in the case of In re Lester (a 1991 case) has been widely applied. Bankruptcy courts in this District have also applied a slightly different test from the case of In re Linton (from an E.D. of Virginia bankruptcy court in 2011). The bankruptcy court in Gorman applied a hybrid version of the Lester and Linton cases. The Circuit Court in Gorman found that the proposed test of the bankruptcy court included all of the factors relevant to a reasonable determination and was the proper test to apply in this case. However, the Circuit Court found that the decision of the bankruptcy court in Gorman that the plan did not unfairly discriminate against the non-student loan creditors was clearly erroneous.
     Using the non-dischargeable nature of student loans, as cited by the bankruptcy court in Gorman, as a basis for discrimination would eviscerate the detailed priority system of Bankruptcy Code Section 507 and make preferential treatment of student loans the rule rather than the exception. The Circuit Court agreed with the view that there are strong policy considerations underlying the student loan program that would favor preferential treatment of student loan debt; however, that is not the law. By not designating student loans as priority claims under Bankruptcy Code Section 507, Congress chose not to categorically treat them differently. Otherwise, the bankruptcy court in Gorman relied on the debtor’s status as a single mother with three children in concluding that the discrimination was reasonable. The debtor did not point to any case law supporting her view that student loans are properly favored under these circumstances. The Circuit Court found that the bankruptcy court erred in finding a reasonable basis for the discrimination. The court sided with the bankruptcy trustee, who challenged the bankruptcy court’s good faith finding by arguing that the debtor had acted in bad faith by failing to pledge her entire disposable income to the plan, instead proposing to retain the disposable income of half of the amount she dedicated to the plan for these creditors. The Circuit Court in Gorman ruled that the bankruptcy court abused its discretion in failing to consider the effect of the disposable income issue on its finding of good faith.