In Steven Harper’s The Lawyer Bubble: A Profession In Crisis, the author (quoting a newspaper article) describes Federally guaranteed student loans as the closest thing to a debtor prison in existence. Lawyer Bubble, p. 11. This statement, while jarring, has some empirical support. In the book, Harper cites bankruptcy code changes that have made it virtually impossible to get student loan debt relief in all but the most extreme (and trying) circumstances. He also provides anecdotes, documented examples and profuse research to back up his arguments.
Hard data aside, the “knowledge” that student loans can’t be discharged in bankruptcy has permeated the collective consciousness. Indeed, the difficulties a bankrupt debtor must surmount to get a discharge from student loan debt have assumed near-mythic proportions. The popular narrative is that student loan relief is given in only the most severe (think physical and mental infirmities coupled with fiscal calamity) circumstances and that it’s basically not even worth trying to get a discharge. And in many cases, the belief is accurate: it is nearly impossible to convince a bankruptcy judge to grant a student loan discharge.
This extreme difficulty in securing a discharge is graphically illustrated by the depressing fact patterns that underlie many student loan discharge cases where relief is granted only under the sadness-tinged “certainty of hopelessness” standard. In many of these cases – in which the court does grant discharge relief – the court chronicles the lives of borrowers who live in abject poverty and in desperate conditions, all the while trying to support themselves and their dependents. Yet, for other student borrowers whose circumstances aren’t as severe, the courts often refuse their discharge requests.
But in the Seventh Circuit, as shown by a recent decision, getting a discharge may not be as difficult as previously understood. In Krieger v. Educational Credit Management Corp., 213 F.3d 882 (7th Cir. 2013), the Court seems to relax the austere requirements for a borrower who seeks to discharge student loan debt. In that case, the Court discharged nearly $25,000 in student loans where the borrower was in good health, educated and had solid academic credentials.
Like other cases in the student loan discharge milieu, Krieger’s underlying facts aren’t sunny. The debtor was in her fifties and lived with her elderly mother. She was divorced and lived in a rural area where jobs are scarce. She hadn’t worked in over twenty years, lacked income, assets and reliable transportation. The debtor filed an adversary proceeding to discharge student loan debt which she acquired to attend paralegal school. The lender objected and after a trial, the bankruptcy judge sided with the debtor and discharged the loans. The lender appealed and the District Court (bankruptcy orders are appealed to District court) reversed on the grounds that the debtor didn’t show undue hardship. The Seventh Circuit reversed and found that the debtor was entitled to a discharge.
Section 523(a)(8) of the Bankruptcy Code provides that student loans are generally excepted from discharge unless “excepting such debt from discharge….would impose an undue hardship on the debtor.” 11 U.S.C. 523(a)(8). Undue hardship isn’t defined in the Code but the standard’s content is instead established by the caselaw from various jurisdictions.
To analyze undue hardship (whether the borrower demonstrates undue hardship) 7th Circuit applies the three-part test espoused by the Second Circuit in In re Brunner (831 F.2d 395 (2nd Cir. 1987) – a seminal Second Circuit case from the late 1980s. To establish undue hardship, the borrower must show, by a preponderance of the evidence that (1) the debtor can’t maintain a “minimal standard of living” based on current income and expenses; (2) “additional circumstances” exist that show that the state of affairs is likely to persist for a significant portion of the repayment period of the loans (the so-called “persistence” element); and (3) that the debtor-borrower has made good faith efforts to repay the loans.
The Seventh Circuit found that all three undue hardship factors were met. The debtor showed that she was destitute, lived in a remote area that was “out of the money economy”, and hadn’t worked in over two decades. The Court also found that the debtor’s circumstances were likely to persist and unlikely to financially improve in the future. On this second factor – the “persistence” factor – the court rejected other courts’ requirement of the debtor showing “certainty of hopelessness”, finding that the undue hardship standard is a more flexible test.
Noticeably absent from the analysis though, is any discussion of the debtor’s “good faith.” Other cases look to whether the debtor took advantage of reduced-payment options as well as the debtor’s past payment efforts. Here, though, the Court simply held that the good faith element of the undue hardship test involves a fact-specific analysis that requires “clear error” for reversal. The Court also held that a debtor is not required to exhaust all reduced-payment options as a predicate for showing good faith. In finding good faith, the Seventh Circuit found that the bankruptcy judge’s good faith determination based on the debtor’s 200 unsuccessful job applications over the years wasn’t clearly erroneous and should have been upheld.
Manion’s cautionary concurrence:
In his concurrence, Judge Manion notes that the debtor is physically healthy, intelligent and graduated from paralegal school with a high GPA. Judge Manion didn’t think the debtor’s circumstances were egregious enough to merit a discharge and even wondered whether other student borrowers will use this case as an “excuse to avoid their own student loan obligations?” He pointed out that debtor’s applying for 200 jobs over a 10-year period amounted to less than two applications per month. Hardly a Herculean job search effort.
Take-aways: Compared to other student discharge decisions – where the debtor is either physically or mentally impaired or is responsible for sick parents or children – Krieger arguably establishes a more lenient discharge standard. Clearly, the debtor was insolvent, destitute and hadn’t worked in decades. But she was also physically healthy and educated. The debtor’s circumstances seem to be missing an element of “certainty of hopelessness” – the standard that governed Seventh Circuit discharge cases before Krieger. At any rate, it’s too early to tell if this case represents a sea-change in student loan discharge cases. It’s also unclear whether this case will result in an uptick in student discharge attempts. Still, the case is worth reading for its topical relevance as well as its statistical description of the Federal loan-student borrower bankruptcy crisis.