The Changing View Concerning Discharge of Student Loan Debt in Bankruptcy
The general rule that student loans are non-dischargeable in bankruptcy proceedings may be in the midst of a changing view among Bankruptcy Judges. The New York times recently reported that borrowers in the government’s direct student loan program are now defaulting at the rate of 3000 per day. The cost to the US economy and the US taxpayer will become overwhelming if more than 1 million of these borrowers continue to fall into default each year.
Borrowers who are falling into default have been put on long term Income-Based Repayment Plans also known as IBR Plans. The United States Bankruptcy Court for the District of Kansas in December of 2016, addressed a case where husband and wife, debtors, sought to discharge their student loans. The common thought by the public and for that matter, most practicing bankruptcy attorneys is that student loans for all practical purposes are non-dischargeable under the strict requirements of the "Brunner" test. Brunner v New York State Higher Educ. Services Corp., 831 F.2d 395 (2nd Cir. 1987). In order to meet the Brunner test, you must meet all three factors of the test.
First, based on your current income and expenses, you cannot maintain a minimal standard of living for yourself and your dependents if you are forced to repay your loans. Second, your current financial situation is likely to continue through a significant portion of the repayment period. Third, you have made a good faith effort to repay the student loans. The Court requires you to meet all three of the Brunner factors and the burden to meet all three is very difficult.
However, the case of Murray v. Educational Credit Management Corporation, 563 BR 52 (2016), may be shedding light on how the bankruptcy courts may be moving on this issue in the future in light of the more than 1.2 trillion dollars outstanding on student loans.
In the Murray case a husband and wife filed for bankruptcy protection and sought to have their student loans discharged. The facts as set out by the Court are simple. The combined income of the debtors who are in their 40s, live in Kansas and have no children is $95,000.00 per year. After a trial, the Court found that they have disposable income of $1,658 per month. The Debtors made good efforts prior to bankruptcy to pay back the loans which were taken out for undergraduate and graduate degrees in music. The original principal borrowed was $41,883 for the husband and $35,641 for the wife from 1987 to 1996. They made payments on the loans for a period of time and were in forbearance from 2000 to 2005. In 2009 or 2010 they entered into an Income Based Repayment Plan (IBR Plan) where payments were based on their income and adjusted annually. The monthly payments were $690 per month in 2011, $902 in 2012 and $994 in 2013. They paid $54,000.00 under the IBR but the payments were insufficient to service the interest accruing at 9%. After forbearance and the payments made under the IBR the loan balances at the time of the filing of their bankruptcy petition stood in the amount of $141,774 for the wife and $120,876 for the husband.
According to affidavits filed at trial, as of September 15, 2016 the husband’s loan balance was $143,390.88 and the wife’s was $168,178.46 and interest was accruing at $65.89 per day. The Court found that a standard repayment plan over 10 years would amount to a monthly payment of $3,945.16 per month and a 25 year standard repayment plan would require monthly payments of $2,613.57. The Court also found that under the IBR Plan based on the debtor’s income the payments would be $907.80 a month and be adjusted annually.
The Court made finding that the debtors met the hardship standards pursuant to Brunner, if they would be forced to repay the full amount of the loans $311,569.34, because they would not be able to maintain even a minimum standard of living . The Court further found that if the debtors were put on an IBR that even though the payments would be affordable the payments would not constitute repayment of the student loans, because the loan balances under repayment would balloon and increase each month during the repayment plan and therefore are not “repayments”. Eventually under an IBR the debtors on a 25 year repayment plan would end up at age 70 owing more than the $311,000.00 currently due and the IBR would forgive the balance due at the end of the repayment plan, but would result in a significant tax debt as a result of the forgiveness of debt to the debtors who would then be in their 70s.
The Court went on to state “When a debtor shows that the requirements of s. 528(a)(8) have been satisfied for a portion of the student loan debt, the bankruptcy court may exercise its equitable powers under s. 105(a) and discharge just that portion of the debt. “ Murray v.. ECMC 563 B.R. 52 (Bankr. D. Kansas 2016) at p. 13. The Court then fashioned a repayment plan, so that the payment plan would be sufficient to repay the original loan amount of $77,524 with 9% interest over 12 years so that the repayment would be complete when the debtors were approximately 60 years old. The court discharged the accrued interest portion of the debt which amounted to more than $234,000.00
The ruling in this case may be an early view of the future treatment of student loan dischargeability by bankruptcy courts in light of the new reality in the United States where more than one million borrowers fall into default each year. The court in this case seems to be taking a practical approach to the difficult realities facing the country and the student loan debt crisis that the public and Congress do not want to address. The court fashioned a repayment plan that recovers interest and the original loan balance while recognizing that the debtors may become a public burden once they retire if they are unable to save anything for retirement from their current age of 48 to 70.
Of interesting note in this case was the court’s comment on the primary cause of the inability to repay the loans, that being the low earnings potential for people who sought masters degrees in music. It seems that the court in a back handed commentary is again applying common sense in pointing out that the debtors may have not used their educational dollars wisely knowing that their earning potential with masters degrees in music would be low.