Circuit Court split over Student Loan Debt in Bankruptcy

The rise in cost for higher education has resulted in more than one trillion dollars of student loan debt in this country and continues to grow; it is only second to the mortgage debt. Kevin J. Smith, Defining the Brunner Test’s Three Parts: Time to Set a National Standard for All Three Parts to Determine When To Allow The Discharge Of Federal Student Loans, 58 S.D. L. Rev. 250, 252 (2013).  With more graduates with high student loan debt than in prior decades, it has led some students to consider bankruptcy as a solution.

However, student loans are almost impossible to discharge under the Bankruptcy Code because of the remarkably difficult standard to meet.  The Bankruptcy Code states that student loans are an exception and will not be discharged, unless it would result in “undue hardship” on the debtor or debtor’s dependents. 11 U.S.C. § 523(a)(8).  Currently, there is a Circuit Court split on how to establish undue hardship, whether through the Brunner test, or through a totality of the circumstances test.

A majority of circuits though have adopted the Brunner test when evaluating whether to discharge a debtor’s student loans.  The Brunner test has three elements to meet. The first element is an inability to maintain a minimal standard of living.  Brunner v. New York State Higher Educ. Services Corp., 831 F.2d 395 (2nd Cir. 1987).  The second element relates to additional circumstances that are likely to persist, and the third is that debtor has made good faith efforts to repay the loan. Id.

The first element of minimal standard of living primarily focuses on how a debtor can maximize income and minimize expenses.  The court will look to debtor’s expenses, such as certain bills, assets, and residence through a reasonableness lens.  For example, a court would be reluctant to find a minimal standard of living if the debtor is residing in a luxurious apartment and driving a nice, new car.  Further, a court may consider the debtor’s degree in correlation to their potential job opportunities.

The second element typically considered the heart of the Brunner test, focuses on the debtor’s physical, mental, or emotional disability that prevents the debtor from obtaining a higher paying or more consistent job. Smith, supra at 261, 263.  However, whether the ailment is physical, emotional, or mental, the illness must be “sufficiently debilitating and unlikely to improve”.  Id. at 263.  The court will also look at the debtor’s responsibilities to any dependents or other important home obligations.

The final element of the Brunner test is that the debtor has made good faith efforts in repaying the loan.  The court will want to see that the debtor has made reasonable efforts, typically the previous six months is time period Courts evaluate while applying this standard.  The federal government offers the Public Service Loan Forgiveness (“PLSF”) program, where a debtor works for ten years full time in a public service job with no defaults in paying; the remaining debt after 10 years will be discharged.  Because the federal government offers the PLSF, if an individual fails to take advantage of this option courts have viewed this against the good faith effort to repay the student loans.  Smith, supra at 254.

While most circuits apply the Brunner test, the minority approach of applying “totality of the circumstances” has been adopted in some circuits like the Eighth and First. 51 Causes of Action 2d 497 (Originally published in 2012).  The Eighth Circuit has adopted several factors for the “totality of the circumstances” test: (1) the debtor’s past, present, and reasonably reliance future financial resources; (2) reasonably necessary living expenses for debtor’s or debtor’s dependents; and (3) other material facts or circumstances of a particular case.  In re Reynolds, 425 F.3d 526, 532 (8th Cir. 2005).

The Eighth Circuit stated that it rejected the Brunner test and reaffirmed the totality of the circumstances test because requiring the “courts to adhere to the strict parameters of a particular test would diminish the inherent discretion contained in §523(a)(8)(B) . . . [and] [w]e believe that fairness and equity require each undue hardship case to be examined on the unique facts and circumstances that surround the particular bankruptcy.” Id. (citing to Andrews v. S.D. Student Loan Assistance Corp., 661 F.2d 702, 704 (8th Cir. 1981)).

Because of the current circuit split, it is important for a debtor who is considering filing for bankruptcy to know which jurisdictional circuit he lives in, primarily because many student loans are not discharged under the Brunner test, while other student loans have been successfully discharged under the totality-of-the-circumstances test.  Further, due to the circuit court split it is likely that the Supreme Court may take up a bankruptcy case involving student loans and whether and how they can be discharged in order to resolve the split.

Julie Camden of Camden & Meridew, P.C. practices in the areas of tax and bankruptcy law and has litigated various issues related to individual and corporate tax obligations.  Please contact our office at 317-770-0000 or complete our online contact form for more information or to schedule a consultation.

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