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Discharging Student Loan Debt

Posted on Feb. 8, 2022

The Department of Education (DOE) recently lost a motion for reconsideration of a bankruptcy court decision involving the discharge of student loan debt. The case is almost a purely bankruptcy matter having no real tax aspect to it, but because the bankruptcy court talks about what will happen to the debt upon its forgiveness, viz., taxable income under IRC 61, the case got picked up in the tax press and caught my eye. If you have ever been curious about why students can almost never get rid of student loan debt, you may find this rare case in which a former student succeeds in getting past the exception to discharge interesting. If you are looking to learn something about taxes or tax procedure, read no further.

In Wheat v. Great Lakes Higher Education Corp, No. 18-03041 (M.D. Ala. 2022) the bankruptcy court issues an opinion explaining its earlier opinion granting Ms. Wheat a discharge. DOE brought this motion for reconsideration because it felt that the bankruptcy court had failed to follow the applicable precedent for determining if a debtor could discharge student loan debt under the exception to discharge provided in B.C. 523(a)(8). In the end, the bankruptcy court sustains its prior decision and provides more explanation for the reasons behind its decision. This outcome happens frequently, as discussed in an earlier blog post on motions for reconsideration and presents a real hazard for parties who file this particular motion. In effect, the bankruptcy court has received and taken the opportunity to write a reply to DOE’s opening brief on appeal.

The court outlines what it should consider in such a motion:

A motion to reconsider, alter, or amend a judgment, if filed within 14 days of the judgment, is governed by Federal Rule of Bankruptcy Procedure 9023, which incorporates Rule 59 of the Federal Rules of Civil Procedure. To warrant reconsideration, a motion must establish one of the following applies:

1. An intervening change in the law,

2. Consideration of newly discovered evidence, or

3. To correct clear error or prevent manifest injustice.

With this test in mind, the court explores its earlier decision and the concerns raised by DOE, which in this case plays the role of Inspector Jobert made famous in Les Miserables.

Ms. Wheat had filed a chapter 7 bankruptcy and received a discharge under B.C. 727. That discharge rids her of her pre-petition debts; however, certain pre-petition debts are excepted from the discharge. The excepted debts are described in B.C. 523, which applies to almost all individual bankruptcy cases. Most often on this blog we discuss the exception in B.C. 523(a)(1) which excepts certain pre-petition tax debts or B.C. 523(a)(7) which excepts certain penalties, but there are 18 subparagraphs under 523(a) and individual debtors must consider all of them in calculating the impact of their discharge.

Debtors seeking to discharge student loan debt must meet the requirements to overcome the statutory exception to discharge for student loan debts. The case of In re Brunner, 46 B.R. 752 (S.D.N.Y. 1985), aff’d, 831 F.2d 395 (2d Cir.1987) (per curiam) is the leading case here and the 11th Circuit adopted the Brunner test in In re Cox, 338 F.3d 1238 (11th Cir. 2003).

Under the Brunner test, a debtor must prove, by a preponderance of the evidence, the following components:

(1) That the debtor cannot maintain, based on current income and expenses, a “minimal” standard of living for herself and her dependents if forced to repay the loans,

(2) That additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period of the student loans, and

(3) That the debtor has made good faith efforts to repay the loans.

The bankruptcy court recounts the financial and family circumstances of Ms. Wheat. As a single mom with three children, ages 8-12, including one with special medical needs and as a daughter whose mom had significant medical needs, Ms. Wheat faces significant challenges. Those challenges cause the calculation for her repayment amount on the student loan to be $0 at the time of the bankruptcy case. DOE has concerns because many individuals with student loans have financial hardship, yet it wants to argue under the second prong of the test that the borrower will not necessarily face these hardships throughout the entire life of the repayment period. Children grow up, people get better jobs, circumstances change, and DOE did not feel the bankruptcy court recognized these possibilities in applying the Brunner test.

DOE wants the bankruptcy court to apply the “certainty of hopelessness” standard some courts have adopted, essentially putting the burden on the debtor to show that there is no hope their finances will improve during the life of the repayment. An example of someone who could meet this standard would be someone with an irreversible medical condition that kept them from working for the rest of their life. The bankruptcy court responds that DOE’s interpretation of the rule would “swallow the rule” and make it essentially impossible for any debtor to meet the second prong of the Brunner test. I think the court accurately describes DOE’s interpretation, which is why it is so hard to discharge student debt and why DOE has concerns about the Wheat case. The court finds, however, that Ms. Wheat’s dire financial situation is likely to continue for so long that the realistic chances she will have the ability to repay the loan are minimal.

In its original decision the bankruptcy court referred to the tax debt that can replace the student loan debt upon forgiveness if the forgiveness triggers cancellation of debt income. It hypothesizes that she could possibly discharge the debt after 25 years using the Income Driven Repayment Plan adopted during the Obama years. The court points out that its discussion of her forgiveness under this plan and the possible tax consequences flowing from it did not form the exclusive basis for its decision. It merely acknowledged the size of her potential tax bill if she paid nothing further on the loan and discharged it at the conclusion of the 25-year period.

Finally, the court addressed DOE’s argument that the discharge exception should apply in all but the most severe circumstances. It finds this policy-based argument to go too far and spends more time detailing her dire financial circumstances, her family circumstances, and her work ethic. It also explains why her circumstances will likely persist for a significant portion of the repayment period. The court rejects DOE’s argument that Ms. Wheat’s children should start helping her pay the student loan when they reach the age of majority.

The test for discharging student loan debt applied here suggests a loosening of the rules, though not a major one. Ms. Wheat is clearly struggling. If you read cases applying the Brunner test, you understand why discharging student loan debt is so difficult. The fact that DOE fights so hard in this case further brings that point home. While her tax debt, if she ultimately has one, will create another debt excepted from discharge, B.C. 523(a)(1) allows the discharge of the tax debt once it ages out after three years. The student loan provision for discharge has no similar mechanism for aging out the debt, requiring student loan borrowers to continue paying, or at least being billed for, the debt forever unless they qualify for the 10 and 25-year relief provisions passed during the Obama administration. That’s why there is so much pressure being brought to bear on the current administration to provide relief from student debt. Because of issues of fairness and equity, providing blanket relief will be difficult.

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