1st Cir. Examines ‘Existential Despair' of Student Loans

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By Stephanie Cumings

Dec. 10 — “If this doesn't constitute an undue hardship, what would?” the First Circuit asked during oral argument in a case involving a 65-year-old man trying to discharge over $200,000 in student loan debt in bankruptcy.

Attorneys for the creditor and the U.S. government argued that the debtor, Robert Murphy, hasn't demonstrated that his inability to repay the loans will persist indefinitely, noting that Murphy himself has testified he could acquire a job earning $30,000 to $40,000 in the future.

One of the judges questioned whether or not this assertion was merely “hopeful pride.”

“Perhaps the single most significant action this court could take in this case is to explicitly state that a ‘certainty of hopelessness' or ‘total incapacity,' that words like that are not required to be shown,” John Rao, an attorney for the National Consumer Law Center and the National Association of Consumer Bankruptcy Attorneys, told the court. Rao was referring to some of the more draconian language courts have used when deciding how bad a debtor's situation must be before his loans can be discharged.

Rao and the debtor's attorney urged the court to adopt a discharge standard that focuses on whether or not the debtor can maintain a “reasonable, minimal standard of living” while repaying the loans.

With over $1 trillion in outstanding student loan debt in the U.S., a more lenient standard could mean significant financial relief for debtors across the country. But it could be a major problem for the federal government, especially because taxpayers are on the hook when students default on federally guaranteed loans (27 BBLR 1449, 10/29/15).

There is currently a case pending before the U.S. Supreme Court, Tetzlaff v. Educ. Credit Mgmt. Corp., U.S., No. 15-00485, petition filed 10/15/15, that concerns this very issue, but Rao said he thinks the chances are “slim” the high court will hear it (27 BBLR 1417, 10/22/15). Rao said the two different tests currently used by the courts aren't that different in practice, and so the Supreme Court “might not be ready to take on the issue.”

That could change if the First Circuit were to adopt a test that is markedly different.

Different Approaches

Student loan debt is more difficult to discharge in bankruptcy than other forms of consumer debt. Under Section 523(a)(8) of the Bankruptcy Code, debtors can only discharge student loans if they can prove repaying them would be an “undue hardship.”

Nine circuits currently use the so-called Brunner test, named for Brunner v. N.Y. State Higher Educ. Servs. Corp., 831 F.2d 395 (2d. Cir. 1987), under which undue hardship can only be found if the debtor shows “(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 Eighth Circuit uses the “totality of the circumstances” test, which requires “each undue hardship case to be examined on the unique facts and circumstances that surround the particular bankruptcy.” In practice, this standard can provide more lenient outcomes that Brunner, but results vary.

‘Extraordinary Powers' to Collect

Steven D. Pohl of Brown Rudnick LLP, Boston, who is representing Murphy in the appeal, argued that even though the lower courts in this case claimed to have applied the totality of the circumstances test, they actually applied a test more akin to Brunner. Pohl urged the court to follow some of the lower courts in the First Circuit and simply ask if the debtor can maintain a minimal, reasonable standard of living while still paying off the loans.

Responding to a question about the “practical effects” of denying the discharge, Rao noted that the federal government has “extraordinary powers” to collect student debt, including offsetting Social Security benefits and tax refunds, as well as administrative wage garnishment.

‘Existential Despair.'

Adam C. Trampe, a lawyer for appellee Educational Credit Management Corporation, said the court doesn't need to pick a test. Trampe said the court only needs to follow its own precedent from Nash v. Conn. Student Loan Found., 446 F.3d 188 (1st Cir. 2006) and find that Murphy failed to show his inability to repay will continue into the future.

Trampe also said Murphy couldn't show undue hardship because he was eligible for one of the federal repayment programs, like the Income Contingent Repayment Plan. The court asked if a debtor could ever prove undue hardship in the face of such an option. Trampe answered that if a debtor could prove he was likely to never be able to pay anything on the loans, then a repayment plan would be “futile” and discharge would be appropriate.

Jeffrey A. Clair, the attorney for the government, agreed with Trampe's approach that the court's focus should be on whether or not the debtor has shown he won't be able to repay anything in the future. He added that advanced age shouldn't be dispositive of this issue.

Clair acknowledged that language like “certainty of hopelessness,” used by some courts, is “too charged” and has injected an “existential despair” into the law that isn't necessary.

The court questioned both sides as to whether or not it should employ or abandon the “truly exceptional circumstances” language it used in a 1995 student loan case, T I Fed. Credit Union v. DelBonis, 72 F.3d 921 (1st Cir. 1995). Both sides agreed that would all depend on what the court meant by “truly exceptional circumstances.”

To contact the reporter on this story: Stephanie Cumings in Washington at sacree@bna.com

To contact the editor responsible for this story: Jay Horowitz at jhorowitz@bna.com