1st Cir. Could Make Landmark Student Loan Decision

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By Stephanie Cumings

Oct. 28 — The First Circuit is expected to hear oral arguments soon in a case that could provide some relief to the growing ranks of student debtors.


Oral arguments were originally scheduled for Nov. 5, but have been postponed.

The First Circuit is expected to weigh in on how destitute a debtor must be in order to discharge student loans in bankruptcy.

Student advocates claim that courts have set the bar too high, while lenders and the federal government argue that discharge should only be granted in extraordinary circumstances. While Congress undoubtedly meant for student loans to be more difficult to discharge than other kinds of consumer debt, the standard used by most circuits is extremely difficult for most debtors to satisfy.

The steep increase in student debt in recent years has become a major concern for the broader economy, especially because taxpayers are on the hook when students default on federally guaranteed loans.

Outstanding student loan balances were at $1.19 trillion as of June 30, 2015, with about 11.5 percent of aggregate student loan debt in default, according to a report from the Federal Reserve Bank of New York.

Possible Three-Way Circuit Split

Nine circuits currently use the same strict test to discharge student loans, while the Eighth Circuit stands alone with a slightly different approach. If the First Circuit were to adopt its own unique approach, creating a three-way split, the issue might become even more appealing to the Supreme Court.

A similar case out of the Seventh Circuit, Tetzlaff v. Educ. Credit Mgmt. Corp., U.S., No. 15-00485, petition filed 10/15/15, is currently on appeal to the high court, but the court has yet to decide whether or not to hear the case (27 BBLR 1417, 10/22/15).

Dad in Debt

Robert Murphy amassed over $240,000 in student loan debt sending his three kids to college. The 65-year-old father has been unemployed since 2002. Despite his unemployment, he still managed to pay $60,000 in principal and interest on the loans, in part by liquidating a $250,000 individual retirement account.

Educational Credit Management Corp. (ECMC), which now holds all of Murphy's loans, noted in its brief that Murphy was at one point making over $165,000 a year as a high-ranking executive, and that his unemployment has been partially due to “self-imposed limitations on his job search.”

Murphy filed for Chapter 7 bankruptcy in September 2011. Both the bankruptcy court and district court denied Murphy a discharge of his student loans, finding that he hadn't proven paying back the loans would be an “undue hardship” as required by Section 523(a)(8) of the Bankruptcy Code. He represented himself in the cases before the lower courts, but Steven D. Pohl of Brown Rudnick LLP, Boston, agreed to take on Murphy's appeal to the First Circuit pro bono.

Debunking the Brunner Test

Murphy argues that the Brunner test, the standard used in nine circuits, shouldn't be adopted by the First Circuit. In Brunner v. N.Y. State Higher Educ. Servs. Corp., 831 F.2d 395 (2d Cir. 1987), the Second Circuit held that in order to demonstrate “undue hardship,” a debtor must show “(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.”

As Murphy's counsel points out, Brunner was decided “over two decades ago under very different circumstances, at a time when educational loans were subject to automatic discharge after a statutory waiting period.”

Courts often require the debtor to show a “certainty of hopelessness” in order to satisfy the second prong of the Brunner test. The debtor's counsel argues that this requirement is “unsupported judicial gloss” that contravenes the statutory language and that Congress could have used “more draconian” language than “undue hardship,” but chose not to. The debtor also notes that the statute says nothing about “good faith efforts” to repay the loans.

Eighth Circuit Stands Alone

One circuit has broken away from the Brunner regime. The Eighth Circuit first articulated the “totality of the circumstances” test in Long v. Educ. Credit Mgmt. Corp., 322 F.3d 549 (8th Cir. 2003), 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 than Brunner, but results vary.

As the appellee noted, the bankruptcy court did in fact apply the totality of the circumstances test in this case, and still found that Murphy had failed to prove undue hardship. ECMC argues that Murphy can't prove undue hardship under either test, in part because certain federal programs, like the Income Contingent Repayment Plan, would allow Murphy to pay nothing monthly on his loans as long as he has no income.

‘Vital Concern' to Federal Government

The federal government filed a brief arguing that the First Circuit should embrace Brunner. This issue is of “vital concern” to the government because “[t]he availability of an ‘undue hardship' discharge in bankruptcy bears directly on the Department of Education’s ability to protect the fiscal stability of the loan program,” the brief argues. Lawyers for the federal government have been pushing tough standards for discharge in student loan cases for years, a fact that shouldn't be surprising with so much federal money on the line.

“A parent borrower who takes out such loans late in his or her work life does so with full knowledge that repayment may require that he remain employed at or past normal retirement age, that his income may top out or decrease at later stages of his or her career, and that further employment opportunities may be limited,” the government argues. “That is part of the bargain that parents strike when they take out loans later in their work life.”

The government further claims that the totality of the circumstances test is “inconsistent with Congress’s intent to protect the financial integrity of the student loan program by imposing strict, statutory limitations on the discharge of student debts in bankruptcy.”

Student Advocates Fight Back

Others think debtors like Murphy deserve more leniency. The National Consumer Law Center filed a brief urging the court to abandon both tests and adopt a standard that would provide that “if repayment of the student loan would prevent the debtor from satisfying ordinary and necessary living expenses so that a debtor could not effectively ‘make ends meet,' this would be an undue hardship.” The NCLC is a non-profit focused on representing low-income and financially distressed consumers.

The NCLC criticized Brunner as “unpredictable and non-uniform” and said that the totality of the circumstances est “has not always been applied in a manner that avoids the harshness of Brunner.” It also said that both tests are “far too complex and encourage parties opposing discharge to engage in costly, contested litigation.”

First Circuit Landscape

As Murphy's counsel noted, most of the lower courts in the First Circuit have already abandoned Brunner for the totality of the circumstances test and simply ask if the debtor can maintain a minimal, reasonable standard of living while still paying off the loans.

According to research conducted by Bloomberg BNA, the First Circuit has only addressed Brunner once, in Nash v. Conn. Student Loan Found, 446 F.3d 188 (1st Cir. 2006). But in that case the court said it found “no need ... to pronounce [its] views of a preferred method of identifying a case of ‘undue hardship.' ”

More recently, the First Circuit bankruptcy appellate panel criticized Brunner in Bronsdon v. Educ. Credit Mgmt. Corp., 435 B.R. 791 (B.A.P. 1st Cir. 2010). In that case, the court said that “[r]equiring the debtor to present additional evidence of ‘unique' or ‘extraordinary' circumstances amounting to a ‘certainty of hopelessness' is not supported” by the text of the statute, nor is the good faith requirement.

That court ultimately held that “the totality of the circumstances test best effectuates the determination of undue hardship while adhering to the plain text of [the statute].”

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.