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Eighth Circuit Affirms Judgment Discharging Student Loan Debt Based on Undue Hardship

Friday, September 9, 2011

Walker v. Sallie Mae Servicing Corp. (In re Walker), Case No. 10-2032, 2011 BL 213731 (8th Cir. Aug. 18, 2011) The United States Court of Appeals for the Eighth Circuit affirmed a judgment of the bankruptcy appellate panel ("B.A.P.") which affirmed the bankruptcy court’s judgment discharging a debtor’s student loan debt under the "undue hardship" provision of 11 U.S.C. § 523(a)(8). In doing so, the Eighth Circuit held that based on the totality of the circumstances, including debtor’s need to care for her five young children; her inability to work, if at all, until her autistic twins reached the age of majority; the staleness of her education by that time; and debtor’s need to maintain a minimal standard of living for her family, excepting her student loan debt from discharge would impose an undue hardship on her.

Debtor’s Student Loan and Family Circumstances

Michele Walker ("Debtor") incurred student loan debt while obtaining her undergraduate degree and two years of medical school. Debtor was dismissed from medical school after failing her state licensing exam. In 1996, Debtor married Troy Walker ("Troy") and graduated with a degree in school psychology in 2000. In 2002, Debtor began a full-time internship as a school psychologist, but her position was eliminated two years later. At that point, Debtor began caring for her five young children, devoting a significant amount of time to her older set of twins, who were diagnosed with autism. Troy worked full-time as a police officer and part-time as a security officer. In 2004, Debtor filed a petition for chapter 7 bankruptcy protection and received a discharge, which had no effect on her student loan debt. In 2008, Debtor’s autistic twins were enrolled in a state-funded program of intensive, in-home therapy that involved eight to nineteen hours during the week, plus eight hours each Saturday and Sunday. Debtor was required to attend each therapy session and spent two hours per day preparing for each session. Based on the time needed to care for the twins, Debtor was unable to work outside the home. From 2004 to 2007, the Walkers’ combined adjusted gross income was approximately $67,000. During this period, the Walkers took out a $50,000 home equity loan to build a deck porch, with a monthly payment of $373 and bought a $40,000 minivan, with a monthly payment of $850, even though they already owned three vehicles.

The Discharge Proceeding and Lower Courts’ Rulings

In 2007, Debtor filed an adversary proceeding requesting the discharge of $300,000 in student loan debt under the undue hardship provision of § 523(a)(8). The Educational Credit Management Corporation ("ECMC") objected to the proposed discharge. Both parties agreed that Debtor was eligible to enroll in a federal income contingent repayment plan ("ICRP") and that based on a $67,639 adjusted income and a family of seven, Debtor’s monthly payment under the ICRP would be $593. Ultimately, the bankruptcy court discharged Debtor’s student loan debt, citing undue hardship. The B.A.P. entered a judgment ("Judgment") affirming the lower court’s ruling. On appeal to the Eighth Circuit, ECMC argued: (1) that the bankruptcy court erred in considering evidence of Debtor’s financial circumstances at the time of the § 523(a)(8) proceeding, rather than at the time of the 2004 discharge; (2) that Debtor failed to prove undue hardship by a preponderance of the evidence; and (3) that the bankruptcy court erred in finding that Debtor’s household expenses reflected a minimal standard of living. In its opinion, the Eighth Circuit considered whether excepting Debtor’s student loan debt from discharge constituted an undue hardship under the Bankruptcy Code. In doing so, the Eighth Circuit reviewed Debtor’s reasonably available financial resources and her reasonable living expenses, both in light of the size and special needs of her family. While noting that Debtor had incurred some questionable expenses, the Eighth Circuit observed that Debtor’s monthly deficit realistically precluded her from making any loan payments while still being able to maintain a minimal standard of living for her family. Moreover, the Eighth Circuit observed that Debtor had not deliberately chosen to fail to make her student loan payments or to remain unemployed. Instead, observing that the special needs of Debtor’s children prevented her from working outside the home, the Eighth Circuit granted Debtor a hardship discharge. The Eighth Circuit’s analysis reflects a delicate balance of the Bankruptcy Code’s goals of deterring debtors from using bankruptcy as a means to relieve financial obligations, while recognizing the need to eliminate that burden in certain limited circumstances.

Section 523(a)(8) of the Bankruptcy Code

Beginning its analysis, the Eighth Circuit explained that under § 523(a)(8), debts from educational loans made or funded by a governmental unit may not be discharged unless excepting the debt from discharge would impose an undue hardship on the debtor and the debtor’s dependents. In determining whether a debtor has met its burden, the Eighth Circuit instructed that courts apply a totality-of-the-circumstances ("TOC") test, which considers: (1) the debtor’s past, present and reasonably reliable future financial resources; (2) a calculation of the reasonable living expenses of the debtor and her dependents; and (3) any other relevant facts and circumstances. See In re Long, 322 F.3d 549, 554 (8th Cir. 2003).

Temporal Scope of Undue Hardship Analysis

Addressing the first factor under Long, the Eighth Circuit reviewed ECMC’s position that when conducting an undue hardship analysis, the issue was whether an undue hardship existed at the time of discharge and not whether an undue hardship existed at the time that a § 523(a)(8) proceeding was initiated. Rejecting ECMC’s view that the bankruptcy court erred by looking at Debtor’s financial circumstances beyond 2004, the Eighth Circuit pointed out that failing to take into consideration the events that occurred after Debtor’s discharge would be inconsistent with the first prong of the TOC test, which directs the court to consider the debtor’s "past, present and reasonably reliable future circumstances." Id. Thus, dismissing ECMC’s argument for a limited temporal scope of undue hardship review, the Eighth Circuit held that the bankruptcy court did not err in considering Debtor’s financial condition from 2004 through 2007 in its analysis.

Net Income Calculations

Next, turning to the second factor under Long, the Eighth Circuit reviewed ECMC’s contention that the bankruptcy court based its calculation of Debtor’s net income on assumptions, instead of requiring Debtor to prove undue hardship by a preponderance of the evidence. First, pointing out that ECMC stipulated to the monthly gross income figures used by the bankruptcy court, the Eighth Circuit rejected ECMC’s challenge to those figures. Next, the Eighth Circuit reviewed ECMC’s assertion that in calculating Debtor’s net income, the bankruptcy court double-counted certain payroll deductions. Notably, the Eighth Circuit declared that without the actual tax returns, it could not determine whether any payroll deductions were also claimed as above-the-line deductions and whether any double counting actually occurred. Nevertheless, while noting that a court cannot use speculation when calculating net income and that the lower court’s calculation method posed a risk of double counting, the Eighth Circuit concluded that the degree of speculation was minimal. Further, the Eighth Circuit added that even if it completely excluded the disputed payroll deductions, Debtor’s expenses still exceeded her monthly income, leaving a monthly deficit of $650. Thus, evaluating the potential error in the larger TOC context, the Eighth Circuit held that the flawed calculation did not bar an undue hardship discharge as a matter of law.

Household Expenses

Finally, analyzing the third factor under Long, the Eighth Circuit examined ECMC’s position that Debtor’s $850 monthly car payment on a third car and $373 monthly payment for the deck were unreasonable expenses, precluding an undue hardship ruling as a matter of law. In that regard, the Eighth Circuit explained that a debtor’s household income must be used to satisfy reasonable and necessary expenses. In re Jesperson, 571 F.3d 775, 779 (8th Cir. 2009). While acknowledging that Debtor’s monthly car payment alone exceeded the $593 monthly payment under the ICRP, the Eighth Circuit declared that the porch and third car may be needed given the size of Debtor's family. Further, the Eighth Circuit pointed out that even if the Walkers had not incurred expenses for the car and deck, Debtor could not have possibly met her $593 ICRP payment in light of her $650 monthly household deficit. Ultimately, the Eighth Circuit held that based on the Walkers’ budget, Debtor could not afford to make any payments on her student loans and still maintain a minimal standard of living.

Eighth Circuit Affirms Judgment

In sum, the Eighth Circuit affirmed the Judgment, discharging the student loan debt because of undue hardship.
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