Failure to Enter Student Loan Repayment Program Does Not Negate Good Faith

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By Stephanie M. Acree

A Chapter 7 debtor's student loans were properly discharged by a bankruptcy court based on undue hardship, the U.S. Court of Appeals for the Seventh Circuit held April 10, reversing the decision of the district court (Krieger v. Educational Credit Management Corp., 7th Cir., No. 12-3592, 4/10/13).

Judge Frank H. Easterbrook found no clear error in the bankruptcy court's decision that the debtor's inability to repay was likely to persist, despite the district court's contention that there were no “additional circumstances” that would suggest her situation would not improve.

Unavailing Job Search
Debtor Susan M. Krieger financed her education in part with five student loans and obtained a paralegal certificate in December 2000 and a bachelor's degree with a major in legal studies in August 2002. Krieger began searching for legal jobs after receiving her paralegal certificate. She applied for at least 180 jobs in the 10 years prior to her bankruptcy without success.

After her apartment flooded in November 2008, Krieger moved to her 74-year-old mother's home in Dallas City, which the bankruptcy court described as “a small rural community of less than 1,000 people, located on the Mississippi River in West Central Illinois.”

“[S]he has no savings or investments of any kind,” the bankruptcy court said, outlining its factual findings regarding Krieger's financial condition. “Her vehicle, which her former husband purchased for her at the termination of the lease, is over a decade old and is in need of repairs, which she cannot afford to make. She no longer has a cell phone. She has no health insurance and cannot afford medical or dental care. Because she could no longer afford internet service, her job search became more difficult and, based on the rural nature of where she lives, her opportunities diminished significantly.” Krieger's only source of income after moving in with her mother was $200 per month in government food assistance.

Discharge and Reversal
Krieger filed for Chapter 7 protection on Jan. 24, 2011, and subsequently filed an adversary complaint seeking a determination that her student loans were dischargeable. The bankruptcy court discharged the loans on the basis of undue hardship pursuant to Section 523(a)(8) of the Bankruptcy code. Creditor Educational Credit Management Corporation appealed the decision to the district court.

The district court found that Krieger had not made enough of an effort to find a job outside of her chosen field. The district court said that Krieger was in good health with no major disabilities and that there is “no objective reason” she should not be able to find work in the future. Krieger also had not utilized certain repayment plans like the William D. Ford Income-Based Repayment Plan (IBR), which the court said suggested she had not made a good faith effort to repay the loans. The district court thus reversed the bankruptcy court's ruling (24 BBLR 1515, 11/22/12). Krieger appealed to the Seventh Circuit.

Brunner Test
The test that has been adopted by the Seventh Circuit for discharging student loans, which are presumptively non-dischargeable in bankruptcy, comes from the U.S. Court of Appeals for the Second Circuit's decision in Brunner v. New York State Higher Education Services Corp., 831 F.2d 395, (2d Cir. 1987). The court must determine if the loans will impose an “undue hardship” on the debtor, which requires a showing that: (1) The debtor cannot maintain a minimal standard of living if forced to repay the loans; (2) Additional circumstances suggest that the debtor's state of affairs will continue to persist for a significant portion of the repayment period; and (3) The debtor has made a good faith effort to repay the loans.

The Seventh Circuit interpreted the Brunner test as requiring a “certainty of hopelessness” in In re Roberson, 999 F.2d 1132, (7th Cir. 1993).

Prospects Can Always Improve
The parties never disputed that Krieger met the first requirement of the Brunner test. The court of appeals said that with regard to the good faith requirement, the district court did not deny the Krieger had paid as much as she could prior to filing for bankruptcy protection. Instead, the district court found that Krieger failed to meet the good faith requirement because she had not enrolled in a repayment plan, which would have demonstrated good faith by committing to pay if her conditions improved in the future.

“[I]f this is so,” the court of appeals said, “no educational loan ever could be discharged, because it is always possible to pay in the future should prospects improve.” The court said such an interpretation would be inconsistent with the statute, which does not forbid discharge of student loans. The court also said the language employed by Brunner and Roberson should not be allowed to “supersede the statute itself,” which does allow student loans to be discharged if they are an “undue hardship.”

Discharge Reinstated
The court of appeals said that the good faith standard “combines a state of mind (a fact) with a legal characterization (a mixed question of law and fact)” and that mixed questions are treated as “factual in nature.” The court also said that “undue hardship” is a “case-specific, fact-dominated standard, which implies deferential appellate review” and that “[f]indings of fact must stand unless clearly erroneous.”

In this case, the bankruptcy court made the factual finding that Krieger's circumstances were likely to persist indefinitely, and the court of appeals found that this was not clearly erroneous, despite the district court's contention that no “additional circumstances” were present to suggest Krieger's condition would persist. The court said that the district court and the appellee both conceded that even if Krieger were to enroll in a repayment plan, she would probably still never be able to make payments.

“To the extent that the district judge thought that debtors always must agree to a payment plan and forgo a discharge,” the court said, “that is a proposition of law--an incorrect proposition, for the reasons we have given.” Having found that the bankruptcy court committed no clear error in determining that Krieger satisfied the Brunner test, the court of appeals reinstated the discharge.

Bankruptcy Not the Answer
In a concurring opinion, Judge Daniel A. Manion agreed that the bankruptcy court had committed no clear error and therefore the discharge must be reinstated. However, he said that Krieger's case should be considered an “extreme exception and an outlier” and expressed concern that other debtors would use her case as “an excuse to avoid their own student-loan obligations.”

“[F]or those who perceive that their employment-seeking efforts are at a dead end, bankruptcy should not be the answer,” Judge Manion said. “Rather than challenging the non-dischargeability barrier in bankruptcy, those who have concluded that there is no way they can pay off the debt should be required to enroll in the William D. Ford Income-Based Repayment Plan.”

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