Student Loan Bankruptcy | The Undue Harship Test

Student loan debt is becoming a national crisis as banks wrote off $3 billion of student loan debt in the first two months of the year, up 36% from the previous year. Student loan debt is not dischargeable in bankruptcy with limited exceptions. However, a recent decision from the Central District of Illinois Bankruptcy Court, and upheld by the United States Court of Appeals for the Seventh Circuit, has provided new case law allowing the discharge of student loans in bankruptcy.

Student Loan Bankruptcy in Peoria, Illinois

The Bankruptcy Code excludes student loans from discharge “unless excepting such debt from discharge under this paragraph would impose an undue hardship on the debtor”, 11 U.S.C. §523(a) (8). A finding of undue hardship requires that the debtor satisfy each part of a three part test: (1) that the debtor cannot maintain, based on current income and expenses, a “minimal” standard of living for himself and his 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 a good faith efforts to repay the loans, In re Roberson, 999 F.2d 1132, 1135 (7th Cir. 1993), quoting Brunner v. New York State Higher Education Services Corp. 831 F.2d 395, 396 (2d Cir. 1987).

The United States Court of Appeals for the Seventh Circuit has decided a case that is important in the area of discharging student loan debt in bankruptcy. In Krieger v. Educational Credit Management Corporation, 12-3592 (7th Cir. 2012), the bankruptcy judge found that Susan Krieger, the debtor, could not pay the debt now or in the foreseeable future. The debtor was living with her seventy five year old mother in a rural area. The debtor and her mother had a few hundred dollars between them every month from governmental programs. The debtor did not have the resources to move in search of employment prospects and her car was a decade old and needed repairs. She also did not have internet access. Educational Credit Management Corporation argued that parts (2) and (3) of the undue hardship test had not been satisfied.

The bankruptcy judge ruled that Ms. Krieger satisfied the undue hardship test. The bankruptcy court found that the debtor made a good faith effort to repay the debt and the lender had not argued the debtor had resources to sustain a wider geographic job search. The bankruptcy court also noted that the debtor paid off as much of the student loan debt as she could with her divorce settlement.

The district court disagreed and reversed the bankruptcy court. The district court found that the debtor could have looked harder for jobs and lacked a showing of good faith because she failed to enroll in a 25-year repayment schedule. The Seventh Circuit Court of Appeals reversed the district court noting that under its standard of review it must find the bankruptcy court’s findings of fact clearly erroneous to reverse. The court noted that the evidence in the record supported the factual findings of the bankruptcy court and it was improper to reverse it.

Concurring Opinion in Krieger

In an interesting concurring opinion in Krieger, a Circuit Judge concurred with the majority opinion based on the standard of review, but preferred the district court’s analysis. The opinion noted that the debtor was fifty-three years old, in good health, and essentially gave up looking for a job. The judge was concerned that with so many people carrying student loan debt and struggling to make payments on their loans, the public may see this case as an excuse to avoid student loan obligations. The court pointed out that a quality and expensive education is no longer a guarantee that a good job will ensue. The debtor has the option to enter a twenty-five year repayment plan which limited payments to 15% of disposable income. Under the plan, the debtor would have paid zero dollars unless she obtained a job paying $17,000 annually and after twenty-five years the debt is forgiven. According to the concurring opinion, this was a better option than erasing what should be an undischargeable debt given the debtor’s age, good health, and solid education.

As you can see, debtors must be well advised when deciding to include debts in bankruptcy. At Kepple Law Group we can help clients make such decision so as to ensure the client’s obligations and liability are no greater than necessary.

Bankruptcy or Other Discharge of Debt Issues?

The Kepple Law Group is highly knowledgeable in bankruptcy matters, including the discharge of debts, and can advise clients in all aspects of bankruptcy proceedings.

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