Student loans are not usually discharged in Chapter 7 bankruptcy. It is difficult, but not impossible, to do so if you can show that payment of the debt “will impose an undue hardship on you and your dependents.” See 11 U.S.C. § 523(a)(8). Whether a student loan is discharged based on hardship is not automatically determined in the bankruptcy process. You must file a petition (called an adversary proceeding) which will prompt the bankruptcy court to decide the issue.
Courts use different tests to evaluate whether a particular borrower has shown an undue hardship. A common test is the Brunner test, which requires a showing that (1) the debtor cannot maintain, based on current income and expenses, a “minimal” standard of living for the debtor and the debtor’s dependents if forced to repay the student loans; (2) 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) the debtor has made good faith efforts to repay the loans. Brunner v. New York State Higher Educ. Servs. Corp., 831 F. 2d 395 (2d Cir. 1987). Michigan, where we practice, is part of the Sixth Circuit, which applies this test. However, not all federal circuits use Brunner; some courts may actually be more flexible. Because the standard for discharging student loans can be different in different parts of the country, you should talk to an experienced bankruptcy attorney in your jurisdiction if you are considering bankruptcy and hope to discharge a student loan debt.
The difficulty of discharging student loan debt in the Sixth Circuit is underscored by this recent opinion. In this case, after filing a voluntary Chapter 7 petition, the debtor initiated an adversary proceeding, seeking discharge of her student loans. The creditors who held the student loans vigorously opposed the adversary proceeding. The adversary proceeding went to trial – complete with witnesses and exhibits – and the debtor lost.
In finding that this particular debtor did not satisfy the Brunner test, the court engaged in a detailed analysis of the debtor’s financial situation and job prospects. This included a review of (1) child support payments that the debtor, a single mother of four, was receiving, (2) tax refunds the debtor had received since 2004, which were between $3,200 and $4,400 per year, and (3) unemployment and food stamp benefits she was receiving from the government. The court also that, until recently, the debtor had lived in “Section 8” federally subsidized housing. The court further mentioned that the debtor apparently spent $100 per month on internet and cable access as well as $50 per month on a gym membership. Additionally, the court questioned whether the debtor was trying hard enough to save money on food, as her credit card statements indicated that she ate out too frequently in the court’s view (even though the debtor testified that she usually ordered from the “value menu” at various fast foot establishments). The court even went as far as to point out that the debtor had apparently spent $120.00 in the past year at a casino: “Even accepting the relatively small amount of the gambling expenditures, the fact of such expenditures undercuts [the debtor's claim] that she has minimized extraneous expenses.”
With respect to the debtor’s job prospects, the court essentially saw no unusual circumstances – apart from Michigan’s economy as a whole – which would prevent her from finding work in her degree field. The debtor must show a “certainty of hopelessness” that their financial situation would improve. The court in this case rejected the argument “generalized economic turmoil may serve as a substitute for a more case-specific evaluation of a student loan debtor’s future prospects.” Finally, the court found that the debtor had not made a good faith effort to repay her student loans because she had failed to take advantage of various loan restructuring plans which were available to her.
This recent opinion confirms that, at least in the Sixth Circuit, a debtor will not be able to discharge student loans if they have even a possibility of improving their financial situation. In this case, the debtor was a single mother of four who had not been employed since September 2008. However, the court essentially found that because she was healthy and apparently employable, her outlook was not sufficiently bleak to pass the Brunner test.