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Are Student Loans Dischargeable in Bankruptcy? Only if You Can Prove Undue Hardship

Many students don't realize the scope and extent of the lifelong financial burden they saddle themselves with when taking out student loans. It is only after getting into the "real world" that they realize that living expenses are higher, and after tax income is lower, than they anticipated, making student loan debt repayment difficult if not impossible.

Some look to bankruptcy for relief and a fresh start. But all debt is not treated equally in bankruptcy. Student loan debt is not the same as, for instance, credit card debt. It is not dischargeable pursuant to Bankruptcy Code section 523(a)(8) except in one narrow circumstance. Specifically, to discharge student loan debt, a debtor must show undue hardship - a very high bar.

Student loan discharge was at issue in a recent case in the U.S. Bankruptcy Court for the Western District of Michigan. In this case, Chapter 7 debtor Nicolas Warner ("Warner") initiated an adversary proceeding against his student loan lenders (the "Lenders") seeking discharge of a staggering $432,000 in student loans.

The Sixth Circuit has adopted the Brunner test (named for a Second Circuit case) for bankruptcy judges to use when determining whether they should discharge a debtor’s student loan debt. Pursuant to Brunner, in order to discharge his student loans, Warner was required to establish by a preponderance of the evidence the following three elements:

  1. First, that he could not maintain, based on current income and expenses, a minimal standard of living for himself and his dependents if forced to repay the loans;
  2. Second, that additional circumstances existed that indicate that his current state of affairs was likely to persist for a significant portion of the balance of the loan period; and
  3. Third, that he made a good faith effort to repay the loans.

The court analyzed Warner's circumstances in light of each of these elements, and found that he did not prove his case and thus his loans were not dischargeable.

Present Inability to Pay

Warner earned $48,657 as a clinical psychologist in 2013, and after monthly expenses (apartment rent, food and other necessaries) he had only $31 left each month available to pay his Lenders. The court, therefore, found that Warner lived a "frugal" existence and could not pay the $1,700 monthly payment required to service his student loan debt and maintain a minimal standard of living. Warner, therefore, satisfied the first Brunner element.

Persistence of Financial Circumstances During the Repayment Period

Brunner requires a court to evaluate not only present hardship, but to make a prediction about future ability to pay. Factors to consider include a debtor's mental and physical health, dependent's needs, age and other conditions affecting earning capacity. Also considered are prospects for income in the debtor's profession, in this case clinical psychology. The court noted that the "most important factor" to satisfy this element is that the debtor's circumstances must "be beyond the debtor's control, not borne of free choice."

Warner stipulated that he had no mental or physical incapacity, and no dependents. The court assessed him at trial to be in "good health, alert, intelligent, and sophisticated." While the court determined that Warner's current circumstances did not allow him to repay his Lenders, it found that he could do so in the future. The court looked to his future earning potential based on Bureau of Labor Statistics and determined that Warner was likely to earn approximately $70,000 in the near future, which would allow him to start repaying some of the debt. Warner, therefore, failed to meet his burden for the second element.

Good Faith

The court then analyzed whether Warner had made a good faith effort to repay the loans, and found that he did not. First, while $18,643.69 in payments were made to the Lenders, Warner's mother (who cosigned on the loans) made those payments. Warner made only a single payment of $379. Second, while Warner received over $6,000 in tax refunds in 2013, he did not pay any of this amount to his Lenders. The court held that these circumstances failed to demonstrate good faith.

In denying Warner's attempt to discharge the student loans, the court wrote that Warner and the Lenders "will have to live, uneasily it seems, with the consequences of the bargains they improvidently struck at the beginning of their relationship."

Categories: Chapter 7, Western District of Michigan

Photo of Laura J. Genovich

practice focuses on bankruptcy, municipal law, collections, and trial-level and appeals litigation. In the bankruptcy arena, she represents primarily Chapter 7 trustees. Laura has handled a wide range of trial and appellate matters for individual and business clients and has appeared before the U.S. Sixth Circuit Court of Appeals, the Michigan Court of Appeals, and the United States Bankruptcy Court for the Western District of Michigan, as well as Michigan circuit and district courts across the state.

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