Chapter 3 Undue Hardship

• Jurisdiction: United States

Chapter 3 Undue Hardship

A. The Majority Test: Brunner v. New York State Higher Education Services Corp.

Because the term "undue hardship" is not defined in the Code, bankruptcy courts have created case law to determine whether a debtor's circumstances constitute undue hardship. Most courts use the three-prong test set forth in Brunner v. New York State Higher Education Services Corp.²⁰² The elements of the test are as follows:

1. The debtor cannot maintain, based on current income and expenses, a "minimal" standard of living for herself and her dependents if forced to repay the 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 loan.²⁰³

The test is based on the debtor's circumstances as of the date of the trial,²⁰⁴ and the burden is on the debtor to establish each element by a preponderance of the evidence.²⁰⁵ Brunner has been adopted by the Third,²⁰⁶ Fourth,²⁰⁷ Fifth,²⁰⁸ Sixth,²⁰⁹ Seventh,²¹⁰ Ninth,²¹¹ Tenth²¹² and Eleventh Circuits,²¹³ and is the majority rule.

1. Brunner's First Prong

Under the first prong of Brunner, the debtor must show that with his current income and expenses, he cannot maintain a "minimal standard of living" if he is forced to repay the student loans.²¹⁴ Although not required to live in poverty, "the debtor is expected to do some financial belt-tightening and forgo amenities to which he may have become accustomed."²¹⁵ Thus, he must do everything possible to maximize income and minimize expenses,²¹⁶ including seeking a job in any field, not just one that the debtor prefers.²¹⁷ Courts also look at whether the debtor has imposed his financial hardship on himself, such as through unnecessary spending.²¹⁸ Luxury spending or excessive amounts spent on otherwise reasonable expenses could show that the debtor is able to maintain a minimal standard of living.²¹⁹

The Bankruptcy Code does not define "minimal standard" of living. Most courts agree that a minimal standard of living is not such that the debtor must live in abject poverty, but it does require a showing of more than just "tight finances."²²⁰ In the absence of specific guidance from the Code, some courts look to the expenses considered in In re Ivory,²²¹ which include (1) shelter (including heating and cooling); (2) basic utilities such as electricity, water, natural gas and telephones; (3) food and personal hygiene products; (4) vehicles, along with insurance, gas, licenses and maintenance; (5) health insurance or money to pay for health care; and (6) some amount of entertainment or diversion, even if only a television or a pet.²²² The Ivory list is not intended to be applied mechanically:

Rather, in appropriate circumstances, the court must be prepared to depart from the list based on its own experiences, common sense, knowledge of the surrounding area and culture, and assessment of the reasonableness of what debtor claims he or she needs. In addition, what is minimal can and probably should change over time (e.g., with new technology driving down the cost of things that might have previously been cost-prohibitive).²²³

Because what qualifies as a "minimal standard of living" can change over time, a debtor's reasonable expenses may include the cost of cell phones, cable and internet.²²⁴

To determine whether repaying a student loan would result in undue hardship, some courts use the monthly payment the debtor would pay under an incomebased repayment plan rather than the full contract amount that would be due under the student loan agreement. Using this approach, the debtor would fail the first prong of Brunner if he refused to enter into an income-based repayment agreement.²²⁵ If strictly applied, such a rule would effectively replace undue hardship discharge under § 523(a)(8) with income-driven repayment (for federal loans), since no debtor could pass the first prong of the Brunner test if he was unwilling to participate in income-driven repayment.²²⁶

2. Brunner's Second Prong

For the second prong of Brunner, the debtor must demonstrate "additional circumstances" that show that the debtor's state of affairs is likely to persist for a significant portion of the repayment period.²²⁷ One court has grimly described this as a "certainty of hopelessness."²²⁸ The second prong can be difficult to meet because it requires the debtor to prove that she will be unable to repay her student loan debt in the future for reasons outside her control.²²⁹

In a widely cited opinion, Educational Credit Management Corporation v. Nys, the Ninth Circuit Court of Appeals offered the following nonexclusive list of additional circumstances that a court may consider:

(1) serious mental or physical disability of the debtor or the debtor's dependents which prevents employment or advancement; (2) the debtor's obligations to care for dependents; (3) lack of or severely limited education; (4) poor quality of education; (5) lack of usable or marketable job skills; (6) underemployment; (7) whether the debtor has maximized his income potential in the chosen educational field and has no other more lucrative job skills; (8) limited number of years remaining in [the debtor's] work life to allow payment of the loan; (9) age or other factors that prevent retraining or relocation as a means for payment of the loan; (10) lack of assets, whether or not exempt, which could be used to pay the loan; (11) potentially increasing expenses that outweigh any potential appreciation in the value of the debtor's assets and/or likely increases in the debtor's income; (12) lack of better financial options elsewhere.²³⁰

The most common circumstances that support undue-hardship discharges are chronic mental or physical ailments that interfere with the debtor's ability to work and generate income.²³¹ The mere existence of a medical condition will not suffice; the debtor must demonstrate that the medical condition is the primary cause of the debtor's inability to pay his loans.²³² Depression caused by debt, without more, does not appear to suffice.²³³

The debtor's adverse financial circumstances must be beyond the debtor's control and not a result of the debtor's own choices.²³⁴ Thus, a debtor's decision to keep a low-paying but more satisfying job when better earning options are available suggests that the debtor's circumstances are a result of his own decisions.²³⁵ A debtor who left a well-paying nursing career at age 45 to enter chiropractic school could not complain that, at age 54, the profession did not provide enough income for her to repay her student loan debts within her lifetime.²³⁶ In another case, the debtor, an adjunct professor, refused to apply for permanent work at other schools because she deemed them to be too far from her home, even though the increased income would more than offset the extra transportation costs.²³⁷ At least one court has recognized the circular effect of excessive student debt driving down the debtor's credit score, which in turn deters prospective employers from hiring her, thereby preventing the debtor from increasing her income.²³⁸

Some courts have found that a debtor's choices were not necessarily free choices. In a case where a debtor discontinued her studies in order to care for her infirm parents, the court characterized her decision as a moral choice, not a choice to be poor:

The Brunner test looks to the present and future, not to the distant past.... A moral choice that some debtor made 24 or more years ago to forego opportunities she then had to improve herself, and thus to optimize her potential to earn enough money to repay her student loan debt, is not relevant to a Brunner analysis.²³⁹

In another case, a debtor incurred $200,000 of student loan debt for undergraduate and medical school, but by the time of her bankruptcy petition, she had become a full-time stay-at-home mother with five young children, including two children with special needs.²⁴⁰ The court found that "[t]his is not a case in which a debtor willfully chose to avoid payments that could have been made or was underemployed or unemployed for no discernible reason. Caring for her five young children has become [the debtor's] full-time occupation."²⁴¹

The distinguishing element in these cases is whether the debtor had options that could increase income or decrease expenses.²⁴² Foregoing career plans to care for elderly parents or raise children were found to not constitute free choice, whereas personal career choices or preferences were within a debtor's control. In addition, the timing of the choice, i.e., a recent choice of the debtor or one in the distant past, can also be a factor to be considered by the courts.²⁴³

The inability to find employment has been held by most courts to be insufficient to meet the second prong of the Brunner test. However, in Krieger v. Educational Credit Management Corp., a pro se debtor who had trained as a paralegal tried unsuccessfully for 10 years to land any type of a job.²⁴⁴ The bankruptcy court, observing the debtor's worn demeanor at trial, held that the debtor's prolonged inability to find employment satisfied the second prong of Brunner:

Rarely has the Court seen the kind of persistent job search efforts in which this debtor has engaged over the past decade. Never has the Court seen such utter futility be the result of a debtor's job search efforts. This debtor is truly destitute and has been in these straits for many years without any respite.... If the term "certainty of hopelessness" is to ever have any application, it is in this case.²⁴⁵

The bankruptcy court's order discharging the debt was reversed by the district court but was reinstated on appeal by the Seventh Circuit. The ruling appears to be the first appeals court decision finding that a prolonged unsuccessful career search constitutes the requisite "additional circumstances," and it may signal a...