Student Loans: The Modern-Day Debtor’s Prison (A “Certainty of Hopelessness” Standard for Discharge?!) and a Tax Glitch

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11 U.S.C. § 523(a)(8)

By: Donald L Swanson

A student loan cannot be discharged in bankruptcy, unless the loan “would impose an undue hardship on the debtor and the debtor’s dependents.”

11 U.S.C. § 523(a)(8)

So, what qualifies as “undue hardship” under § 523(a)(8)?

–You might think that an, “I can’t pay both rent and child care, let alone student loans too,” circumstance might qualify as “undue hardship.” But you’d be wrong, according to a new appellate ruling in the In re Price bankruptcy case. [Fn. 1.]

The actual “undue hardship” standard is described by the In re Price Bankruptcy Judge as this:

–A “certainty of hopelessness.”

And I’m here to declare that this is a terrible and appalling standard!! It is tantamount to debtor’s prison. And it is a huge part of the crisis that faces many current and former students of today.

The Facts

Kristin Price files Chapter 7 bankruptcy on October 26, 2015, at which time she owes these student loans:

$25,850 to U.S. Department of Education; and
$30,817 to Chace Bank on private student loans.

On January 14, 2016, Ms. Price files a lawsuit in Bankruptcy Court against the Secretary of the Department of Education and against Chase Bank. She wants a discharge of her student loans under the “undue hardship” standard. Her attorney declares, in the lawsuit:

her “monthly net income, including child support, can barely meet her family of four’s monthly living expenses, not including her student loan obligations”;

her “current and expected future income is and will be barely adequate (if at all) for her to afford a minimal standard of living for the debtor and her three minor dependent children”; and

she “made a good faith attempt to pay these loans,” but she “lacks the resources to repay them”: any payments she might make “would create a hardship” for her and her family.

Her case goes to trial. But here are practicalities of her litigation circumstance:

–Here’s a woman who lives frugally but can barely make ends meet; yet she is litigating in Federal Court against deep-pocket parties to simply get a discharge. Presumably, her attorney is working for free—or nearly so.

The Bankruptcy Court Ruling

The Bankruptcy Court issues a 56-page opinion on June 23, 2017. That’s an exceptionally long opinion.  You’d think this is a highly complex case. But it’s not. It’s simple and straightforward.

The Bankruptcy Court agrees with the Debtor: she and her dependents are facing “undue hardship,” and she is entitled to a discharge of student loans.  Here are some of the Judge’s findings of fact from the trial:

–Personal

Debtor is twenty-nine years old, has “no health problems,” and holds “a Bachelor of Science in Radiologic Science.”

–Family

Debtor “is married but has been separated from her husband” and “believes there is no chance of a marital reconciliation”;

She “resides with” her three children, ages three, five and eleven; and her husband “does not take on day-to-day child-care responsibilities” because of his “lack of a suitable, permanent residence”; and

Her “oldest child attends public school”; her middle child is in day care, but will begin half-day kindergarten next year; her “youngest child is in day care and will begin half-day kindergarten in September 2018”; and they will need “before-school-care and after-school-care.”

–Employment

Debtor has been employed “part-time” for three years “as a vascular sonographer” and is paid “$34.22/hour,” working two full days (7:30 a.m. to 4:00 p.m.) and one half day per week, “for a total of twenty” hours per week; she is “on-call,” but has only been called-in for extra hours three times since her employment began; and

She “has looked for additional hours or a full-time position in her field in the nearby area, but no such position is available” (the “current full-time vascular sonographers” where she works “are not due to retire” for eight years), and she “has not sought lower-paying, part-time employment outside of her field.”

–Income and Expenses

Debtor’s monthly income consists of, $3,455.83 gross ($2,405.00 take-home), plus $1,400 per month child support and $507.05 direct payments by her husband toward auto-related expenses: which “result in $4,312.00 available” for “living expenses”; and

Her monthly expenses total $4,482.00, which exceed her monthly income by $170.00.

–Assistance from Mother

Debtor “manages” the $170.00 per-month shortfall in expenses over income by taking loans from her mother, which she repays with her income tax refund;

She “lives in a home owned by her mother” and pays “below-market monthly rent of $1,400, which covers her mother’s mortgage payments”; and her “mother provides free childcare for the oldest child” after school on days when Debtor is working; and

Her car “is leased,” with two years remaining on the lease, after which her husband “has promised to make monthly payments” for a new car and related insurance.

–Owns Little Property

Debtor “owns no property” other than a “modest amount of exempt cash, cash equivalents” and household property.

Settlement with Chase Bank

While the case is pending, Debtor settles with Chase Bank.

[Editorial Note: Here’s guessing she paid a steeply-discounted and lump-sum amount, which she borrowed from her mother.]

Two Government Debt-Forgiveness Programs

The U.S. Government has two programs for student loan repayment and forgiveness. One program requires income-based payment amounts for twenty-years, and the other is for twenty-five years. At the end of monthly payments and full compliance under those twenty or twenty-five year programs, the remaining student loan amount is forgiven.

Debtor “explored” these programs “by attempting to set up a repayment plan online” but abandoned the effort “after she realized she could not pay the lowered monthly payments”; and

She does not qualify for zero ($0.00) monthly payment amounts because her income is too high: had her income been below 150% of the poverty line, zero ($0.00) monthly payments amounts might be possible.

–A Tax Glitch

The Bankruptcy Judge notes a significant tax glitch in the U.S. Government’s loan-forgiveness programs. Forgiveness is great, right? Of course it is. But there’s a catch:

Forgiveness of indebtedness is a taxable event, and Debtor will owe income taxes on the amount forgiven!

–A Tax Glitch Hypothetical

So . . . let’s say, hypothetically, that a student has hundreds of thousands of dollars of student loans, and the income-based payments are less than interest accruals: i.e., the amount owed increases each month, despite monthly payments.

And let’s say, hypothetically, that the student fully complies for the entire twenty or twenty-five program years and receives forgiveness of $500,000. That forgiveness creates an income, for tax purposes, of $500,000. Such a forgiveness amount will make the student, for tax purposes, one of the “wealthy” taxpayers who must pay a high tax rate.

So . . . the result is this: the $500,000 forgiveness of student loan debt will create a very-large tax liability, which the student still can’t repay. Now what is he/she supposed to do?!

Bankruptcy Judge Grants Discharge

The Bankruptcy Judge finds the existence of an “undue hardship” under such evidence and, therefore, grants Debtor a discharge under § 523(a)(8).

While this ruling seems to be the right one, the Bankruptcy Judge almost apologizes for his ruling with these words:

“To some readers, parts of the above analysis may appear unorthodox and my determination that the Debtor’s student loan debt is dischargeable may seem counterintuitive.”

Attempting to be diplomatic and deferential, the Bankruptcy Judge adds:

“unlike some courts and commentators, I do not suggest that” the legal test for undue hardship “needs to be replaced”; and

“I suggest only that courts take a fresh look at the manner” in which the legal test is applied.

–The “Certainty of Hopelessness” Test

Then, in a telling statement about the prevailing judicial attitude on discharging student loans, the Bankruptcy Judge adds this:

–if the true test for discharging student loans for “undue hardship” is “certainty of hopelessness,” then “the outcome of this case is incorrect” (emphasis added).

Yikes!

–Reversal on Appeal

The U.S. Government, of course, appeals the Bankruptcy Judge’s grant of discharge.

And the appellate court reverses [see Fn. 1], saying: “the bankruptcy court improperly applied the legal standard.”

Conclusion: This is a Terrible and Appalling Result!!!

I don’t know about anyone else, but the denial of discharge in this case is, to me, a terrible and appalling injustice – on multiple levels!

–For starters, this poor debtor is in difficult straights, is trying to keep her family afloat, maintains a minimal standard of living, and can’t make ends meet—even with assistance from her mother.

–Second, the U.S. Government is enabling a huge number of students (mostly young people), all across this land, to go to college on borrowed money without any regard to repayment ability, and then the Government turns into tough-guy when the loan goes bad?!

–Third, the U.S. Government is propping up a high-price model of higher education on the backs of our young people, which hampers their job and career mobility, impairs their home-ownership prospects, and keeps them under the thumb of unrealistic debt burdens for much of their adult lives.

It truly appears that “certainty of hopelessness” is the operative legal standard for discharging student loans. And this is a horrible reality for everyone involved.

This is our modern-day debtor’s prison.

And this needs to change!!!

Footnote 1: The ruling is by the U.S. District Court in Devos v. Price, (In re Price), Case No. 17-3064, Doc. 14 (E.D.Pa., January 24, 2018), which overrules the Bankruptcy Court’s decision. The Bankruptcy Court opinion is Price v. Devos (In re Price), Adv. No. 16-0011, Doc. 49 (Bankr.E.D.Pa., June 23, 2017).

** If you find this article of value, please feel free to share.  If you’d like to discuss, let me know.

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