Court Rejects “Certainty of Hopelessness” Standard for Discharging Student Debt

Hon. Cecelia G. Morris, Chief Judge of United States Bankruptcy Court for the Southern District of New York, put down a momentous decision on January 7, 2020, granting summary judgment in favor of a debtor in an adversary proceeding seeking to have $221,385.49 in student loan debt declared dischargeable in bankruptcy. See, Rosenberg v. N.Y. State Higher Education Services Corp. (In re Kevin Jared Rosenberg), Case No. 18-35379 (CGM), Adv. No. 18-09023 (CGM) (Docket 68).

Background

The United States Bankruptcy Code contains a well-known provision excepting from discharge student loan debts absent a showing of “undue hardship on the debtor.” 11 U.S.C. § 523(a)(8). Over the years, courts have interpreted the “undue hardship” standard to create an almost insurmountable hurdle – hence, the proverbial burden on the debtor to demonstrate a “certainty of hopelessness.” In light of this standard, as one can imagine, obtaining a discharge of student loan debt in bankruptcy has become exceedingly rare, to the point that most debtors and their attorneys simply assume that student loans are “non-dischargeable.”

Proponents of this provision cite to a disappointing history of abuse by students gaming the system by incurring guaranteed-issue, and government-guaranteed, student loans to pursue frivolous educational experiences, or to obtain highly valuable degrees, only to absolve themselves of any responsibility to repay through the expedience of a bankruptcy proceeding. Critics, on the other hand, contend that guaranteed-issue student loans (often guaranteed by the government) that are effectively non-dischargeable in bankruptcy fuel economic distortion and predatory conduct by some academic and lending institutions.

Against this conflicting backdrop, the Court addressed the politically charged issue of whether a relatively recent law school graduate could obtain a discharge from his student loan debt.

This Case

The debtor began borrowing money in 1993 to pay for his undergraduate education at the University of Arizona. After obtaining his B.A., he enlisted and served active duty in the United States Navy for five years. Following his tour, he attended Cardozo Law School, graduating in 2005 with student loans then totaling $116,464.75.

For the next 14 years, the debtor made a series of full and partial payments in varying amounts, and he requested and obtained several forbearances. At one point, he elected the income sensitive repayment option. In total, he missed only 16 payments, but despite his efforts, by November 19, 2019, with accrued interest and penalties, his student loan debt had ballooned to $221,385.49. The debtor commenced a bankruptcy proceeding seeking relief from his crushing debt and an adversary proceeding asking the court to declare the debt dischargeable.

The Court began its analysis by reviewing the applicable binding authority from the Second Circuit in Brunner v. N.Y. State Higher Educ. Servs. Corp. (In re Brunner), 831 F.2d 395, 396 (1987). In Brunner, the Second Circuit articulated a three-part test, which can be summarized as follows:

(1)    Would the debtor and any dependents be able to maintain, based on current income and expenses, a “minimal” standard of living?

(2)    Are there additional circumstances indicating that this state of affairs is likely to persist throughout the repayment period?

(3)    Has the debtor made a good faith effort to repay?

Chief Judge Morris examined the line of decisions that has purported to follow Brunner and concluded that the Brunner standard did not require the “punitive standards” that were being applied, and that they had “subsumed the actual language of the Brunner test.” The Chief Judge went on to hold that her Court would not participate in “perpetuating these myths” and would instead “apply the Brunner test as it was originally intended.”

In reviewing the undisputed facts and circumstances of this case for purposes of the first prong of the test, the Court concluded that the debtor had met the test to obtain a discharge from his student loans. Among other things, his schedules demonstrated that he had negative income each month, his student loan had been declared fully due and owing, and he was not eligible for a repayment plan. As for the second prong, the Court held that there was no requirement for a showing that the state of affairs would need to persist forever; only that it be likely to persist for a significant portion of the repayment period. Finally, as for the third prong, good faith, the Court held that it was inappropriate to consider a petitioner’s reasons for filing bankruptcy, the total amount of the petitioner’s debt, or whether the petitioner had previously rejected repayment options. In examining the debtor’s performance in this case, the Court found that he missed only 16 payments in the 13 years since his loan was originally initiated, and that he had met the test after factoring in all of the facts and circumstances surrounding his loan and forbearance history.

Conclusion

Given the trillions of dollars in student loan debt being shouldered by debtors today, the reliance of our academic institutions on the continued ability of students to obtain guaranteed-issue student loans, and the fact that reform of the student loan provisions of the Bankruptcy Code has been raised by at least one presidential candidate, this decision is virtually certain to receive continued attention in the lending and academic and legal communities. It will likely be reviewed by the Second Circuit, either on direct appeal or on appeal from another case, and it will be interesting to see how this precedent is treated by the Second Circuit and other courts in the future. In the meantime, it is worth noting that the fact that the loan had been accelerated weighed heavy in the Court’s analysis, and lenders will want to consider this factor in deciding whether to accelerate student loans in other cases. In so doing, they should consult with their bankruptcy attorneys in reviewing their lending practices and policies.