The Eighth Circuit Court of Appeals recently affirmed a decision made by its Bankruptcy Appellate Panel last year that may grant a student loan borrower discharges on 15 separate private student loans totaling more than $118,000. The bankruptcy panel relied on a unique treatment of ability to repay that is not used in any other circuit.

Student loans are notoriously difficult to discharge in bankruptcy, the primary reason being a strict standard of “undue hardship” in determining a borrower’s ability to repay the loans. In order for a student loan to be discharged, a debtor must prove that they haven’t been able to, currently cannot, and will not in the future reasonably make payments on the loan.

Most courts use the three pillars laid out in a 1987 case, Brunner v. New York State Higher Education Services to determine if a student loan debt is dischargeable in bankruptcy. In order to be granted discharge under the “Brunner test,” a debtor must prove:

  1. He cannot maintain a minimal standard of living for himself and his dependents if forced to repay the loans,
  2. That additional circumstances exist that tend to indicate that this condition is likely to persist for a significant portion of the life of the loan, and
  3. That he has made a good faith effort to repay the loan.

Most petitions fail this test because monthly payments are typically not egregious enough to trigger the first pillar and the second pillar fails since most student loan borrowers have a college degree, which bankruptcy courts can point to as evidence their situation will improve at some point.

But recent economic developments, combined with soaring higher education costs, have changed the calculus somewhat.

This factored in to the recent case Conway v. National Collegiate Trust.

Conway graduated with a B.A. from Webster University and about 20 student loans totaling more than $100,000. She initially found full time work in her field but was laid off from two different jobs between graduation and late 2008. She filed for bankruptcy protection and sought the discharge of many of her private student loans (she also had some $18,000 in federal-backed loans that were not part of the proceedings).

Conway was granted discharge on $20,000 in private student loans to two other lenders. But the 15 loans held by National Collegiate Trust (NCT) were contested by the lender. In November 2012, the total balance owed on the loans, including interest, was $118,579.66.

A bankruptcy court in Missouri sided with the lender and did not allow the debts to be discharged. The court argued that while Conway cannot reasonably make payments now, her degree and “well-developed writing and reasoning skills” gives her “at least 30 years left to navigate the job market” and turn things around.

But on appeal, the 8Th Circuit’s Bankruptcy Appellate Panel (BAL) overturned that decision, noting that if Conway made the minimum monthly payments of $846.17 on all 15 loans, she could not maintain a minimum standard of living. Instead, the panel insisted that each loan be individually evaluated to determine dischargeability.

Rather than using the Brunner test, the BAL used a “Totality of the circumstances” test to determine whether repayment would be deemed a hardship. That standard uses the debtor’s past, present and future financial resources to determine hardship.

Since being laid off for the second time in late 2008, Conway has been working part-time as a server in various restaurants. The BAL used her income as a server against her monthly expenses to support its finding of undue hardship. The panel noted that it could not speculate on Conway’s future earnings should she find another job in her field, writing, “We will not substitute assumptions or speculation for reasonably reliable facts.”

NCT appealed the decision to a judicial panel in the 8th Circuit. That three-judge panel affirmed the decision in June.

The decision is ultimately very narrow. It applies only to the Eighth Circuit — which covers the Dakotas, Minnesota, Nebraska, Iowa, Missouri, and Arkansas – and is not a formal discharge order; the lower bankruptcy court must still evaluate each of the 15 student loans to determine which Conway can reasonably repay.

But creditors and bankruptcy specialists are noting the apparent easing of the Brunner test standard. Bankruptcy specialist ARM firm Weltman, Weinberg & Reis wrote on its blog, “…courts in other circuits may start to relax their analysis of the undue hardship test in Brunner.”

With the job market still depressed and soaring student loan balances which result in high minimum monthly payments, bankruptcy courts may indeed look to other criteria to determine ability to repay.

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