Student Loans In Chapter 13 Bankruptcy: Recent Court Decisions Show A Disturbing Trend

Student loans have achieved a unique position in the world of debt. Those student loans with federal guarantee or public sponsorship have no statute of limitations on collection. Authorized debt collectors have extrajudicial tools they are allowed to use for collection and they are given access to the Federal Payments Levy Program that allows a continuous collection levy against federal payments such as social security. They are only dischargeable under the “Brunner Test” in cases where the debtor is beset by the most hopeless of circumstances.  Then, under that often cited test, even when an appropriate level of hopelessness is achieved, a discharge is available only when the debtor has made reasonable efforts at payment and there are “additional circumstances.” see Brunner v. New York State Higher Education Services Corp., 831 F.2d 395 (2d Cir. N.Y. 1987)
The individual consumer with slightly above median income, substantial unsecured consumer debt, and a large outstanding student loan balance often ends up in a difficult situation when resorting to Chapter 13 for relief from oppressive collection measure brought to bear in the event of default.  In granting student loans their unique privileged status as unsecured, nonpriority, nondischargeable debt, Congress created a situation pitting the debtor against other unsecured creditors concerning which will be most disadvantaged in order to preserve the entire claim of the student loan creditor.
A number of courts (In re Templeton, 365 B.R. 213 (Bankr. W.D. Okla. 2007); In re Haman, 366 B.R. 307 (Bankr. D. Del. 2007); In re Delbecq, 368 B.R. 754 (Bankr. S.D. Ind. 2007)); In re Martin, 371 B.R. 347 (Bankr. C.D. Ill. 2007); In re Knight, 370 B.R. 429 (Bankr. N.D. Ga. 2007); In re Robinette, 2007 Bankr. LEXIS 3523 (Bankr. D.N.M. Oct. 2, 2007)) have allowed student loan payments as a special circumstance in means testing. There appears to have been a shift late in 2007, with U.S. trustees acting in the interest of other unsecured creditors showing more disposition to refuse to confirm such plans and arguing more forcefully for requiring above median debtors with substantial student loan obligations to file under Chapter 13. The pivotal case appears to be In re Vaccariello, In re Vaccariello, 375 B.R. 809 (Bankr. N.D. Ohio 2007), cited as precedent by in re Champagne, Lexis 953, U.S. Bankruptcy D. Kansas, April 4, 2008. All ten such cases decided since January 1, 2008 resulted in refusal to confirm the Chapter 7 plan. In five of these (In re Wagner, Lexis 725, U.S. Bankr. Nebraska 2008; In re Walker, 383 B.R. 830 (Bankr. N.D. Ga. 2008); Stapleton v. Haynes, Lexis 192, Bankr. L. Rep. (CCH) p81, 117, U.S. Bankr. M.D. Pennsylvania, January 25, 2008; In re Reimer, Lexis 517, U.S. Bankr. N.D. Ohio, Feb 21, 2008; and, In re Nolan, 2008 Lexis 1588, U.S. Bankr. N.D. Ohio, May 20, 2008), the debtors’ incomes were well above median and the student loan payments were not the only disputed expenses. Wagner and Walker involved parental PLUS loans. In re Kaminski, 2008 Bankr. Lexis 1211, U.S. Bankr. N.D. Ohio, April 14, 2008, and In re Redmond, Bankr. Lexis 1495, U.S. Bankr. S.D. Texas, April 14, 2008, involved debtors of more modest circumstances.  Courts (such as Delbecq) that allowed student loan payments as a special circumstance accepted the argument that the debtor had no reasonable alternative to making the loan payments, and ruled that this was adequate to establish special circumstances within the meaning of the bankruptcy code.
The recent decision in In Re Champagne draws upon two earlier cases, Vaccariello and In re Pageau, 2008 BNH 1 (Bankr. D.N.H. 2008).  The Vaccariello case presents many atypical features which distinguish it from the typical student loan in bankruptcy. The Vaccariellos initially scheduled the student loan as a priority debt.  They were cosigners on a student loan taken out for their son who developed mental problems in college.  This was presumably a private student loan as Federal Family Education Loan Program (FFELP) loans do not normally require cosigners. There is no information in the case record about when they incurred the loan; it may well be one which became nondischargeable after the fact due to BAPCPA.  Neither the Vaccariello opinion nor the Champagne opinion which cites it extensively address whether changes to the bankruptcy laws which substantially and adversely affected payment options long after the loan was incurred might weigh in favor of a special circumstances determination. The court in Vaccariello stated that: “It is not the obligation to repay a loan itself that qualifies an expense as a special circumstance under §707(b)(2)(B)(i) but rather it is the circumstances that lead to incurring a loan that must be special and justify the inclusion of this additional expense item in the means test.”
In reaching its decision in Champagne, the court relied on three lines of reasoning:
(1) That finding in favor of the debtor would result in a per se rule that nondischargeability of student loans automatically makes them a special circumstance.
(2). That the present circumstance was not unusual.
(3). That the circumstances under which the individual incurred the loan were not unusual.
The court added, “It is the nondischargeability of student loans which cause a debtor to be faced with unsatisfactory alternatives, but the flexibility of the special circumstances rebuttal of the presumption of abuse does not have as its purpose the mitigation of economic hardship resulting from nondischargeability.”
If the court refuses a debtor’s attempt to file for bankruptcy under Chapter 7, there remain two possibilities under Chapter 13, viz:
  • Pay the student loan as scheduled outside of the Chapter 13 plan, resulting in a low dividend to other unsecured creditors and possible challenge on grounds of unfair discrimination against them, or
  • Pay ongoing student loan payments through the Chapter 13 plan, resulting in a higher dividend to unsecured creditors but allowing unpaid interest on the student loan to accumulate and capitalize, creating a negative amortization situation.
The legal issues are more complex than in means testing, because the court must balance the degree of harm the unsecured creditors experience because of discrimination against the harm done to the debtor because her fresh start is being further compromised by negative amortization. Some courts have used the four prong Wolff Test, based on a 1982 business Chapter 13 case (in re William Kyle Wolff, B.A.P. 9th Circuit, 22 B.R. at 512) to resolve the discrimination issue. This test is highly subjective and results in contrary rulings under circumstances which are at least broadly similar.
The trend in the last three years, at least in the 9th circuit, has been not to allow payment of student loans outside of a Chapter 13 plan.  In contrast, a very recent decision by a Pennsylvania bankruptcy court (In re Orawsky, U.S. Bankr. E.D. Pennsylvania, May 2, 2008) provides a well-reasoned argument for discrimination while In re Zahringer, 2008 Bankr. LEXIS 1770 (Bankr. E.D. Wis. May 30, 2008), disallows special treatment, relying on the small total value of the outstanding loan. 
This same period has also seen an increasing proportion of Chapter 13 cases involving student loans. At the same time, the courts in Champagne and Pageau used the possibility of separate treatment of student loans in Chapter 13 as part of the rationale for refusing to consider those loans a special circumstance – while declining to consider evidence that the option was becoming increasingly unavailable.
None of the three options (Chapter 7, separate treatment, payment through the plan) does a particularly good job of achieving either of the underlying aims of the bankruptcy code: ensuring equitable treatment of creditors or removing ongoing unaffordable debt obligations as a barrier to a person’s future economic viability as a member of society. Unless the debtor has a reasonable expectation of emerging from a Chapter 13 plan with either a significantly higher income or significantly reduced living expenses, even careful management will not long forestall falling back into a debt trap when the ongoing student loan payment reduces available income below median. This is because the differential between median income and income needed to maintain a minimal standard of living without subsidies is not large – about $8000 a year for a family of four in Portland Oregon in 2006.[1]
In an economy characterized by sharply rising costs for food, fuel, housing, and unreimbursed medical care, stagnant wages, rising unemployment, and a large birth cohort (many of them still carrying their own student loans or loans incurred for their children) entering retirement, the value of a “fresh start” still encumbered by a huge student loan obligation is seriously overrated.
There is not much a bankruptcy attorney can do to address this fundamental economic bind: billions of dollars of outstanding unaffordable student loans which do not amortize, cannot be discharged, and will eventually become uncollectible. The Champagne decision, however, stands out as one which is both (1) prejudicial to the debtor without providing any real benefit to general unsecured creditors, and (2) is based upon premises (that a common circumstance cannot qualify as a special circumstance and that the circumstances which led to incurring a debt must themselves by unusual for an obligatory payment to qualify as a special circumstance in means testing) which, were they to be generally applied, would drastically emasculate an already enfeebled and compromised bankruptcy code.

[1] Calculated from a Washington State website on self sufficiency income and evaluating welfare-to-work programs.
  • Anonymous

    That’s very true that Student loans have achieved a unique position in the world of debt. Those student loans with federal guarantee or public sponsorship have no statute of limitations on collection.

  • Anonymous
    This is a great article on the nuances of bankruptcy law, specifically student loan debt and how cosigners who go through bankruptcy are affected. Thank you Lexis.