Student Loan Debtor May Reject Zero-Payment Plan in Good Faith

Posted by NCBRC - December 11, 2014

Finding the debtor to be “honest but unfortunate,” the bankruptcy court discharged her student loans so that she could “sleep at night without these unpayable debts continuing to hang over her head for the next 25 years.” Lamento v. U.S. Dept. of Educ. No. 14-1054 (Bankr. N.D. Ohio Oct. 31, 2014).

The 35 year old debtor got married prior to finishing college and, at the insistence of her abusive husband, neither finished school nor found employment. After the birth of two children, a number of marital separations and finally divorce, and two more attempts to complete a post-high school education, the debtor was left with single-parenthood, no completed education, a minimum wage job, dependence on her mother, and student loans totaling approximately $72,000. The lenders (or their successors), ECMC and the U.S. Department of Education, each offered zero payment plans based on the debtor’s low income with the possibility of complete loan forgiveness after 25 years. The debtor refused the offers and sought, instead, to discharge the loans in bankruptcy.

Addressing objections by the lenders the court applied the three part test set forth in Brunner and applied by the Sixth Circuit: “(1) that 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) that additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the re-payment period of the student loans; and (3) that the debtor has made good faith efforts to repay the loans.” Brunner v. New York State Higher Educ. Serv. Corp., 831 F.2d 395, 396 (2d Cir. 1987).

There was no real contention with respect to the first prong of the test: the debtor could not maintain a minimal standard of living even taking the loans out of the equation. With respect to the second prong, the lenders argued that the debtor was young and in good health and once her children were independent she would likely have the means to make payments on the loans. ECMC further argued that by failing to complete any of her post-high school education the debtor had failed to maximize her earning potential (the US lender did not join this argument).

The court found these arguments unrealistic. The debtor currently was limited to minimum wage jobs and had neither the time, means, nor support to further her education in the foreseeable future. Any other conclusion would necessarily rely on speculation.

Finally, the lenders argued that the debtor’s failure to accept the zero payment plan they offered amounted to bad faith. The court noted a number of factors used in the Sixth Circuit to determine good faith: “(1) was the debtor’s failure to pay due to factors beyond her reasonable control; (2) did the debtor use all available resources to pay the debt; (3) is the debtor making her best effort to maximize her earning potential; (4) how soon after the loan first became due did the debtor seek to discharge the debt; (5) what is the percentage of the student loan debt in relationship to the debtor’s total debt; and (6) has the debtor obtained a tangible benefit from the student loan debt.” A court will also look at the debtor’s repayment history, efforts toward obtaining maximal employment and minimizing expenses, and participation in “alternative repayment programs.”

The court noted that the fact that the debtor continued to borrow money despite failing to complete her education was mirrored by the lenders’ continued lending of the money. Therefore, that in itself did not constitute bad faith. Moreover, there was no real question as to whether the debtor was doing the best she could with respect to employment and expenses. Instead, the lenders rested on the fact that she had turned down offers to reduce her payments to zero, reasoning that the only purpose she could have in turning down the offers would be to avoid having to pay back the loans if and when she became solvent.

Recognizing the Catch-22 this argument poses, the court said “the only way for [debtor] to show good faith would be if she agrees to forego her undue hardship lawsuit. That would mean that any debtor who decided not to participate would be subject to a per se finding of lack of good faith[.]” But, the court found, there are valid reasons for rejecting a zero-payment offer such as: futility based on low prospects for future income; lender-imposed requirements that the borrower agree to the non-dischargeability of the loan; the debtor’s ongoing duty to supply annual information regarding her financial condition; the psychological burden of carrying unpayable debt. The court concluded that the debtor had proven entitlement to a hardship discharge.

Neither lender appealed this decision.

Lamento Bankr ND Ohio opinion


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