The United States Court of Appeals for the Seventh District just ruled that a student loan debtor could not discharge his loans in his consumer bankruptcy case. Lately I've been writing about bankruptcy cases where consumers have been able to discharge substantial amounts of student loan debt. You can see the articles here.
Before I go on I owe a hat tip to the kind reader who sent the court decision in to me. Thank you. If you have similar information you'd like to share with me, click here.
The case of Tetzlaff v. Educational Credit Management Corporation (ECMC) is a loss for Tetzlaff but a good lesson for other consumers who might want to discharge their loans through bankruptcy to pay attention to.
Other Courts have ruled that even if a consumer can't make payments on their student loan debt, it would not hurt their chances of having made a good faith effort to pay. Being unable to pay anything can't count against you if there is nothing available to pay.
For example, "The Court finds that this evidence of Conniff's status of being in a loan deferral provides further support for her claim that she cannot pay the debt and maintain a minimal standard of living without suffering an undue hardship and in addition, is evidence of good faith." - Source
But this case, Tetzlaff v. ECMC, is different because the Court determined Tezlaff had not really made a good faith effort to repay ECMC through regular payments, a deferment, or income driven payment program.
So let's look at the appeal details.
"Tetzlaff currently owes approximately $260,000 in student loan debt, which is guaranteed by Educational Credit Management Corporation. When Tetzlaff filed for Chapter 7 bankruptcy in 2012, he sought to have this debt discharged, claiming that repayment constituted an 'undue hardship' under 11 U.S.C. § 523(a)(8). After a trial, the bankruptcy court held that Tetzlaff's student debt could not be discharged."
"Tetzlaff is fifty-six years old and lives [XX] with his eighty-five-year-old mother; they both subsist on the income from her Social Security payments. Tetzlaff is divorced, has no children, and is currently unemployed. From the mid-1990s until 2005, Tetzlaff pursued a Masters in Business Administration from Marquette University, as well as a law degree from Florida Coastal School of Law ("Florida Coastal"). Most relevant to this appeal, Tetzlaff took out various federally guaranteed student loans to finance his graduate education. In 2004, Tetzlaff consolidated his student loan debt, and Educational Credit Management Corporation ("Educational Credit") is now the guarantor for the outstanding loan amount.
Tetzlaff has been unsuccessful at passing a state bar exam to date (although he has made two attempts). Prior to attending graduate school, Tetzlaff worked as a financial advisor, an employee-benefits consultant, an insurance salesman, and a stock broker."
At this point it seems like the Plaintiff has a similar case as others have made that would lead to an undue hardship student loan discharge.
But the standard which bankruptcy courts are currently using to determine if student loans are dischargeable in bankruptcy is called the Brunner test. That test requires debtors to show that:
(1) [he] cannot maintain, based on current income and expenses, a "minimal" standard of living for himself and his dependents if forced to repay [his] loans;
(2) additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period; and
(3) [he] made good faith efforts to repay the loans.
So on face value it looks like Tetzlaff might have qualified for the student loan discharge on part of those standards.
But here is where it appears things ran off the rails, the good faith effort to pay. According to the public court record, "The bankruptcy court noted that "[Tetzlaff] repaid much of the loan to Florida Coastal Law School, but nothing on the loan at issue in this adversary proceeding." Drawing on these facts, the bankruptcy court concluded that, as with the additional circumstances prong, Tetzlaff did not meet Brunner's good faith requirement."
The case comes down to this, "Educational Credit points to In re Roberta Spence, 541 F.3d 538, 545 (4th Cir. 2008), in which a debtor also sought to discharge student loan debt (also held by Educational Credit) and argued that her attempt to pay Perkins Loans should qualify as a "good faith" effort to re-pay her Educational Credit debt. The Fourth Circuit noted that "[Spence's] choice to repay some of the Perkins Loans does not demonstrate a good faith effort to repay the student loans held by [Educational Credit]."
In the Tetzlaff case the payments made to Florida Coastal is not what sank the discharge. Rather it was the failure to pay the ECMC loans. The Court concluded, "The bankruptcy court was not required to consider Tetzlaff's payments to Florida Coastal as evidence of a good faith effort to repay Educational Credit, as his Florida Coastal debt was not included in the discharge action. Furthermore, as the bankruptcy court noted, it seems that Tetzlaff repaid his debt to Florida Coastal largely because he needed the school's cooperation in releasing his diploma and transcript. Thus, Tetzlaff was motivated by certain incentives to pay down his Florida Coastal debt that do not apply to the repayment of his debt held by Educational Credit. Therefore, we decline to hold that the bankruptcy court erred when it refused to consider the repayment of debt not included in the loan discharge proceeding before it in making a determination of good faith under the Brunner test."
You can read the full appeal, here.
Bottom line, before pursuing a bankruptcy discharge for student loans, take some action to deal with your student loans in some way.
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This article by Steve Rhode first appeared on Get Out of Debt Guy and was distributed by the Personal Finance Syndication Network.