Alert April 16, 2013

Seventh Circuit Permits Discharge of Student Loan in Bankruptcy Proceeding

The United States Court of Appeals for the Seventh Circuit ruled that a borrower can discharge her student loans under the bankruptcy code. Generally, the bankruptcy code prevents discharge of student loan debt unless the debtor shows that requiring her to repay the loan constitutes "undue hardship." The bankruptcy court ruled that the debtor who incurred student loans to finance her paralegal education showed "undue hardship"—she applied for over 200 jobs over a 10-year period without success, after which she moved to a rural area with few jobs available to live with her retired mother. The student loan servicer appealed arguing that the debtor had failed to diligently search for work and that she did not apply to any non-paralegal jobs. The district court agreed and reversed.

In deciding to reverse the district court’s ruling and reinstate the bankruptcy court’s ruling, the Court started by recognizing that the bankruptcy code did not strictly forbid discharge of student loan debt—as the code does for crime- or fraud-related debts—but instead allowed discharge upon a showing of hardship. The Court agreed with the bankruptcy court in concluding that the debtor’s situation was "hopeless"—a burden, according to the Court, "more restrictive than the statutory [showing of,] undue hardship." Finding there was no basis to reverse the bankruptcy court’s discretionary determination that the debtor showed no ability to pay, and no realistic chance of ever repaying the debt despite her good-faith efforts, the Court reinstated the bankruptcy court’s ruling and held that the debtor’s educational debt was dischargeable.

Of import was the concurring opinion authored by Judge Daniel Manion. While agreeing that the wide latitude allowed bankruptcy judges in determining "undue hardship" required the Court to uphold the bankruptcy court’s determination, Judge Manion disagreed that the bankruptcy judge reached the right result. In particular, Judge Manion focused on the debtor’s 200 applications over a 10-year period noting that it was less than two job applications per month. Most notably, however, Judge Manion inquired whether given the current state of affairs in which many people struggle to make payments on their student loans, other similarly situated debtors might "see in this case and perhaps others like it an excuse to avoid their own student-loan obligations."