JULIE A. ROBINSON, District Judge.
Educational Credit Management Corporation ("ECMC") appeals the order and judgment of the bankruptcy court determining that repayment of the student loan debt owed by debtors George and Melanie Johnson (collectively, the "Johnsons," or "Debtors") would constitute an undue hardship, and therefore was dischargeable under 11 U.S.C. § 523(a)(8). Having reviewed the record and the applicable law, the bankruptcy court's order and judgment are vacated and remanded for further proceedings consistent with this opinion.
The Appellant has elected to have the appeal heard by this Court.
In reviewing a bankruptcy court's decision, this Court functions as an appellate court and is authorized to affirm, reverse, modify, or remand the bankruptcy court's ruling.
Debtors George and Melanie Johnson financed their higher education, in part, through federally guaranteed student loans that they later consolidated into a spousal consolidation loan in 2005 ("the Loan"). George has a B.A. in sociology from the University of St. Mary's, and Melanie left school one class short of earning a degree in biology from University of California-Davis. ECMC, a guarantor in the Federal Family Educational Loan Program ("FFELP"), is the holder of the Johnsons' outstanding Loan.
Acting pro se, the Johnsons filed for Chapter 7 bankruptcy protection on October 6, 2011, and listed $73,010 in student loan debt, which constituted approximately 82% of their total unsecured debt. The Loan was incurred during the 1990s, and initially had a balance of approximately $63,000.
On November 10, 2011, the Johnsons brought an adversary proceeding, seeking discharge of the Loan.
Melanie Johnson works full-time at the Veteran's Administration (the "VA") as a billing supervisor, making approximately $40,000 per year. At the time of trial, her adjusted net income was $2,124.00 per month after payroll deductions.
The Johnsons also testified about their monthly expenses and spending habits. As detailed in their responses to interrogatories and on their Schedule J, the bankruptcy court found their total monthly expenses in 2012 were approximately $3922, after subtracting $100 allocated to repayment of the personal loan to George Johnson's uncle.
Based on their 2012 adjusted gross income ("AGI") of $60,000, the Johnsons were eligible for a monthly payment of $234 paid over a twenty-five-year period under the Income Based Repayment plan ("IBR"). The Johnsons did not pursue the IBR option, explaining that they were not aware of the IBR until shortly before the trial and had not applied. At the hearing, Melanie Johnson explained that they did not wish to consider the IBR because her oldest child would be starting college in six years and with three kids in college, it would be hard to "scrape by." She was also concerned that the IBR payments might increase in the future, with a cap at over $800 per month. Instead, both Debtors testified, they preferred a "fresh start," with a full discharge of the Loan. At the end of the hearing, counsel for ECMC explained that if the Debtors' income got down to a low enough number, they might be in a position that the monthly payment may pay off the balance and not require a twenty-five year period.
Section 523(a)(8) of the Bankruptcy Code states that a Chapter 7 discharge does not discharge an individual debtor from any debt "for an educational . . . loan made, insured or guaranteed by a government unit . . . unless excepting such debt from discharge under this paragraph will impose an undue hardship on the debtor and the debtor's dependants[.]"
The debtor must prove all three elements by a preponderance of the evidence to be entitled to a discharge.
In this case, the bankruptcy court discharged all of Debtors' Loan based on its finding that failure to discharge the student loan debts would impose an undue hardship on the Debtors. As a preface to its analysis, the court engaged in a general critique of the student loan system, noting the burden it poses on society and the "skyrocketing" costs of higher education. The court concluded that the "reality is that even if the Debtors' gross income were $60,000 per annum, providing for a family of five would be a Herculean task."
ECMC contends that the bankruptcy court's decision to discharge the Loan was improper, and takes issue with a number of the factual findings made by the court with regard to the Brunner factors. The Court discusses ECMC's arguments in turn.
Under the first prong, the Court must "evaluate the debtor's current financial situation" and "take into consideration whether the debtor has demonstrated any reason why he or she is unable to earn sufficient income to maintain him/herself and dependants while repaying the student loan debt."
With regard to this inquiry, the bankruptcy court found that "the record establishes that Debtors barely maintain a minimal standard of living, even without repaying the Loan." The court noted that Debtors' projected expenses were actually too low, and did not include adequate budgeting for items such as household maintenance, car repair expenses, or unforeseen medical expenses.
ECMC contends that this finding was erroneous and points to a number of what it characterizes as "gratuitous items" in Debtors' spending history, including multiple sports activities, frequent dining out, and a $200 monthly recreation budget. ECMC also takes issue with expenses related to the Johnsons' three children, such as food, birthday party gifts, sports equipment and fees, clothing, and expenses for school trips, arguing that many of these expenses are temporary and will gradually phase out as the children reach the age of majority.
It is undisputed, however, that at the time of trial George Johnson had been laid off from his job and was bringing in next to no income to support the family. When subtracted from the bankruptcy court's estimated reasonable expenses of $3,922, the Debtors' available net monthly income is negative $1,797.84. Even assuming that the "gratuitous" items to which ECMC objects are subtracted from their budget, at the time of trial, Debtors' budget was significantly in the red. Accordingly, the Court finds the bankruptcy court's findings on this factor are not clearly erroneous.
The second prong of the Brunner test requires that additional circumstances exist indicating that the debtor will be unable to repay the loans while maintaining a minimal standard of living for a significant portion of the repayment period, and "properly recognizes that a student loan is viewed as a mortgage on the debtor's future."
The bankruptcy court concluded that this prong has been satisfied, noting again that the Johnsons' projected monthly expenses for car payments, maintenance, and gasoline were unrealistically low and would most likely be offset by future expenses. The court found that based on their income history and increasing costs of their family, "this state of affairs is likely to persist for a significant portion of the Loan's repayment period."
Significantly, the bankruptcy court reasoned that the second prong does not apply to the Johnsons because the court believed the ten-year repayment period of the Loan had already expired. The court explained,
While stopping short of determining the bankruptcy court's findings on the second prong were clearly erroneous, the Court believes that Brunner and its progeny dictate a more searching inquiry. As ECMC notes, the bankruptcy court devotes scant analysis to the second prong and at best, concludes that the Johnsons' expenses will remain constant. While the bankruptcy court found that George Johnson is a healthy young male, and that he was optimistic about finding employment, the court failed to consider whether his unemployment constitutes an additional circumstance that is likely to persist into the future. Indeed, Mr. Johnson testified that the feedback he had received from potential employers was that he was overqualified for the positions for which he applied. Moreover, the court did not address Mr. Johnson's employment history, skills, and future earning potential—instead, its discussion was limited to Mrs. Johnson's employment and salary history with the VA. The court did not explore whether taking jobs in other fields was a possibility or might put Mr. Johnson in better financial standing.
ECMC also takes issue with the bankruptcy court's reasoning that the Johnsons met their burden or that prong two does not apply to them because the court believed the repayment period of the Loan had already expired—which it characterizes as a clearly erroneous fact not supported by the evidence. ECMC contends that when the Johnsons received their Loan in 2005, it was subject to a 30-year repayment term, which was further extended by multiple deferments and forebearances.
Given the record before it, the Court cannot say that the bankruptcy court was on solid ground in its determination that Debtors met their burden on the second Brunner prong. Accordingly, the Court remands for further analysis and clarification on whether George Johnson's unemployment is temporary, his future earning potential, and the correct repayment period of the Loan.
Similarly, the bankruptcy court's analysis of this third prong also deserves closer scrutiny. The third prong of the Brunner test requires the Court to consider whether the debtor has made a good faith effort to repay the student loan debt "as measured by his [or] her efforts to obtain employment, maximize income and minimize expenses."
The bankruptcy court found that "Debtors' small voluntary payments toward their loans, the consolidation of those loans, and the Debtors' efforts to stay in contact with the student loan creditor establishes that they were acting in good faith." As noted by the bankruptcy court, a debtor's pursuit of loan consolidation is a component of the good faith analysis as it may demonstrate that a debtor takes the obligation to pay seriously and that he is doing what he can to repay despite his circumstances.
Here, it appears that the Debtors qualify for the IBR, where the amount of monthly payments on the Loan is calculated based on their monthly income; if Debtors earn less than 100% of the federal poverty line (150% of the IBR), they would not be obligated to make any payments while that condition persisted, and after twenty-five years, any remaining debt would be forgiven. The record indicates that ECMC calculated an IBR payment based on Debtors' 2012 AGI when both of them were working; although counsel indicated the payment would be income-based, there was no evidence of what the payment would be, if anything, while George Johnson was unemployed. The bankruptcy court merely mentions in passing the IBR in its statement of facts, noting there were potential income tax concerns. In Alderete, however, the Tenth Circuit held that failure to seriously consider these repayment alternatives is an important factor to consider in the good faith analysis.
Although this Court's review of the ultimate issue of undue hardship is de novo, that review must be predicated on an analysis that fully takes into account the record adopted by the parties. It would be inconsistent with the Bankruptcy Code's goal of providing a "fresh start" for qualifying debtors to eliminate from this analysis a debtor's potential earning capability after a period of temporary employment, the term of repayment, and a program to restructure that debt as factors in the undue hardship analysis.
Accordingly, in view of the heavily fact-dependent nature of the undue hardship inquiry, the Court will vacate the judgment of the bankruptcy court and the case is remanded for further proceedings to make more complete findings under the second and third factors under the Brunner test as discussed above. Of course, the bankruptcy court may reassess its views or reaffirm those already stated, with a more fully developed explanation; the Court leaves to the discretion of the bankruptcy court whether such an explanation requires the parties to supplement the record with additional evidence.
