Category Archives: Bankruptcy

UPDATE: Even Newer Hope for Student Loan Borrowers Contemplating Bankruptcy

On the heels of this week’s discussion of the strategic potential of bankruptcy, even if a significant portion of debt is educational, comes a decision in the case In re Jeffrey Howell and Rebecca Howell, 11-12685, from the Bankruptcy Court in the Western District of New York.  Howell recognizes a peculiar difficulty for holders of student loans that I did not touch upon in my earlier post, namely, the difficulty debtors have in filing petitions under Chapter 7, rather than Chapter 13, when a significant portion of their debt is educational.  This is because a debtor with an income higher than the median income for his state, who nevertheless spends an inordinate percentage of his monthly income on the repayment of his student loans, has difficulty qualifying for a Chapter 7 bankruptcy, and is often forced to consider Chapter 13.

Chapter 13 is not without its advantages, which are beyond the scope of this discussion.  The disadvantage, for many debtors, is that Chapter 13 does not wipe the slate clean.  Debts are not completely discharged, but a percentage of debts are paid off over time, based on the debtor’s monthly disposable income.  Because, as previously discussed, student loans are generally not dischargeable in bankruptcy, whether in Chapter 7 or Chapter 13, a debtor who is forced to pursue a Chapter 13 plan will receive a stay of efforts by creditors to collect upon student loans during the Chapter 13 repayment period, but those loans will continue to accrue interest while the debtor is forgoing monthly student loan payments in favor of making payments on other debts under the Chapter 13 plan, often for a number of years.  The result, all too often, is that the debtor obtains some measure of relief for some of their debts, but ends up even further in debt on the educational loans, for which the debtor can obtain no meaningful relief through the bankruptcy system.

Offering a small ray of hope is Howell, courtesy of the Western District of New York’s Chief Bankruptcy Judge Carl Bucki.  Debtors whose monthly income is above the median, including those debtors who may have relatively high-paying employment offset by high monthly student loan payments, can defeat the presumption that a Chapter 7 bankruptcy filing is abusive by demonstrating that their student loan payments are “special circumstances” siphoning off their monthly disposable income.

Chief Judge Bucki’s ruling does not accord with other rulings across the country, such as those in Pennsylvania, Ohio, Arizona, Kansas and New Hampshire, but follows an emerging trend started by bankruptcy courts in Alabama, Illinois, Indiana, Delaware, Oklahoma and Georgia.  The Howell ruling also is not binding upon other bankruptcy courts in New York.  However, until a contrary binding authority appears, there is reason to believe that Howell will benefit debtors with significant student loans who would otherwise not be eligible for Chapter 7 relief.  It certainly must factor into the strategy of bankruptcy lawyers counseling debtors whose income has not yet caught up to their educational debt.

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How Not to Lose Your Discharge Before it’s Even Granted

The decision to file for Chapter 7 bankruptcy protection has become so momentous, so fraught with what-ifs and what-thens, that the general consensus is that it’s this act of filing that is the hard part.  The papers are filed, the automatic stay is imposed on creditors, the judge and trustee are assigned, the Section 341(a) meeting of creditors is scheduled, and the debtor breathes a sigh of relief.  What could possibly go wrong?

The actual discharge of a debtor from his debts in a Chapter 7 bankruptcy proceeding does not occur until, best case scenario, 60 days after the 341 meeting, which is a meeting at which the bankruptcy trustee and a debtor’s creditors can question the debtor, under oath, concerning the debtor’s assets and liabilities.  In clear-cut cases, where a debtor has a relatively small amount of consumer debt and no assets, the trustee should close the debtor’s 341 meeting and promptly file a Report of No Distribution with the bankruptcy court.  Then, at the expiration of the roughly 60-day period following the meeting, the debtor will receive a discharge and move ahead with the promised “fresh start.”

Often, however, the process hits a few road bumps along the way.  The United States Trustee requires each case trustee to examine certain financial records, including bank statements, credit card statements, tax returns, mortgage statements, insurance policies and other documents evidencing assets and/or liabilities, for debtors whose unsecured debt exceeds $100,000.  The trustee may seek these documents promptly, well before the 341 meeting, or only after meeting with the debtor.  While the trustee is investigating the debtor’s finances, he will generally hold the debtor’s 341 meeting open and ask the debtor to stipulate that the time for the trustee to object to the debtor’s discharge will be extended for a certain amount of time.  During that time, the court will not enter the debtor’s discharge.

This investigation has been a pitfall for more than a few debtors.  Trustees often request a standard list of documents from debtors, to be supplemented by additional documents tailored to each debtor’s situation.  For instance, if a debtor’s petition and schedules show an interest in a partnership, a trustee might ask for the partnership agreement.  If a debtor’s petition and schedules show that a debtor has income disproportionate to his assets, a trustee might seek documentation of his income.  All too often, debtors are not forthcoming with these documents.  Sometimes they are actively hiding assets, and don’t want to turn over evidence of their deception.  More often than not, they are simply poor record-keepers, which is part of why they’re in such dire financial straits to begin with.  Other times they simply do not have the time or energy to deal with the trustee’s requests, and stall hoping that the trustee won’t bother pursuing these documents.

This is ill advised, as all three of these scenarios can, and very often do, result in the denial of a debtor’s discharge.  Providing these and other documents to the trustee is an absolute requirement, and it is a valid basis for the trustee to commence an adversary proceeding objecting to a debtor’s discharge.  The same is true for the debtor actively hiding assets – if the trustee can show that the debtor lied under oath (whether in the petition or schedules, at the 341 meeting, in a hearing before the court or in a deposition or other discovery papers), the debtor will surely be denied his discharge.  Simply stating to the trustee that you don’t have the documents anymore, you threw them out, is not a defense to denial of discharge.  Debtors have an affirmative duty to keep and maintain all financial records, or obtain them from any accountant, bank, institution, school, agency or person who might have access to them.

Here’s where things can get very messy for the dishonest or lazy debtor.  If the judge decides to deny a debtor his discharge, none of the debtor’s debts will be discharged as part of that bankruptcy proceeding.  Furthermore, any debts the debtor attempted to discharge in that proceeding will never, ever be dischargeable, even in a future bankruptcy proceeding.  And, if the debtor has assets, they might still be liquidated to pay the debtor’s creditors, including the trustee and his attorneys, who expended a lot of money seeking documents from the debtor and litigating the objection to discharge action.  Sometimes it doesn’t even end there – for very egregious cases, the debtor may actually be prosecuted for bankruptcy crimes.

The moral of this story is that it ain’t over until the discharge is entered.  Simply filing a bankruptcy petition does not absolve you of your obligations, and in fact creates new ones, to the trustee and the court.  The petition and schedules are statements under oath.  Lying (or not being thorough) on these documents is perjury, and sometimes even fraud.

Attempting to hide assets from a trustee is not a good idea.  True, trustees have mountains of cases to review every month, but they each have systems in place to weed out potential fraud and asset cases.  One trustee in the Southern District of New York recently reviewed a case where the debtor disclosed that he was an “employee” of a company, but did not disclose that the company was actually registered to his home address.  His petition and schedules did not reflect any ownership interest in the company, but the trustee had to investigate.  As it turns out, the company is not profitable and it is not a valuable asset of the debtor’s estate.  However, because the debtor dragged his feet getting documentation concerning the company to his trustee, the trustee was forced to bring an objection to discharge action against the debtor.  In the end, the debtor produced sufficient documentation and was able to obtain his discharge, but not before his attorney and trustee and the court itself jumped through hoops of fire.  The judge had to set down a date certain for the debtor to comply with the trustee’s requests or else the judge would “seriously consider” a motion for a default judgment denying the debtor’s discharge – generally not something this judge would be willing to do.  That’s how close this debtor came to losing his discharge – and all over the (possibly inadvertent) omission of a worthless ownership interest in the bankruptcy petition and schedules.

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“Nondischargeable” student loans: if you can’t beat ’em . . . err, try again, and at least you can beat your other debts

In recent years, the old adage that nothing is certain in life, save death and taxes, has grown to include a third unavoidable certainty: student loans.  American students – including myself – have signed on the dotted line, many of us only days past our eighteenth birthdays, sentencing ourselves to at least a decade of educational debt controlling so many of our choices, from the choice of whether, where and when to attend graduate school, to whether and when to have children.  Most of us came into this debt with optimism and youthful exuberance.  When I took out my first educational loan, it was 1997.  I was using the money to attend a good college.  I had limitless potential and energy, and I believed that the economy would continue to be robust.  We all did.

Fast-forward 15 years, and though I indeed graduated, with honors, my first job was as a teacher in an expensive metropolitan area.  My next career move took me on a path that could prove lucrative, but my entry-level position was low-paying.  As the economy began its slow slide from those halcyon days of the ‘90s, my career path became less secure, and I made a decision that was generally regarded, at that time, as being one of the most prudent for long-term financial stability: I went to law school.  By the time I graduated in 2008, we were in a full-blown recession.

Unfortunately, a law degree just isn’t worth what it used to be.  Students in disciplines running the gamut from film theory to medicine are learning that a recession-proof degree is a myth.  Even more unfortunately, so many of us have paid dearly for those degrees, and will continue to pay disproportionate amounts of our monthly incomes toward repayment of our student loans, or else default.

While the Bankruptcy Code provides relief and a “fresh start” for debtors who owe just about any kind of debt, the debtor with educational loans who wishes to get out from underneath the crushing debt is usually out of luck.  Fearing that millions of students would borrow tuition money, earn their degrees and then immediately file for bankruptcy protection to get out of repaying those obligations spurred Congress to enact legislation barring all but the most unfortunate debtors, those with a verifiable “undue hardship,” from discharge of their student loans.  Congress never defined what “undue hardship” means, but here in the Second Circuit (New York, Connecticut and Vermont), debtors wishing to discharge their student loans must meet the stringent Brunner Test, named after the landmark case Brunner v. New York State Higher Education Services Corp., 831 F. 2d 395 (2d Cir. 1987).

In Brunner, the court adopted a three-pronged standard debtors must meet for discharge of their student loans.  First, a debtor must show that, if the debtor is forced to repay her student loans at her current level of income and expenses, she will be unable to maintain even a minimal standard of living for herself and her dependents, consisting of little more than food, shelter and medical insurance.  Second, the debtor must show that these circumstances are permanent, or at least likely to persist for a “significant portion” of the remaining repayment period.  Third, the debtor must show that she has made good faith efforts to repay the loans.

Generally, the Brunner test has been applied very strictly.  Here in the Southern District of New York, in the case Bacote v. Educational Credit Management Corporation, 2006 WL. 3732993 (Bankr. S.D.N.Y. 2006), the recently-retired Chief Bankruptcy Judge Arthur J. Gonzalez denied the discharge of the student loans of a 56-year-old unemployed debtor caring for her elderly, disabled husband because her employment options, though decidedly limited, were not completely foreclosed, and because her spotty repayment history did not sufficiently demonstrate good faith.  In a more recent Second Circuit case, this one coming from the District of Connecticut, In re Traversa, 2011 WL 5110214 (2d Cir. 2011), a debtor who had been unemployed since 2004, suffered from mental illnesses and sleep disorders and received monthly social security disability income of only $1,500 was denied the discharge of his student loans when he could not show that his condition was “likely to persist for a significant portion of the repayment period.”  This had led many in the legal profession to theorize, only partly in jest, that you could be a blind quadriplegic living in a box in Central Park with no income of any kind, and you will still never be out from under your student loans.  Theoretically, unless you are dead or in a persistent vegetative state (and even then, some still maintain hope!) there is still a chance you can be cured, no matter how unlikely.  Oh, and you could also win the lottery.  That might happen, too.

Not surprisingly, the onerous burden placed on would-be dischargers of student loan debt has dissuaded even the most economically disadvantaged from even attempting to obtain a ruling of undue hardship.  According to a recent New York Times article, fewer than 1,000 debtors across the country even attempt to bring undue hardship adversary proceedings as part of their bankruptcy cases.  That’s a very small subsection of the tens of millions of Americans currently struggling to repay their student loans.  However, some researchers at Emory University School of Law recently crunched the numbers, and determined that 57% of debtors who initiated adversary proceedings to discharge their student loans were able to get at least a portion of such loans discharged.  Another researcher from Princeton found that 39% of debtors receive at least partial discharges of student loans.  Perhaps these numbers are skewed, in that only debtors in the most dire of circumstances even attempt to obtain discharge of their student loan debts.  Yet, these figures do offer at least a small ray of hope in an otherwise defeatist and pessimistic area of bankruptcy law.

Even if a discharge, or partial discharge, of student loan debts is not ultimately possible, debtors who are struggling to repay educational as well as consumer debts should still consider bankruptcy as an option.  If a debtor is burdened with monthly debt repayment of, say, $2,000, representing $500 in student loan payments and $1,500 in credit card and other consumer debt, freeing up monthly disposable income to pay down the educational debt, without the crushing burden of the other debt, could be enough to get that debtor’s head back above water.  Just because bankruptcy may not eliminate the full extent of the debt in order to give the debtor a complete “fresh start,” it may still offer enough relief to give the debtor a “fresher start,” and may still be a viable option for those with educational debts.

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