Bankruptcy Newsletter

Student Loan Debt Wasn't Means Test "Special Circumstance"
The nondischargeable student loan debt of Chapter 7 debtors did not present a "special circumstance" rebutting the presumption arising under the means test that the debtors' case should be dismissed as an abuse of Chapter 7, an Arizona bankruptcy court ruled as an issue of first impression for that court.

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The nondischargeable student loan debt of Chapter 7 debtors did not present a "special circumstance" rebutting the presumption arising under the Bankruptcy Code's means test that the debtors' case should be dismissed as an abuse of Chapter 7, an Arizona bankruptcy court ruled as an issue of first impression for that court. Nothing suggested that the debtors had incurred the debt other than in the ordinary course of obtaining their college educations, and since the debtors would not have to make any loan payments while in Chapter 13, the debt would not leave them with insufficient income to fund their obligations under a hypothetical Chapter 13 plan.

The United States Trustee (UST) moved to dismiss the debtors' Chapter 7 case for presumed abuse of the provisions of Chapter 7 pursuant to 11 U.S.C.A. § 707(b)(2). Under § 707, the Arizona bankruptcy court explained, a court may dismiss the Chapter 7 case of an individual debtor with primarily consumer debts if granting relief would be an abuse of Chapter 7. Whether a presumption of abuse arises is determined under the Code's means test, which involves a detailed examination of the debtor's income and expenses. A presumption of abuse arises if, after certain allowable expenses are deducted from the debtor's "current monthly income," which is determined based upon the debtor's income from the six-month period immediately preceding the debtor's petition filing, the debtor's remaining income, as calculated over a five-year period, either exceeds $10,950 or falls between that amount and $6,575 and would pay more than one-fourth of the debtor's unsecured debt.

Performing the means test calculations for the debtors before it, the bankruptcy court determined that the debtors had monthly disposable income of $414. Multiplying that amount by 60 produced a result demonstrating that the debtors were subject to a presumption of abuse of Chapter 7. To rebut that presumption, pursuant to § 707(b)(2)(B)(i), the court indicated, the debtors had to demonstrate "special circumstances...to the extent such special circumstances...justify additional expenses or adjustments of current monthly income for which there is no reasonable alternative." The debtors relied upon their nondischargeable student loan debt, which totaled $456 per month, to establish such "special circumstances." According to the debtors, their student loan debt was a "special circumstance" because they had not been able, for the prior three years, to make more than interest-only payments on the first mortgage on their home. Both debtors had graduated from college, and apparently were unable to defer payments on their student loans or further restructure them.

The court explained that a debtor had to satisfy both procedural and substantive requirements to establish "special circumstances" rebutting the presumption of abuse of Chapter 7. Procedurally, the debtor had to itemize the additional expense or adjustment of income, provide supporting documentation and a detailed explanation of the special circumstances showing that the expenses or adjustment to income were necessary and reasonable, and had to attest under oath to the accuracy of the information supplied. The substantive requirements, however, were "less clear." Under the statute, a "special circumstance" had to justify additional expenses or a reduction in income for which there was no reasonable alternative. "Special circumstances" was not defined by the Code, which instead provided two examples: a serious medical condition and a call or order to active duty in the Armed Forces.

The bankruptcy court thus turned to the language of the statute and concluded that the examples given in the statute were not meant to be exhaustive. The court noted Congress's use of the words "such as," which implied that the examples provided were merely illustrative, and cited the statute's legislative history, which indicated that the examples were given not to define "special circumstances" but to ensure that those covered by the examples received the statute's protection. The court noted, furthermore, a split of authority on the issue of whether "special circumstances" had to be of an involuntary nature or otherwise beyond a debtor's control. Although the examples given frequently involved forces outside the debtor's control, the court pointed out that a serious medical condition could arise from a debtor's conscious choices, and, absent a draft, a call to active duty would result only from the debtor's voluntary membership in the armed forces.

Some courts, the bankruptcy court explained, had ruled that the circumstances which led to the debtor incurring a student loan obligation had to be special to justify including the additional expense of the obligation in the means test; the obligation to repay a student loan did not itself qualify as a "special circumstance." Those courts had focused on the reasons for incurring the debt, recognizing that incurring student loans was generally not due to something special. "But this Court is not sure that the circumstances leading to the incurring of student loan debts would even qualify as 'special circumstances' for purposes of § 707(b)(2)(B)(I)," the bankruptcy court said. And since the debtors before it did not identify any special circumstances that had caused them to incur their student loan obligations, the court assumed that the loans arose in the ordinary course of the debtors' obtaining their college educations. Without more, the court reasoned, the debtors' student loan obligations did not rise to the level of "special circumstances" under the statute.

The debtors asserted that the fact that their student loan debt was nondischargeable was sufficient to establish a "special circumstance." The court acknowledged that student loan debts received different treatment under the Code, in that they were dischargeable only upon a showing, pursuant to 11 U.S.C.A. § 523(a)(8), that excepting the debt from discharge would impose an undue hardship upon the debtor and the debtor's dependents. The debtors, however, did not claim to satisfy the Brunner test used to establish undue hardship.

The bankruptcy court noted the disagreement among courts as to whether the nature of student loan debts as generally nondischargeable was to be considered in determining whether they presented a "special circumstance." Although some courts had concluded that such debts qualified as per se "special circumstances," on the grounds that they were nondischargeable and debtors thus had no reasonable alternative to repayment, the Arizona bankruptcy court disagreed. "[I]f nondischargeability standing alone were sufficient to constitute a 'special circumstance,' Congress would have said so," the court opined, or Congress likely would have made them an allowable expense, as it had with priority claims. "Congress['s] failure to treat nondischargeable debts the same as priority debts suggests that they should not be regarded as 'special circumstances' to achieve the same result," the court reasoned.

Other courts, the bankruptcy court continued, had concluded that student loan debts were not "special circumstances" because they were nondischargeable, but because repayment of the debts had become onerous due to such misfortunes as catastrophic illness and military deployment. In general, courts had found a lack of a reasonable alternative to repayment only for documented reductions in income or unusual expenses that would have to be paid in full during a hypothetical Chapter 13 plan period. Disagreeing with the holdings in In re Delbecq, 368 B.R. 754 (Bkrtcy.S.D.Ind. 2007), and In re Knight, 370 B.R. 429 (Bkrtcy.N.D.Ga. 2007), the bankruptcy court found that a Chapter 13 repayment provided a reasonable alternative to raising the debtor's expenses to avoid the presumption of abuse under the means test.

The means test was intended, the court explained, to provide a mechanical formula for determining whether Chapter 7 debtors had the means to repay a portion of their debts and thus should be required to do that, through a Chapter 13 filing, to obtain a bankruptcy discharge. The "special circumstances" exception to the means test presumption was intended as a safeguard to allow the consideration of additional expenses or reductions in income that were not accounted for in the means test but which would prevent the meaningful repayment of the debtor's obligations under a Chapter 13 plan. The court recognized that some courts had refused to consider the potential return to a debtor's unsecured creditors under a hypothetical Chapter 13 plan to determine whether "special circumstances" existed. It disagreed, however, in light of Congress's clear intent to steer debtors with an ability to pay a higher portion of debts into Chapter 13 filings. It concluded, rather, that "the hypothetical Chapter 13 should be considered when determining whether nondischargeable student loans constitute a 'special circumstance' sufficient to rebut the statutory presumption of abuse." It then explained that, pursuant to 11 U.S.C.A. § 1322(b)(5), the debtors, though permitted to make regular student loan payments under a Chapter 13 plan, were not required to do so. The debtors would thus not be left without sufficient income to meet their obligations under a Chapter 13 plan.

Treating the nondischargeability of student loan debt as per se "special circumstances" would effectively reverse the holding reached in In re Labib-Kiyarash, 271 B.R. 189 (9th Cir.BAP 2001), by the Bankruptcy Appellate Panel for the Ninth Circuit, the bankruptcy court said. Student loans could be paid in full while other unsecured debt was paid nothing and discharged, despite the debtor's ability, as demonstrated by the means test, to make meaningful payments under a Chapter 13 plan. Moreover, any collection methods of a student lender creating "special circumstances" requiring the debtor to maintain payments pursuant to § 1322(b)(5) were properly used to demonstrate the fairness of discrimination in a Chapter 13 plan's designations of classes of claims under § 1322(b)(1), and not "special circumstances" permitting a Chapter 7 discharge.

Despite the debtors' argument that their student loan debts presented a "special circumstance" rebutting the means test's presumption of abuse, due to their inability to make more than interest-only payments on their home mortgage, the court concluded that the debtors did not show unusual circumstances resulting in a reduction of income or unusual expenses for which there was no reasonable alternative but to pay. Thus, the "special circumstances" exception did not apply, and the debtors' case would be dismissed for abuse of Chapter 7 absent a timely motion to convert the case to Chapter 11 or Chapter 13. In re Carrillo, 2009 WL 4884053 (Bkrtcy.D.Ariz., Judge Haines).

A transfer that occurred during the "gap period" between entry of an order dismissing the debtor's Chapter 11 case and reversal of that order on appeal and reinstatement of the case, when an escrow agent released a quitclaim deed executed by the debtor in favor of the deed of trust creditor and the deed was recorded, involved a transfer of an "interest of the debtor in property," as opposed to a transfer of "property of the estate," as required for the avoidance of the transfer pursuant to the strong-arm statute. A bankruptcy judge in Tennessee rejected the creditor's assertion that the strong-arm statute applied only to prepetition transfers, and had no application to transfers occurring after the petition date. In re Webb Mtn, LLC, 2009 WL 4505624 (Bkrtcy.E.D.Tenn., Judge Stair).

A deed of trust lender that, as a result of its failure to ensure that its borrower had a recorded interest in the deed of trust property prior to advancing funds, found itself subject to a strong-arm avoidance proceeding brought by a Chapter 11 debtor-in-possession, the record owner of the property, whose warranty deed to the borrower was never recorded prior to its Chapter 11 filing, could not successfully assert an unjust enrichment counterclaim against the debtor-in-possession, on the theory that it was unjust to allow the debtor to recover the property free and clear of its deed of trust lien, when a portion of the proceeds of the deed of trust loan were used to satisfy a prior mortgage granted by the debtor. The lender's argument ignored the reality that the debtor would receive no benefit from the recovery of the property under the strong-arm provision, and that the property would be brought back into the bankruptcy estate so that proceeds thereof could be distributed to creditors of the estate. In re Bill Heard Enterprises, Inc., 2009 WL 3055277 (Bkrtcy.N.D.Ala., Judge Caddell).

The term "applicable commitment period," as used in a bankruptcy statute requiring Chapter 13 debtors, as a prerequisite to the confirmation, over an objection of the trustee or an unsecured creditor, of any plan that will result in less than a 100% distribution on unsecured claims, to devote their projected disposable income to the payment of such claims over their applicable commitment period, was in the nature of a temporal concept that obligated above-median-income debtors proposing less than a full-payment plan to propose a plan of 60 months' duration. It did not matter that the debtors' "projected disposable income," as statutorily defined, was a negative number. Allowing the debtors to exit Chapter 13 in less than five years would deprive the trustee and creditors of a right to seek an increase in plan payments if the debtors' financial situation were to improve dramatically during that period. In re Moose, 2009 WL 3808369 (Bkrtcy.E.D.Va., Judge Mitchell).