First Circuit Considers Whether Student Loan Debt May Be Dischargeable Through Bankruptcy

A case pending before the Court of Appeals for the First Circuit could upend the established rules for paying off student loans. In Murphy v. Dep’t of Educ., et al., no. 14-1691, plaintiff-appellant Robert Murphy principally alleges that the trial court erred in concluding that the plaintiff-appellant’s student loan repayment would not constitute an “undue hardship” under the relevant portion of the Bankruptcy Code. If the First Circuit agrees with Mr. Murphy, certain student loan debt currently excluded from discharge through bankruptcy could become dischargeable, and lenders could be left holding the bag.

The case started as an adversary proceeding associated with Murphy’s bankruptcy under Chapter 7. Murphy had taken out 12 loans, in the initial principal amount of $220,765 to finance the college education of his three children. Although Murphy was in good health with a long work history, he was unemployed and unable to find work since losing his job in 2002. In 2012, Murphy sought a discharge of his student loan indebtedness on the grounds of undue hardship pursuant to 11 U.S.C. 523(a)(8).

At issue is whether the Bankruptcy Court erred in concluding that Murphy had not shown the “undue hardship” required to render his student loan indebtedness dischargeable. The parties dispute which legal standard Murphy must meet to qualify for an undue hardship discharge under 11 U.S.C. 523(a)(8)—a “totality of the circumstances” test, or the so-called “Brunner test”—though Educational Credit Management Corporation (“ECMC”) contends that “the choice of tests is rarely outcome-determinative.”  

Murphy principally argues that the “totality of the circumstances” test, as applied by the Bankruptcy Court, is outdated and too narrow—narrower than the standard established by the statute. Murphy opposes the lower court’s apparent requirement of “truly exceptional circumstances,” which, he avers, exceeds the standard set by Congress and precedent. Moreover, Murphy argues, he demonstrated undue hardship by showing that his “sparse resources,” family living expenses, and other circumstances prevent him from paying the student loans. 

Appellee ECMC, the holder of Murphy’s indebtedness, notes that student loans are “presumptively non-dischargeable” and that proving undue hardship is meant to be a “formidable task.” Contrary to Murphy’s assertions, ECMC maintains that Murphy failed to show undue hardship because, inter alia, he was in good health, he presented no evidence that he would never be able to obtain employment, and he was eligible for a monthly payment of $0. 

At oral argument on December 10, 2015, the Court facilitated significant debate regarding the nuances of the proposed standards and expressed interest in the practical effects of a determination that Murphy’s debt was not dischargeable. Significantly, the Court will evaluate the appellee’s contention that the debtor’s circumstances in this case do not constitute “undue hardship” because he failed to show a future likely inability to repay. 

Student loans have a higher rate of default than any other type of mainstream consumer loans, and now litigation and legislation threaten to broaden the definition of “undue hardship.” Accordingly, lenders providing student loans must manage both the escalating volume of outstanding student debt and the unsettled expectations as to whether debtors might be able to discharge their debt through bankruptcy. Dykema will continue to closely monitor and report on relevant developments in Congress and the courts.

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