Your Student Loans May Help You Qualify For Chapter 7 Bankruptcy
If someone has to file bankruptcy, I generally prefer to be able to get them into a Chapter 7 instead of a Chapter 13. It’s over quickly (about four months) and allows them to begin rebuilding their financial life much sooner. I would never recommend a Chapter 13 where Chapter 7 is available. Chapter 13 means being tied to the bankruptcy court for three to five years, and that’s enough of a reason to steer my clients away from Chapter 13 if I can.
Of course, there are some reasons a person should a Chapter 13 even though they qualify for Chapter 7. For example, if they have more equity in their home or other assets than could be protected in a Chapter 7. If they file a Chapter 7, those assets – including their home – can be sold by the bankruptcy trustee to satisfy the filer’s debts. Another reason someone might file Chapter 13 instead of a Chapter 7 is because of a divorce-related obligation.
While neither Chapter 7 nor Chapter 13 will eliminate a child support or spousal maintenance (alimony) obligation, only Chapter 13 will eliminate an obligation like the payment of the other spouse’s debts or the turnover of certain assets.
But the primary reason someone has to file a Chapter 13 instead of a Chapter 7 is because they make too much money. In order to file a Chapter 7, a person’s household income (including that of a non-filing spouse) has to be below the median income for the state the person lives in at the time of filing. Median income is determined by the United States Census Bureau which updates its numbers twice a year, typically May and November.
If the filer’s income is over median income, then Chapter 7 is usually not an option. I’ve been able to qualify over-median clients for Chapter 7, but the typical reason is they have a high child support or spousal maintenance obligation.
But there is one more way that someone who is above the median income can qualify for Chapter 7.
If a more than 50% of a filer’s debts are non-consumer (as opposed to consumer debts), we can disregard the means test. That means we don’t have to worry about their income. They can file a Chapter 7 even if they’re over the median income.
What is non-consumer debt? First, the bankruptcy code defines consumer debt as “debt incurred by an individual primarily for a personal, family, or household purpose.” Common examples of consumer debt are mortgages, car loans, credit cards, and medical bills.
Frustratingly, the bankruptcy code doesn’t include a definition of a non-consumer debt. However, courts have focused on the word “primarily” in the definition of consumer debt to differentiate those debts from non-consumer debts.
Student loans exist somewhere between consumer and non-consumer debt. As one bankruptcy court noted, “A student loan is a debt with a somewhat esoteric quality; it is a debt incurred by an individual, but it is not a good that one purchases or an investment one makes in a tangible thing. It is a personal debt, yet does not fit neatly within the definition of “consumer debt”.
To resolve this question of whether or not a student loan is a consumer or non-consumer debt, courts have started applying a “profit motive” test. The Fifth Circuit has held that, “the test for determining whether a debt should be classified as a business debt, rather than a debt acquired for personal, family, or household purposes is whether it was incurred with an eye toward profit.”
Whether or not student loans were taken out with a profit motive in mind requires, in part, looking at what the loan funds were used for. If the funds were used for expenses such as rent, food, clothing, and other family expenses (including things like vacations), then it’s hard to argue that the loans were taken out with “an eye toward motive”.
On the other hand, if the loans were used to pay tuition for a graduate degree, then a profit motive is easier to find. It’s easy to assume that someone seeks a graduate degree with an eye toward increasing their income and opportunities.
But one court has concluded that the standard should be narrow and that “in order to show a student loan was incurred with a profit motive, the debtor must demonstrate a tangible benefit to an existing business or show some requirement for advancement or greater compensation in a current job or organization.” It isn’t a given that a student loan for a graduate degree will be viewed as having been taken out with a profit motive, the court concludes, “the goal must be more than a hope or an aspiration that the education funded, in whole or in part, by student loans will necessarily lead to a better life through more income or profit.” It appears that the court is looking for a specific anticipated outcome from the graduate degree, such as a promotion at a person’s current employer.
However, other courts have found that a profit motive is present even without specific opportunities with a current employer. In other words, it’s enough that the person sought a graduate degree with the general hope of improving their station in life.
So, while student loans might seem like a passport to filing Chapter 7, it’s not an easy trip. Whether or not your student loans can be used to help you avoid the means test is very fact driven. No attorney can simply give you a black or white answer without having a significant amount of detail about what your student loans were used for.
Keep in mind that even if you can avoid the means test and file Chapter 7, doing so may not be a good idea. In a Chapter 7, you can lose assets if they are worth more than what is protected under the exemption rules. Filing a Chapter 7 only to lose your home would be a terrible trade off, so one has to be mindful and careful about all of the consequences in deciding which chapter to file.
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