WHY DOES IT MATTER WHETHER OR NOT STUDENT LOANS ARE CONSIDERED CONSUMER DEBTS?
Whether your student loans are considered consumer debts may determine whether you can file a Chapter 7 “straight bankruptcy” case. If you have a lot of student loans, and if they can be classified as non-consumer debts, then you may qualify for Chapter 7 when otherwise you could not have.
Why would that matter? If you wouldn’t qualify for Chapter 7 your other alternative would be filing a Chapter 13 “adjustment of debts” case, which requires you to pay all you can afford to your creditors during a 3 to 5 year period. Instead, under Chapter 7 you could discharge—legally, permanently write off—your other debts within about 4 months and then be able to focus on paying your student loans. Or you could then deal with your student loans in other ways (such as through an income-driven repayment plan).
WHY MAY I NOT BE ABLE TO FILE A CHAPTER 7 CASE?
You have to financially qualify to go through a Chapter 7 case. You have to pass the “means test.” If you don’t pass you would likely instead have to go through a lengthy Chapter 13 case.
The “means test” involves as many as three steps. The first step compares your current income (focusing on your last 6 months of income) with the median income of people of your family size in your state. If your income is too high, the second step involves subtracting a set of allowed expenses from your income to see whether that leaves you with too much disposable income. If so, there’s a final rare possibility that you qualify by showing “special circumstances.” See Section 707(b) of the U.S. Bankruptcy Code.
If you don’t qualify under the “means test” your Chapter 7 case would be “dismissed”—thrown out—or changed into a Chapter 13 case.
WHAT’S WRONG WITH FILING A CHAPTER 13 CASE INSTEAD OF A CHAPTER 7 ONE?
Chapter 13 does have significant advantages in the right circumstances. But it usually takes 3 to 5 years, instead of the 3 to 4 months that a consumer Chapter 7 case takes. So if you don’t have special debts or other circumstances requiring a Chapter 13 case, Chapter 7 can be much, much better.
This can be particularly true if you have student loans that you want to deal with after discharging your other debts. Under Chapter 13 you have to pay your “general unsecured” debts as much as you can afford to during the 3-to-5-year “applicable commitment period.” (The length of the “applicable commitment period” depends on your current monthly income.) So instead of being able to just quickly discharge non-student loan debts in a Chapter 7 case, under Chapter 13 you have to pay these as much as you can for years.
Also, under Chapter 13 your student loans are paid a pro rata share along with the other unsecured creditors. You do have the advantage that throughout the 3-to-5-year period the student loan creditors can’t take collection action against you. But you also can’t favor them. As a result, by the time you get out of the Chapter 13 case all your student loans are in deep default. By then you likely have lost opportunities to deal with your loan through income-driven payment plans and other relatively favorable ways.
HOW CAN CLASSIFYING STUDENT LOANS AS NON-CONSUMER DEBTS ALLOW ME TO GO THROUGH A CHAPTER 7 CASE?
You may avoid the “means test” and otherwise qualify for Chapter 7. You don’t have to pass the “means test” if your debts are not “primarily consumer debts.” The relevant statute says that
the [bankruptcy] court . . . may dismiss a case filed by an individual debtor under [Chapter 7] whose debts are primarily consumer debts, or, with the debtor’s consent, convert such a case to a case under chapter 11 or 13 of this title, if it finds that the granting of relief would be an abuse of the provisions of this chapter.
Section 707(b)(1) of the Bankruptcy Code, with bold added. In other words, if your debts are “primarily consumer debts” then you have to pass the “means test” or else you are in “abuse” of the law and your case will be dismissed or converted to Chapter 13.
But if your debts are NOT “primarily consumer debts” then you don’t have to take and pass the “means test.”
WHAT DOES IT TAKE TO NOT HAVE “PRIMARILY CONSUMER DEBTS” AND AVOID THE “MEANS TEST?
First, “consumer debt” is defined in the Bankruptcy Code as “debt incurred by an individual primarily for a personal, family, or household purpose.” The big issue is whether or not student loans fit this definition. More on that in a minute.
Second, “primarily” means “more than half.” According to the decision that decided this for California (and the rest of the federal Ninth Circuit):
“Primarily” means “for the most part.” Webster’s Ninth New Collegiate Dictionary 934 (1984). Thus, when “the most part” — i.e., more than half — of the dollar amount owed is consumer debt, the statutory threshold is passed.
Zolg v. Kelly (In re Kelly), 841 F.2d 908, 913 (9th Cir.1988).
So, if all the non-consumer debts are equal to or more than the consumer debts, than the “primarily consumer debts” statutory threshold requiring the “means test” is NOT met. Therefore, if your student loans are not consumer debts, and their balances total more than your consumer debts, you don’t have “primarily consumer debts.” You don’t need to take and pass the “means test” and can still file a Chapter 7 case, quickly discharging all or most of your non-student loan debts so you can then focus on your student loans.
SO IS A STUDENT LOAN A CONSUMER DEBT OR NOT?
Plugging this question into the legal definition, is a student loan a debt incurred “primarily for a personal, family, or household purpose”? Section 101(8) of the Bankruptcy Code.
A good starting point is that student loans aren’t necessarily consumer debts. For example a bankruptcy court in Sacramento ruled in 2016 that it “declines to adopt a per se rule that holds all student loans are always consumer debt.” The judge rejected the contrary argument that
student loans are or should be per se consumer debt because education is a benefit inherently personal, that is, it is instilled in a person’s mind and can never be separated from the person.
In re Ferreira, 549 B.R. 232, 237 (Bankr. Court, E.D. California, 2016). So far so good—student loans aren’t necessarily consumer debts; they could be non-consumer ones.
SO WHAT FACTORS DO BANKRUPTCY JUDGES LOOK AT IN DECIDING WHETHER A STUDENT LOAN IS A NON-CONSUMER DEBT?
Let’s focus first on court rulings that govern what factors bankruptcy judges in Southern California are required to consider. We are in the 9th Circuit (which covers California and 8 other Western States). Our local bankruptcy judges are bound by what the 9th Circuit Court of Appeals and the 9th Circuit Bankruptcy Appellate Panel decides. The local judges also tend to seriously consider what other bankruptcy judges in the 9th Circuit have said, without being bound by them.
The 9th Circuit Court of Appeals has said that “[w]e must look to the purpose of the debt in determining whether it falls within the statutory definition” of a consumer debt quoted above. Kelly, 841 F.2d at 913.
What purpose would a debt need to have for it to be considered a non-consumer debt? This same 9th Circuit Court of Appeals opinion held that “[d]ebt incurred for business ventures or other profit-seeking activities is plainly not consumer debt.” Kelly, 841 F.2d at 913.
MUST A DEBT’S PURPOSE BE PROFIT-SEEKING OR A BUSINESS VENTURE FOR IT TO BE A NON-CONSUMER DEBT?
No, this language does NOT mean that these are the only purposes that would make for a non-consumer debt. Yes, incurring a debt “for business ventures or other profit-seeking activities” would clearly work. But other non-consumer purposes might also. Indeed, a very recent (October 2017) opinion by the 9th Circuit Court of Appeals emphasized that “it is appropriate to consider all the circumstances indicative of the debtor’s primary purpose.” In particular, while “the profit motive analysis may assist in the determination of which debts are not consumer debt, it does not prohibit other debts from falling outside of the category of consumer debt.” In re Cherrett, (9th Cir., October 16, 2017) (quoting from other court opinions). In other words, a non-consumer debt can have a purpose other than “profit-seeking” or the operation of a business.
As a good example, individual income tax debts are not incurred for business or profit-seeking purposes, yet have been overwhelmingly classified as non-consumer debt. Instead of being “incurred for personal or household purposes, as stated in the statute, . . . taxes are incurred for a public purpose.” In re Westberry, 215 F. 3d 589, 591 (6th Cir., 2000)(re the same statutory definition of “consumer debts,” although in a different context).
SO WHAT ARE OTHER PERTINENT PURPOSES HAVE COURTS USED THAT MAY APPLY TO STUDENT LOANS?
I don’t know of a recent published opinion that the local bankruptcy courts must follow that answers this question. But we do have some guidance.
The 9th Circuit Cherrett decision of this last October cited above was not specifically about student loans. The court determined that a home loan provided by an employer as part of a new management employee’s compensation package was a not a consumer debt. As a result, the debts of the debtor and his wife were not “primarily consumer debts” and they could proceed with their Chapter 7 case without being dismissed or forced into a Chapter 13 case.
The language that the 9th Circuit Court of Appeals used in Cherrett could be applied to student loans. The “court found that Cherrett primarily had a business purpose—not a personal, family, or household purpose—for incurring the Housing Loan.” He accepted the new employer’s “offer and the Housing Loan so that he could ‘grow in salary and responsibility’ and have the opportunity to oversee expansion of the . . . brand.”
Accordingly, if a student loan is incurred in order to increase income and work opportunities, Cherrett arguably provides some helpful authority.
IS ALL OF THIS CHERRETT 9TH CIRCUIT OPINION ENTIRELY SUPPORTIVE?
No, because there is also language in this opinion that could cut in the opposite direction with student loans:
This is not the ordinary situation where a person takes out a loan to move closer to a job for convenience or better schools, for example. This is the unusual situation where a person accepts a loan from his employer as part of a larger transaction to further his career. . . . [T]he the Housing Loan and the annual bonus were part of Cherrett’s negotiated compensation package, undertaken for a business purpose connected to furthering his career, rather than a personal, family, or household expense.
Yes, student loans are often taken out to “further [one’s] career. But it’s a stretch to say that just about any conventional student loan would have a purpose anywhere as closely tied to a direct business or profit-seeking motive as in the facts of the Cherrett case.
IS THERE OTHER POTENTIALLY BINDING JUDICIAL AUTHORITY ON THIS?
Yes.
It’s worth noting that the Cherrett Chapter 7 case was filed here in the federal Central District of California (the greater Los Angeles area). After the local bankruptcy judge ruled in favor of the Cherretts against the creditor/former employer, it filed an appeal at the Bankruptcy Appellate Panel. The creditor/former employer lost again, and so appealed once more to the 9th Circuit Court of Appeals, resulting in the opinion favoring the Cherretts you’ve been hearing about.
The Bankruptcy Appellate Panel published opinion (In re Cherrett, 523 B.R. 660 (9th BAP, 2014)), affirmed by the 9th Circuit, is still good law to the extent it wasn’t contradicted by that higher court’s opinion. The Bankruptcy Appellate Panel opinion goes through the evidence presented at the bankruptcy court trial in detail before concluding that the debtor provided ample evidence that he obtained the Housing Loan for a business purpose with respect to his employment with Aspen. Given his testimony at the Hearing, his deposition and his declaration, as well as the written offer of employment from [the prospective employer] Aspen, the bankruptcy court had sufficient evidence to find that Paul’s purpose in obtaining the Housing Loan was primarily related to his employment. We discern no clear error by the bankruptcy court in making that determination.
This language could cut either way regarding student loans. If you take out a student loan for the purpose of qualifying for anticipated employment, this language is arguably helpful. On the other hand, that employment would be a number of further steps removed from the specific “offer of employment” in this situation.
ISN’T THERE ANY BINDING CASE LAW INVOLVING STUDENT LOANS BEING NON-CONSUMER DEBTS?
Neither the 9th Circuit Court of Appeals nor its Bankruptcy Appellate Panel has a published opinion on this. There is an opinion from 2016 by a bankruptcy judge in Sacramento, In re Ferreira, 549 B.R. 232 (E.D. Calif. 2016). Since that is in a different federal district it’s not binding locally, although our local judges would likely look at it with at least some deference.
This Ferreira opinion is not favorable to debtors. Ferreira owed $53,123 in student loans to attend nursing school, resulting in employment as a nurse at a gross annual income of $148,000. The court held that the debtor has failed to satisfy her burden of demonstrating that she incurred any of the student loan debt with the necessary profit motive.
. . .
The profit motive element in the consumer debt analysis is interpreted narrowly.
In support of this assertion the judge briefly and questionably cited the Bankruptcy Appellate Panel’s Cherrett opinion (the Court of Appeals one had at that point not yet been decided), and then based most of his rationale on a Colorado bankruptcy judge’s opinion, In re Palmer, 542 BR 289 (D. Colorado 2015). The gist of the Palmer opinion was a “narrow interpretation of the profit motive”:
[I]n 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. 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. More than hindsight representations are needed to meet this burden.
Most student loans are not incurred to benefit an existing business or are not required to advance in a current job or with a current employer. So the standard laid out in Ferreira would not be helpful for most people.
SO WHERE DOES THIS LEAVE US?
First, Ferreira is not binding on bankruptcy judges in the Los Angeles area.
Second, both appellate Cherrett opinions have some potentially helpful language.
Third, the door remains open for finding non-consumer purposes of student loans beyond the profit-seeking/business purposes that both Cherrett and Ferreira seemed to rely on.
There are other interesting cases along these lines outside the 9th Circuit, although those were beyond the scope of this blog post. If you have substantial student loans, the strategy laid out earlier—discharging other debts in a Chapter 7 case so you can focus on your student loans—may still be viable. This is clearly a complex and emerging area of law, so it’s crucial to discuss it with an experienced bankruptcy lawyer. The result will likely depend on the specific details about the purposes for which you incurred your student loan(s).
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