Under the totality of the circumstances test, the bankruptcy court erred when it found that the debtor’s student loans of $106,000 were not dischargeable as undue hardship because she had sufficient exempt equity in her home to fully repay the debt. Schatz v. Access Group, No. 18-16 (B.A.P. 1st Cir. July 26, 2019).
In an effort to increase her earning potential, Audrey Schatz, a single mother, obtained a law degree when she was in her fifties, financing her education with student loans. After she graduated and passed the bar, however, Ms. Schatz spent three years unsuccessfully seeking work in her field. Ultimately, she earned minimal income through a variety of avenues including self-employment, operation of a legal non-profit for low-income clients, using her home as an Air bnb, and performing real estate closings.
With expenses exceeding income, she filed for chapter 7 bankruptcy and listed her home equity of $125,000 as exempt under Massachusetts’s generous homestead exemption law. When she sought to have her student loans discharged, the bankruptcy court relied on the existence of her exempt home equity to find that repayment of the loans would not constitute undue hardship.In so holding, the bankruptcy court specifically declined to address other considerations relevant to whether Ms. Schatz’s income could, now or in the future, be sufficient to repay the student loans. Schatz v. U.S. Dept. of Educ. (In re Schatz), 584 B.R. 1 (Bankr. D. Mass. 2018).
On appeal, the BAP for the First Circuit vacated and remanded. Because the First Circuit has not specified the test to be applied when faced with a student loan discharge case under section 523(a)(8), and the parties did not challenge the bankruptcy court’s application of a totality of circumstances test, the BAP likewise analyzed the case under that standard. Under this test, courts in the first circuit consider the debtor’s past, present and future earnings; reasonable expenses; and any other relevant facts and circumstances. The panel found that the bankruptcy court erred in disposing of the case entirely on the basis of Ms. Schatz’s exempt equity in her home.
Section 522(c) shields exempt property from liability for pre-petition debts. Section 522(d) specifies certain exceptions to that shield including use of exempt property to repay student loans obtained through fraud. In Law v. Siegel, 571 U.S. 415 (2014), the Supreme Court determined that Congress intended the exceptions listed in section 522(d) to be exclusive and found, for that reason, that courts could not surcharge exempt property for any reason not listed in that section. It was undisputed that Ms. Schatz did not obtain her student loans by fraud.
The panel addressed the cases that the bankruptcy court relied on when it found that it was appropriate to include the exempt asset in the calculation of the debtor’s ability to pay. The panel found those cases generally did not rely exclusively on that consideration as the dispositive factor. Rather, those courts considered the value of a debtor’s home as relevant to the balance between maximizing income and minimizing expenses. In that regard, the panel cautioned that “lifestyle choices should not be conflated with the consideration of the mere existence of home equity that is exempt and immunized from liability for pre-petition debt.”
The panel rejected the arguments set forth by the creditors, Massachusetts Educational Financing Authority and Access Group, that Law did not apply because Ms. Schatz would not necessarily have to sell her home to access her equity. The panel found that, as a practical matter, there would be no way for Ms. Schatz to access her equity without selling the home or taking out a new loan which she would then have difficulty repaying.
The panel was persuaded in part by arguments set forth in the amicus brief filed by the Massachusetts Office of the Attorney General. The AG argued that the state homestead exemption law is intended to prevent various ills including homelessness and the need for government housing assistance, and that requiring the debtor to tap into her home equity would both undermine that public policy and run contrary to section 522’s prohibition against using exempt assets to pay pre-petition debts.
The panel concluded that by relying entirely on the existence of exempt home equity and ignoring other relevant factors, the bankruptcy court erred in its application of the totality of the circumstances test. The panel thus vacated and remanded with instructions that the bankruptcy court reapply the test using the proper considerations.
