Bankruptcy Means Test: Student Loans Used to Obtain Dentistry Degree...

The 2005 Bankruptcy Reform Act’s “means test” for chapter 7 bankruptcy filers was weakened by a recent ruling from a Texas bankruptcy court.  Under this ruling, student loans incurred for the purpose of obtaining a professional degree to be used in business are not “consumer debts” under section 707(b) of the bankruptcy code.  This new ruling places some chapter 7 filers outside the strictures of the means test, and allows a chapter 7 filing if the unpaid student loans balances are large enough.

The bankruptcy means test is an income-based formula designed to prevent high income bankruptcy debtors from filing chapter 7.  The means test seeks to shepard such debtors into chapter 13 bankruptcy plans where a portion of the debt must be repaid to creditors over a three to five year period.

Chapter 13′s gradual debt repayment stands in sharp contrast to chapter 7′s immediate debt discharge provisions, causing many bankruptcy debtors to prefer chapter 7.  However, the means test forces some high earning debtors to file chapter 13 instead.

Importantly, under section 707(b), the means test applies only to bankruptcy debtors whose debts are “primarily consumer debts.”  In other words, if the debts are mostly business debts, the means test doesn’t apply, and even a high earning debtor can opt for chapter 7 and an immediate fresh start.

In the Texas case, In re De Cunae, No. 12-37424 (Bky.S.D.Tex. Dec. 6, 2013), the chapter 7 debtor had incurred $251,058 in student loans in order to obtain a degree in dentistry.  His dental practice collapsed and after a difficult divorce he became a single father.  He also suffered a stroke and was unable to work for a time.

The U.S. Trustee argued that the debtor should be subject to the means test based upon his income, and that he should be required to file chapter 13 instead of chapter 7.

The debtor countered that if his student loan debt was included in the total of his business debts, then his debts were not primarily consumer debts, and he was not subject to the means test or section 707(b).

The Texas bankruptcy court agreed with the debtor, noting that $220,931.04 of the $251,058.00 in student loan debt had been spent on dentistry school tuition, books and fees.  This part of the debt was incurred with a business purpose, and was not spent on household expenses of the debtor.  When added to the other business debts, the debtor’s debts were not primarily debts and section 707(b) did not apply.

The Texas court also observed that the only other reported decision on this question, In re Stewart, 175 F.3d 796 (10th Cir.1999), also supported viewing student loans incurred with a profit motive as non-consumer debt.