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Developments in the Treatment of Student Loan Debt

By Merrie L. Chappell, Esq., with contributions by Addison Freebairn
Posted: 12th September 2017 12:02
On Appeal, the United States District Court in Colorado ruled in November 2016 that student loan debt, if incurred with a profit motive, is classified as non-consumer debt for the purposes of an 11 U.S.C. §707(b)(1) dismissal. Palmer v. Laying, 559 B.R. 746 at 748 (D. Colo. 2016) (“Palmer II”). This ruling substantially altered the way student loan debt was previously treated by the 10th Circuit, and will likely have far reaching effects on Bankruptcy jurisprudence going forward. This article will not address possible implications concerning 11U.S.C. § 523 and tax liability exemption.
11 U.S.C. §707(b)(1) allows dismissal of a chapter 7 case when the debtor’s debts are “primarily consumer debts,” and when granting such a debtor relief would be an abuse of chapter 7. Id. 11 U.S.C. §101(8) defines consumer debt as “debt incurred by an individual primarily for a personal, family, or household purpose.” Id. In Palmer v. Laying, the United States Trustee filed a motion to dismiss citing the above sections of the Bankruptcy Code, asserting that the student loan debt in that case was consumer in nature, thus triggering §707(b)(1) and (2). The Bankruptcy Court granted the motion to dismiss, citing the Tenth Circuit’s decision in Stewart v. U.S. Trustee, 175 F.3d 796 (10th Cir. 1999). The Court held in Stewart that “consumer debt is further distinguished from non-consumer debt as a debt incurred with a profit motive.” Id. The Bankruptcy Court in In re Palmer did not find that Mr. Palmer’s student loans were incurred with a profit motive. Luckily for Mr. Palmer, and financially struggling students everywhere, the District Court reversed that decision on appeal.
In the previous Palmer case, In re Palmer, 542 B.R. 289 (Bankr. D. Colo. 2015) (“Palmer I”), the Bankruptcy Court gave four concepts it saw important to a consumer/non-consumer classification question: “(1) the Tenth Circuit's reference to “profit motive” in Stewart should be interpreted narrowly because this was in keeping with the intent of the changes made to the Bankruptcy Code in 2005; (2) trying to determine whether a debt is a business or personal investment will be problematic without a narrow, objective standard; (3) without a narrow interpretation of “profit motive,” it could be applied to virtually all student loans, and thus, would become an exception that swallows the rule; and (4) “[a] narrow standard, tied to an existing business, or to some requirement for advancement in a current job or organization, is necessary to avoid a student's aspirational goal, or a wished-for ‘hope and dream’ being the focus, as opposed to the advancement of a tangible opportunity.” Palmer II, 559 B.R. at 748. Because of this, the Court in Palmer I found that for profit motive to exist, 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.”Id.
The Stewart Courtdid bankruptcy jurisprudence a disfavour when it chose not to address how to characterise loan money used for educational expenses such as books and tuition. Stewart, 175 F.3d at807-808. In Palmer, it was undisputed that all his student loans were put towards educational expenses, not room and board (which would perhaps require a complicated bifurcation of the loan money into both consumer and non-consumer classifications). Palmer II, at 749. In the wake of Stewart, a void existed where student loan debt used purely for education could not be definitively classified.
The Palmer II court agrees that the primary purpose of the debt’s incurrence should be determinative of its classification. The Court reiterated that the profit motive test did not have to apply directly to the student’s employer, and explained that an investment in oneself was sufficient. Id at 750. This does away with requiring a “tangible benefit to an existing business” standard used by Palmer I. Id. Palmer II found no reason to tie the guidelines from Stewart to a requirement for advancing in a current job. Id at 751. In fact, it makes more sense to view the decision to pursue education as being motivated by profit. This also does not require the student to be currently employed while seeking education. The Court doubts that most students wish to “rise through the ranks” of their place of employment while still attending school. Id. It is much more likely that the students will be able to do so once they graduate with a few letters added to their names.
The Court in Palmer I observed that the “means test” of §707(b)(2) is a way of weeding out debtors who have the capability of funding their financial reorganisation. Palmer II notes that this may be the case, but “the “means test” of § 707(b)(2) has nothing to do with whether a debtor has “primarily consumer debts” under § 707(b)(1). In other words, the weeding out of undeserving debtors is done by the “means test,” not in deciding whether a debtor has “primarily consumer debts.” Palmer II at 752. The Court further noted that if Congress had wanted to change the definition of consumer debt to include educational expenses, it had every opportunity to do so and chose not to. Id.
Further, the Palmer I Court seemed to think that the word “may” from Stewart was a word of limitation, decreasing the types or numbers of situations where student loan debt could be classified as non-consumer. Palmer II disagrees that Stewart intended this, and sets aside Palmer I’s test as too narrow, opining that debt incurred with a profit motive is not “an exception to consumer debt” but a way to “[differentiate] between consumer and non-consumer” debt. Id. Thus, Palmer I presumed incorrectly that “all student loan debt is consumer debt, with only an exception such as a profit motive able to save it from being designated as such.”
The most important takeaway from Palmer II is that profit motive does not mean profit realised. If a debtor can show that they took steps to realise the potential of their education (and profit thereby), there is no reason why evidence would not show that the debtor had a profit motive in incurring their student debt. Palmer II at 754.
This development could have far reaching consequences for students whose student loans represent a substantial proportion of their total debt. Only filers with primarily consumer debts need to take the means test, so ordinarily, if the large student loan debts were classified as consumer, they would (i) be required to take the means test and (ii) potentially fail it and not receive the benefits of chapter 7 bankruptcy. Palmer II also places the burden of proof on the U.S. Trustee to show that there was not a profit motive in the student’s incurrence of student loan debt, and gives the student only the burden of persuasion to show there was indeed a profit motive. This standard is far easier on struggling students and saves them from the confining grip of Palmer I. Other courts should apply this new standard accordingly.
Merrie L. Chappell offers nearly 25 years of legal experience in diverse areas. Ms. Chappell is licensed to practice law in New Mexico and Washington State. She is admitted to practice law before the New Mexico Supreme Court, The United States District Court for the District of New Mexico and The United States Bankruptcy Court for the District of New Mexico.

Merrie can be contacted on + (505) 289-1922 or by email at

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