Using Student Loans to Qualify for Chapter 7 Bankruptcy

In 2005, Congress changed the bankruptcy laws to include a new “means test” for consumer debtors. The purpose of the means test is to ensure that debtors are not “abusing” the bankruptcy system by unfairly discharging debts they can afford to repay. The means test is a gatekeeper for Chapter 7 bankruptcy and disqualifies certain high income debtors from Chapter 7 who can afford a repayment plan in Chapter 13. Congress also created a business exception to the means test. If the individual debts are “primarily” business debts, the debtor can avoid taking the means test, and can avoid being presumptively disqualified from filing a Chapter 7.

Most courts have stated that “primarily” means that more than half of the individual debts are business debts. Separating a consumer debt from a business debt has proven a more challenging question for bankruptcy courts. The starting point is Section 101(8) of the Bankruptcy Code, which defines a consumer debt as a “debt incurred by an individual primarily for a personal, family, or household purpose.” Many courts have distinguished a business debt as one that was incurred with a “profit motive,” that it was created for the purpose of trying to turn a profit. Non-consumer debts are generally business-related debts, such as:

  • Investment real estate
  • Business vehicle loan
  • Business utilities
  • Business credit
  • Business insurance

Some debtors have argued that a student loan debt is a business debt when it is incurred with a profit motive. These cases are examined on a case-by-case basis. The primary inquiry is whether the debt was incurred primarily for a personal, family, or household purpose, which necessitates a trial. When the lion’s share of student loans are used to pay living expenses, rather than funding a professional education, the student loan debt is often characterized as a consumer debt. See In re Stewart, 175 F.3d 796 (10th Cir. 1999).

Recently, a south Texas bankruptcy court found that $220,931.04 of a debtor’s $251,058.00 student debt for dental school was spent on tuition, books and fees. The court applied the “profit motive” test, and found that the majority of the debtor’s student loans were incurred with a business purpose (obtaining a professional degree), and not spent on the debtor’s household expenses. When added to the debtor’s other obligations, the court found that the debts were not primarily consumer debts and that the means test did not apply. See In re De Cunae, No. 12-37424 (Bky.S.D.Tex. Dec. 6, 2013).

Debtors with primarily non-consumer debts are not required to complete the means test, however the bankruptcy trustee may still argue that the debtor has the ability to pay creditors and should be forced into Chapter 13 by the bankruptcy court after looking at the “totality of the circumstances.” See 11 U.S.C. §707(b)(3)(B). The Bankruptcy Code imposes a good faith requirement on Chapter 7 debtors, and some courts have found that the lack of good faith may constitute “cause” for dismissal under §707(a). See 11 U.S.C. §707(b)(3)(A). In other words, if the debtor can reasonably adjust his budget to pay creditors (consumer or business creditors), the bankruptcy court may disqualify the debtor from Chapter 7.

There are many roads to Chapter 7 bankruptcy, and an experienced bankruptcy attorney can help you identify the right path for you. If you need debt relief, discuss your situation with experienced and knowledgeable counsel.