Can Student Loans Help You Qualify for Chapter 7 Bankruptcy?

StudentLoans_iStockIf you plan to file for bankruptcy and have a bundle of student loan debt, those loans might make it easier for you to be eligible for Chapter 7 bankruptcy.  A Texas bankruptcy court recently ruled that because a bankruptcy debtor’s substantial dentistry school loans were not consumer debts, he did not have to take the means test in order to file for Chapter 7 bankruptcy.

What Is the Chapter 7 Means Test?

In order to qualify for Chapter 7 bankruptcy, you must pass the means test. The Chapter 7 means test looks at your income and expenses and determines if you have enough money left over to repay your unsecured creditors a portion of what you owe.

The means test often prevents high earners from filing for Chapter 7 bankruptcy. For many debtors, Chapter 7 is preferable to Chapter 13 because it allows you to discharge most or all of your debts, and you don’t have to make payments to a plan for three to five years. (Of course, there are many situations when Chapter 13 is better than Chapter 7.)

Exceptions to the Means Test Requirement

There are several situations when debtors do not have to pass the means test in order to file for Chapter 7 bankruptcy. One of those is referred to as the business debt exception:  If the majority of your debts are not consumer debts, you don’t have to take the means test.

Texas Court:  Dentist School Loans Are Not Consumer Debts

In In re De Cunae, No. 12-37424 (Bkcy S.D. TX 2013), Mr. De Cunae, a dentist, filed for bankruptcy. He lost his dental practice after a difficult divorce, was a single father, and couldn’t work for a time because of a stroke. At the time of his bankruptcy filing, he was once again working as a dentist on a contract basis. He filed for Chapter 7 bankruptcy.

Mr. De Cunae argued that he did not have to pass the means test (his income was high enough that if he did have to pass it, he would have failed) because his student loans from dentistry school were nonconsumer debts, and therefore the majority of his debts were nonconsumer.  The Texas bankruptcy judge agreed, ruling that the portion of his dentist school loans (about $200,000) that was used for tuition, books, and fees, was not a consumer debt. On the other hand, the portion of the student loans that he used for household expenses (about $30,000) was consumer debt.

Loans Incurred With an “Eye Towards Profit” Are Not Consumer Debts

Bankruptcy courts often struggle to distinguish consumer and nonconsumer debts. The Fifth Circuit Court of Appeals (Texas is in this circuit) has come up with the following definition: A nonconsumer debt is one that the debtor takes out “with an eye toward profit.”

The Texas bankruptcy court found that Mr. De Cunae did not attend dentist school, nor incur loans to attend dentist school, only for self-improvement or self-esteem, as the United States Trustee argued. Instead, the court found that Mr. Cunae’s intent was to enhance his ability to earn a future living.  To the court, that seemed to fit squarely within the profit motive category — and therefore they were not consumer debts. The portion of student loans that Mr. De Cunae used for household expenses, however, were consumer debts.

Because he could classify most of his dentist school student loans as nonconsumer debt, Mr. De Cunea’s  total nonconsumer debt load outweighed his consumer debt load – and he was allowed to file for Chapter 7 bankruptcy without passing the means test.