PLAIN CITY, Ohio — It isn’t easy to stand up in an open courtroom and bear witness to the abject wretchedness of your financial situation, but by the time Doug Wallace Jr. was 31 years old, he didn’t have much left to lose by trying.
Diabetes had rendered him legally blind and unemployed just a few years after graduating from Eastern Kentucky University. He filed for bankruptcy protection and quickly got rid of thousands of dollars of medical and other debt.
But his $89,000 in student loans were another story. Federal bankruptcy law forces those who wish to erase that debt to prove that repaying it will cause an “undue hardship." And one component of that test is often convincing a federal judge that there is a “certainty of hopelessness" to their financial lives for much of the repayment period.
“It’s like you’re not worth much in society," Wallace said.
Nevertheless, Wallace made his case. And on Wednesday, nearly six years after he first filed for bankruptcy, he may finally get a signal as to whether his situation is sufficiently bleak to merit the cancellation of his loans.
The gauntlet he has run so far is so forbidding that a large majority of bankrupt people do not attempt it. Yet for a small number of debtors like Wallace who persist, some academic research shows there may be a reasonable shot at shedding at least part of their debt. So they try.
Before the mid-1970s, debtors were able to get rid of student loans in bankruptcy court just as they could credit card debt or auto loans. But after scattered reports of new doctors and lawyers filing for bankruptcy and wiping away their student debt (on the way to the BMW dealership, presumably), resentful members of Congress changed the law in 1976.
In an effort to protect the taxpayer money that is on the line every time a student or parent signs for a new federal loan, Congress toughened it again in 1990 and again in 1998. In 2005, for-profit companies that lend money to students persuaded Congress to extend the same rules to their private loans.
But with each change, lawmakers never defined what debtors had to do to prove that their financial hardship was “undue." Instead, federal bankruptcy judges have spent years struggling to do it themselves.
Most have settled on something called the Brunner test, named after a case that laid out a three-pronged standard for judges to use when determining whether they should discharge someone’s student loan debt. It calls on judges to examine whether debtors have made a good-faith effort to repay their debt by trying to find a job, earning as much as they can and minimizing expenses. Then comes an examination of a debtor’s budget, with an allowance for a “minimal" standard of living that generally does not allow for much beyond basics like food, shelter and health insurance plus some inexpensive recreation.
The third prong, which looks at a debtor’s future prospects during the loan repayment period, has proved to be especially squirm-inducing for bankruptcy judges because it puts them in the prediction business. This has only been complicated by the fact that many federal judicial circuits have established the “certainty of hopelessness" test that Wallace must pass in Ohio.
Lawyers sometimes joke about the impossibility of getting over this high bar, even as they stand in front of judges. “What I say to the judge is that as long as we’ve got a lottery, there is no certainty of hopelessness," said William Brewer Jr., a bankruptcy attorney in Raleigh, N.C. “They smile, and then they rule against you."
Bringing a case
Debtors themselves struggle with testifying in their undue hardship cases. Carol Kenner, who spent 18 years working as a federal bankruptcy judge in Massachusetts before becoming a lawyer for the National Consumer Law Center, said that one particular case stuck in her mind.
The debtor had a history of hospitalization for mental illness but testified that she did not suffer from depression at all. “She was so mortified about the desperation of her situation that she was committing perjury on the stand," Kenner said. “It just blew me away. That’s the craziness that this system brings us to."
Debtors also stretch the truth in other directions. In 2008, a federal bankruptcy judge in the Northern District of Georgia expressed barely disguised disgust in deciding a case involving a 32-year-old, Mercedes-driving federal public defender with degrees from Yale and Georgetown. With nearly $114,000 in total household income, the woman’s financial situation was far from hopeless, despite her $172,000 in student loan debt.
No one keeps track of how many people bring undue hardship cases each year, but it appears to be under 1,000, far less than the number of people failing to make their student loan payments. In its most recent snapshot of student loan defaults, the Department of Education reported that among the more than 3.6 million borrowers who entered repayment from Oct. 1, 2008, to Sept. 30, 2009, more than 320,000 had fallen behind in their payments by 360 days or more by the end of September 2010. About 10.3 million students and their parents borrowed under the federal student loan program during the 2010-11 school year.
One reason so few people try to discharge their debt may be that such cases require an entirely separate legal process from the normal bankruptcy proceeding. In addition, those who may qualify generally lack the money to hire a lawyer or the pluck to file a suit without one. Nor is the process quick, since the lender or the federal government often appeals when it loses. And even if clients can pay for legal assistance, some lawyers want nothing to do with undue hardship cases. That’s the approach Steven Stanton, a bankruptcy lawyer in Granite City, Ill., settled on after trying to help David Whitener, a visually impaired man who was receiving Social Security disability checks. The judge wasn’t ready to declare him hopeless and gave him a two-year “window of opportunity" to recover from his financial situation, saying he believed that Whitener had the potential to obtain “meaningful" employment.
Stanton did not see it that way. “It’s the last one I’ve ever done, because I was just so horrified," he said. “I didn’t even have the client pay me. In all of the cases in 30 years of bankruptcy work, I came away with about the worst taste in my mouth that I’ve ever had."
Those who do go to court face the daunting task of arguing against opponents who specialize in beating back the bankrupt.
If they’re trying to discharge a federal loan, they’ll often square off against Educational Credit Management Corp., a so-called guaranty agency sanctioned by the government to handle a variety of loan-related legal tasks, from certifying students who are eligible for loans to fighting them when they try to discharge the loans in bankruptcy court.
On its website, the agency paints a picture of how much of a long shot an undue hardship claim is, noting that people “rarely" succeed in discharging student loan debt.
Some academic researchers have come to a different conclusion, however. Rafael Pardo, a professor at the Emory University School of Law, and Michelle Lacey, a math professor at Tulane University, examined 115 legal filings from the western half of Washington state. They found that 57 percent of bankrupt debtors who initiated an undue hardship adversary proceeding were able to get some or all of their loans discharged.
Jason Iuliano, a Harvard Law School graduate who is now in a Ph.D. program in politics at Princeton, examined 207 proceedings that unfolded across the country. He found that 39 percent received full or partial discharges.
His assessment of ECMC’s view of the rarity of success? “I think that’s wrong," he said. While his sample size was small and he agrees that it’s not easy to prove undue hardship and personal hopelessness, his assessment of bankruptcy data suggests that as many as 69,000 more people each year ought to try to make a case. And they don’t necessarily need to pay lawyers to argue for them, as he found no statistical difference between the outcomes of people who hired lawyers and those who represented themselves.
Dan Fisher, ECMC’s general counsel, said it had no opinion on whether more borrowers should try to make undue hardship claims. As for the “rarely" language on its website, he said the company stood by its assertion that it was uncommon for an undue hardship lawsuit to end in a judgment discharging the loans in its portfolio.
Getting a ruling
Sometimes, getting any judgment is a challenge, as judges may delay a decision if the case seems too close to call or there is a possibility that the facts may change reasonably soon.
Radoje Vujovic, a North Carolina consumer bankruptcy lawyer, for instance, had more than $280,000 in student loan debt and just $23,000 in annual income.
When Judge A. Thomas Small, a federal bankruptcy judge in the eastern district of North Carolina, examined the case in 2008, he decided to wait two years before rendering final judgment, given that Vujovic thought his law practice might grow. “Must the cost of hope be permanent denial of discharge of debt?" Small asked in his written opinion. “The answer to that question cannot be an unequivocal ‘yes.’ Hope is not enough to end the inquiry and, ironically, permanently tip the scales against a struggling debtor."
The Department of Education, unhappy with the two-year delay, appealed before the period was up and persuaded a higher court to overturn the ruling. “I would stand by my decision," Small, who is now retired, said in an interview. “If you’re forced to make that decision, all you have is speculation, and speculation is really not good enough to overcome the burden of proof."
Getting judges out of the speculation business, however, would require a new law or an entirely new standard, possibly from the U.S. Supreme Court. Neither appears likely anytime soon.
In the meantime, Doug Wallace, the blind man in Ohio, is nearing the end of his long wait for a ruling.
In December 2010, C. Kathryn Preston, a federal bankruptcy judge in the southern district of Ohio, tried to assess Wallace’s hopelessness by pointing to expert testimony that blindness does not necessarily lead to an inability to ever work again. But she also noted that because he lived in a rural area, he faced significant transportation obstacles. So she set a new court date for Sept. 5, to give him “additional time to adjust to his situation."
The question for Wallace then became what sort of adjustments he was supposed to make aside from a court-ordered $20 monthly loan payment. His routine hasn’t changed much. Aside from hernia surgery a few months ago, his days consist of sitting close to the television (he can just make it out through one eye that still has a bit of vision) and regular trips to the gym with his father. His college diploma hangs on the living room wall, and at night he sleeps underneath it on the couch of the rental house he shares with his father and sister.
Wallace’s sister, a community college student, is sometimes around during the day while his dad works at a Honda factory. There are few visitors. “I’ve got friends around here, I’m sure, but they’ve got lives for themselves," he said. “So I don’t really bother them."
The judge did not explicitly order him to move closer to a training center, and his lawyer, Matt Thompson, said that doing so would set him up for certain failure. “I don’t think there is any place he could go in central Ohio and live on $840 a month," he said.
Logistics aside, Wallace said that it was hard to imagine his overall situation ever improving and wonders who would hire a blind man in this economic environment.
“Do I think I’m hopeless?" he said. “Well, yeah, I mean by looking at it you would think I am hopeless. Like it won’t get better for me."