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In a ruling that promises to make it much more difficult for bankruptcy debtors to win forgiveness of their student loans on “undue hardship” grounds, the 3rd U.S. Circuit Court of Appeals has ruled that such debtors must prove that they made good faith efforts to repay the loans over the “entire” period from the first due date of the loans to the bankruptcy filing date. The court’s unpublished per curiam opinion in Pelliccia v. U.S. Department of Education is a significant narrowing of the court’s 1995 decision that established the undue hardship test, Pennsylvania Higher Education Assistance Agency v. Faish. But it isn’t the first time the court took a narrow reading of Faish. In October 2001, the court held in Re: Patricia A. Brightful that bankruptcy debtors are not entitled to discharge student loans simply by showing that they can’t make payments on their current income and maintain a “minimal” standard of living, but instead must also show that their financial prospects are so “hopeless” that they won’t be able to make payments in the foreseeable future. Now, in Pelliccia, the court has instructed bankruptcy judges to scrutinize the debtor’s entire loan payment history when deciding whether he or she can meet Faish‘s three-prong test for showing an undue hardship. The Faish court held that a debtor seeking discharge of student loan obligations on undue hardship grounds must prove three elements: � That the debtor cannot maintain, based on current income and expenses, a “minimal” standard of living for herself and her dependents if forced to repay the loans. � That additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period for student loans. � That the debtor has made good faith efforts to repay the loans. In Brightful, the court expanded on the second prong of the Faish test, and now, in Pelliccia, the court has expanded on the third prong. In the appeal, Lanny C. Pelliccia argued that the bankruptcy and district courts erred in holding that he had not satisfied the third prong. Although the three-judge panel sided with Pelliccia in ordering that the bankruptcy court must study the issue again, the appellate court’s new holding is almost sure to make the Faish test more difficult to meet. “While there is no binding authority explicitly stating that the ‘good faith effort’ requirement in Faish requires a debtor to begin making a good faith effort to repay his loan when the first payment on the loan becomes due, it is clear to us that a debtor should be so required,” the court wrote in a per curiam opinion joined by Judges Samuel A. Alito Jr., Julio M. Fuentes and Morton I. Greenberg. “There is no sound reason to require a debtor solely to make good faith attempts to repay a loan during the year immediately prior to the year in which the debtor files a bankruptcy petition,” the court said. As a result, the court held that “a debtor seeking to discharge a student loan obligation on the ground that barring him from doing so would result in undue hardship must prove that he or she made good faith efforts to repay the loan over the entire time period between the date on which the first loan payment became due and the date on which the debtor filed for bankruptcy.” Since Pelliccia’s loan obligations became due in 1991, the court found that he must show that he made a good faith effort to repay his loans between 1991 and 2000 when he filed for bankruptcy court protection. Pelliccia submitted financial records to the bankruptcy court for 2000, but provided nothing for the previous nine years. As a result, the 3rd Circuit found it was “impossible to decide, on the present record, whether Pelliccia made a good faith effort to repay his loans for the entirety of the relevant time period.” Offering additional guidance to the bankruptcy court on remand, the appellate judges also said that Pelliccia’s decision to have children should not be taken into account when performing the good faith effort inquiry. “We defer to the Department [of Education]‘s position that a debtor’s decision to have children should not be considered in determining whether that debtor has made a good faith effort to meet his student loan obligations,” the court said. But the court also rejected Pelliccia’s argument that a debtor who has made financially irresponsible purchases may nevertheless meet the good faith requirement by demonstrating that he would have been unable to repay the loan even if those purchases had not been made. “The few courts of appeals that have applied the good faith prong of the Faish test … have focused on the questions whether the debtor (1) incurred substantial expenses beyond those required to pay for basic necessities and (2) made efforts to restructure his loan before filing his petition in bankruptcy. They have not inquired as to whether the debtor could have reasonably expected to acquire a positive cash flow by taking such measures,” the court said. Pelliccia’s lawyer, David J. Harris of Wilkes-Barre, Pa., insisted that his position was grounded on a quote from Faish in which the 3rd Circuit said, “the good faith inquiry is to be guided by the understanding that ‘undue hardship encompasses a notion that the debtor may not willfully or negligently cause his own default, but rather his condition must result from factors beyond his reasonable control.’” As a result, Harris argued, the Faish decision allows a debtor to excuse his financially irresponsible purchases under the good faith test by showing that those purchases did not cause him to default on his loans. The appellate panel disagreed, saying, “Since we did not have occasion to apply the good faith test in Faish … the above statement is dictum and therefore not binding on this court.” Instead, the court followed the approach taken by three of its sister circuits — the 2nd, 6th and 9th — and held that a bankruptcy court inquiring whether a debtor has made a good faith effort to repay a student loan must consider two factors: whether the debtor incurred substantial expenses beyond those required to pay for basic necessities; and whether the debtor made efforts to restructure his loan before filing his petition in bankruptcy.

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