Earlier this month the Supreme Court held oral argument on an appeal arising out of the Seventh Circuit Court of Appeals that revisits the thorny and frequently litigated issue of bankruptcy court jurisdiction post-Stern v. Marshall.

In Wellness Int’l Network v. Sharif, the Seventh Circuit Court of Appeals held that (i) a bankruptcy court lacks constitutional authority to issue a final judgment on the resolution of a claim involving state common law issues, and (ii) that a party’s consent to bankruptcy court jurisdiction cannot cure a constitutional deficiency.  727 F.3d 751 (7th Cir. 2013).

The debtor, Richard Sharif, filed for Chapter 7 relief and the petitioner, Wellness International Network Ltd., filed an adversary proceeding in the bankruptcy court to collect on a pre-petition judgment against Sharif, alleging that certain funds not reported on Sharif’s bankruptcy petition should be part of the bankruptcy estate under an alter ego theory of liability.  Following Sharif’s failure to comply with discovery orders in the adversary proceeding, the Bankruptcy Court entered a default judgment in favor of Wellness.  On appeal, Sharif argued that the Bankruptcy Court lacked constitutional jurisdiction to enter final judgment on Wellness’ claim.  The Seventh Circuit held that because Wellness’ claim, based on alter-ego liability, was rooted in state common law, it was not sufficiently related to the claims-allowance process to permit bankruptcy court jurisdiction.  The Seventh Circuit also rejected Wellness’ argument that Sharif had waived his Stern objection by consenting to bankruptcy court jurisdiction and failing to raise the issue in the Bankruptcy Court.

The Supreme Court granted certiorari to consider the following issues:

  1. Does the presence of a subsidiary state property law issue in an action brought against a debtor to determine whether property in the debtor’s possession is property of the bankruptcy estate mean that such action does not “stem[] from the bankruptcy itself” and therefore, that a bankruptcy court does not have the constitutional authority to enter a final order deciding that action; and
  2. Does Article III permits the exercise of the judicial power of the United States by the bankruptcy courts on the basis of litigant consent, and if so, whether implied consent based on a litigant’s conduct is sufficient to satisfy Article III.

At oral argument, Justice Breyer echoed the arguments put forth by counsel for Wellness and supported by the Solicitor General as amicus curiae, that removing questions of what property constitutes the bankruptcy estate — “the most fundamental thing imaginable” — from the jurisdiction of the bankruptcy court would disrupt “the constitutional grant to Congress to make uniform laws of bankruptcy.”  However, Justice Roberts expressed concern that allowing bankruptcy judges to decide certain state law issues “takes out of the Federal courts our constitutional birthright to decide cases and controversies under Article III.”

The Justices also spent some time considering the effect of any decision on lower courts, in light of the confusion that stemmed from Stern and its progeny.  Justice Scalia turned to the parties to ask which of the two questions presented to the Court “is the prettier question . . . or the one that you think has more real world effect?”  Justice Kennedy followed up, “are the bankruptcy courts more confused by Question 1 or Question 2?”  Justice Breyer suggested that there was no precedent of the Court that prohibited it from deciding both questions.

It is particularly difficult to speculate on the outcome of this oral argument because the Justices that joined the majority decision in Stern v. Marshall (Justices Roberts, Scalia, Kennedy, Thomas and Alito) did not indicate a strong preference for either side at oral argument.  We will report back when a decision is entered, which should occur before the end of the Supreme Court’s term in June 2015.

In a recent decision considering the dischargeability of student loan debt, the Eighth Circuit Court of Appeals affirmed a lower court’s decision establishing a unique and flexible test for determining whether repaying student loans imposes an “undue hardship” on a debtor.

Under the Bankruptcy Code, graduates generally cannot discharge student loan debt absent certain conditions.  Section 528(a)(8) of the Bankruptcy Code provides that a bankruptcy discharge does not apply to student loans unless excepting student loans from discharge “would impose an undue hardship on the debtor and the debtor’s dependents[.]”  11 U.S.C. § 528(a)(8).  In the absence of an “undue hardship” definition in the Bankruptcy Code, most courts rely on Brunner v. New York State Higher Education Services to determine whether a student loan imposes an undue hardship, and is therefore dischargeable in bankruptcy.  831 F.2d 395 (2d Cir. 1987).  Under the Brunner test, a student loan debtor must demonstrate:

  1. She cannot maintain a minimal standard of living for herself and her dependents if required to repay the loans;
  2. That additional circumstances exist indicating that her financial condition is “likely to persist for a significant portion of the [loan] repayment period.”; and
  3. That she has made a good faith effort to repay the loan.

See id. at 396.  Most courts, applying the Brunner test, find that a college degree militates against a finding of undue hardship because the mere existence of the college degree indicates that a graduate’s financial condition can improve.

The Eighth Circuit took a different approach in Conway v. National Collegiate Trust.  In Conway, the debtor graduated with a B.A. in Media Communications and fifteen student loans with an aggregate balance of over $118,000.  Following a series of lay-offs from her post-graduation jobs, Ms. Conway filed for chapter 7 bankruptcy and sought to discharge her student loans.  Ms. Conway’s private student loan provider, National Collegiate Trust, contested the discharge and the Missouri bankruptcy court refused discharge, citing Conway’s college degree and “at least 30 years left to navigate the job market” as support for her ability to repay the loans.  Conway v. Nat’l Collegiate Trust (In re Conway), 489 B.R. 828 (Bankr. E.D. Mo. 2013).

On appeal, the Eighth Circuit Bankruptcy Appellate Panel overturned the bankruptcy court’s decision applying a test that looked beyond the Brunner test to instead review the debtor’s past, present and future financial resources to determine whether the student loans presented an undue hardship.  Conway v. Nat’l Collegiate Trust (In re Conway), 495 B.R. 416 (B.A.P. 8th Cir. 2013).  The court found that even with her degree, the debtor did not necessarily have the ability to make enough money to make minimum monthly payments, given that she had been laid off from previous jobs, had applied to hundreds of jobs in the interim, and was currently employed as a waitress.  Id. at 421-22.  While the court found that Ms. Conway’s disposable income was insufficient to make the full monthly payments on all fifteen loans, the panel remanded the case to the Bankruptcy Court to determine whether the debtor’s disposable income could be sufficient to service the minimum monthly payment on any of the individual loans.  Id. at 424.  The Eighth Circuit affirmed the decision in a short, unpublished, per curiam opinion.  Conway v. Nat’l Collegiate Trust (In re Conway), 559 Fed. Appx. 610 (8th Cir. 2014).

While the Conway decision may provide a more flexible test for the discharge of student loans, the impact of the decision should not be overstated.  First, the Eighth Circuit merely remanded the matter to the bankruptcy court to evaluate each loan individually.  Second, the Eighth Circuit only includes South Dakota, North Dakota, Minnesota, Nebraska, Iowa, Missouri, and Arkansas.  The Brunner test continues to be applied by courts in other circuits.