In re O'Hearn

• Decision Date: 08 August 2003
• Docket Number: No. 02-3930.,02-3930.
• Citation: 339 F.3d 559
• Parties: In the Matter of: Timothy Gerard O'HEARN, Debtor, Timothy Gerard O'Hearn, Plaintiff-Appellee, v. Educational Credit Management Corporation, Defendant-Appellant.
• Court: U.S. Court of Appeals — Seventh Circuit

339 F.3d 559

In the Matter of: Timothy Gerard O'HEARN, Debtor, Timothy Gerard O'Hearn, Plaintiff-Appellee, v. Educational Credit Management Corporation, Defendant-Appellant.

No. 02-3930.

United States Court of Appeals, Seventh Circuit.

Argued April 22, 2003.

Decided August 8, 2003.

COPYRIGHT MATERIAL OMITTED

Daniel Fisher (argued), Educational Credit Management Corp, St. Paul, MN, for Appellant.

Christine Wolk (argued), Wolk Law Office, Oshkosh, WI, for Debtor-Appellee.

Before COFFEY, RIPPLE and EVANS, Circuit Judges.

RIPPLE, Circuit Judge.

Timothy O'Hearn filed for Chapter 7 bankruptcy relief and sought to discharge his government-guaranteed educational loans owed to the defendant, Educational Credit Management Corporation ("ECMC"), a not-for-profit organization that administers guaranteed student loans. After a hearing, the bankruptcy court concluded that the student loans would impose an "undue hardship" on Mr. O'Hearn. See 11 U.S.C. § 523(a)(8). The court therefore entered an order discharging the loans. The bankruptcy court further ordered that any funds Mr. O'Hearn might collect from an earlier judgment against the person who fraudulently had diverted Mr. O'Hearn's payments to his own use be remitted to ECMC in order to satisfy the amount of the student loans plus interest. ECMC appealed the bankruptcy court's decision to the district court. That court affirmed the decision of the bankruptcy court. For the reasons set forth in the following opinion, we vacate the judgment of the district court and remand the case for proceedings consistent with this opinion.

I BACKGROUND

A. Facts

Mr. O'Hearn had attended Loma Linda University in California in 1993 and 1994 to obtain a master's degree in international public health. He financed this education through student loans totaling approximately $37,000. After graduation, Mr. O'Hearn worked at various jobs in Washington, D.C., and Uganda and Malawi in Africa. Bankr.Hr'g Tr. at 4. During his two-year service in Malawi, he sent $55,000, which was the bulk of his income, to his accountant in the United States. He had given directions that the funds be used to pay his student loans and other bills. Id. at 22-23. Mr. O'Hearn presented evidence that these funds should have been enough to pay his student loans in full, and that, had his accountant done so, the loans would have been repaid upon his return from Africa. Id.

Upon his return home to Wisconsin in April 1999, Mr. O'Hearn learned that his accountant had paid only $6,200 on the student loans and had absconded with the rest of his income and most of his retirement investment. Id. at 6, 23-24; R.3. Mr. O'Hearn sued his former accountant and received a judgment for $79,000 plus punitive damages but, at the time of the bankruptcy court hearing, he had only been able to collect about $5,700. Appellee's Summ. J. Mot. at 3.

Mr. O'Hearn was 50 years old at the time of trial. He had no children or dependents. After filing for Chapter 7 bankruptcy in January 2000 while living in Wisconsin, Mr. O'Hearn relocated to Portland, Oregon, in order to take a job as a diabetes coordinator for the Northwest Indian Health Board. Bankr.Hr'g Ex.2; Bankr. Hr'g Tr. at 10. His salary was $43,000 per year, plus medical and dental benefits. Bankr.Hr'g Tr. at 11, 38. There was some evidence that his salary might increase eventually to $50,000 per year, and that he was eligible for future retirement contributions from his employer. Id. at 19-20, 46. The bankruptcy court found that Mr. O'Hearn had obtained the best-paying job he could, given his age, training and interests. Id. at 99-100. Mr. O'Hearn testified that, before taking this position, he had applied to over 500 public and private employers in such fields as public health, teaching, administration and insurance. Id. at 62-64. The court also noted that, given his age, Mr. O'Hearn might have a "tough time" finding work in the future. Id. at 99. Mr. O'Hearn had no retirement investment left at the time of trial; it either had been stolen by his former accountant or had been used to pay for living expenses. Id. at 13-15. He testified that he did not have any health problems that impaired his ability to work. Id. at 69-70.

In Portland, Mr. O'Hearn lived and shared expenses with his fiancée, although he testified that their relationship was "strained" at that time. Id. at 54-57. The court calculated his net monthly income as $2,376 and his monthly expenses, excluding student loan payments, as approximately $2,500. Id. at 96. Mr. O'Hearn testified that, as part of his monthly expenses, he paid $1,402, or half of the mortgage payment, for his fiancée's house. Id. at 27-28, 97. His fiancée had purchased the 2000-square-foot, four-bedroom house for around $380,000. Id. at 43-44. Mr. O'Hearn claims no equity interest in this property. Id. at 29. He presented evidence that the average purchase price of a 2000-square-foot house in Portland in 1998 was $260,000. Id. at 44-45. The court found that he could rent a two-bedroom apartment in Portland for less than $1,000 per month, but also concluded that his other expenses, no longer being shared, would probably double. Bankr. Hr'g Ex.6; Bankr.Hr'g Tr. at 97-98.

The bankruptcy court detailed Mr. O'Hearn's other monthly expenses as: $115 for a car purchased from his fiancée, $100 for car insurance, $210 for food, $160 for phone and utilities, $80 for clothing and $100 for incidentals. Bankr.Hr'g Ex.1; Bankr.Hr'g Tr. at 32-34, 98-99. Mr. O'Hearn also reported legal expenses of $200 per month, and the court believed that he probably would face additional medical expenses because he had contracted malaria in Africa and had eye and dental problems. Bankr.Hr'g Tr. at 38, 99. ECMC presented the current IRS housing and utility allowance for a family of two or less in Portland as $837 per month. Bankr.Hr'g Ex.5; Bankr.Hr'g Tr. at 79.

As for the student loans, Mr. O'Hearn had defaulted on them in early 1999 and, at the time of the hearing, owed ECMC just over $50,000 in principal and interest. Bankr.Hr'g Tr. at 88; Appellee Summ. J. Mot. at Ex.A. The court calculated that his monthly payments would be around $375. Bankr.Hr'g Tr. at 100. Before filing for bankruptcy, Mr. O'Hearn had offered a lump sum payment of $30,000, comprised of remaining savings and contributions from family, but the collection agency handling the loans rejected this proposed settlement, and Mr. O'Hearn made no further payments. Id. at 15-16; Appellee's Summ. J. Mot. at Ex.D.

B. Earlier Proceedings

The bankruptcy court concluded that Mr. O'Hearn had met the "undue hardship" test of 11 U.S.C. § 523(a)(8). It took the view that Mr. O'Hearn had satisfied the three-part test for "undue hardship" previously established by this court:

(1) the debtor cannot maintain, based on current income and expenses, a minimal standard of living for himself and his dependents if forced to repay the loans; and

(2) additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period of the student loans; and

(3) the debtor has made good-faith efforts to repay the loans.

See In re Roberson, 999 F.2d 1132, 1135 (7th Cir.1993).

The bankruptcy court concluded that Mr. O'Hearn could not cover his current expenses despite what the court characterized as a "frugal" budget. The court also believed that, given his age, Mr. O'Hearn's financial difficulties would persist. With respect to his employment opportunities, the court believed that, considering his age and his particular training and talents, he had maximized his job opportunities. With respect to his living arrangement, the court believed that he could not reduce his overall expenses by renting less expensive quarters because he would not have the advantage of sharing other living expenses. The court also noted that he had made good-faith efforts to pay the loans.

Accordingly, the court discharged Mr. O'Hearn's student loans. The court further ordered that any funds recovered on the judgment against his former accountant be remitted to ECMC. It decided to impose this arrangement despite ECMC's objection that such a plan would have the practical effect of relieving Mr. O'Hearn of any incentive to collect the judgment. On appeal, the district court affirmed the discharge. ECMC timely appealed to this court.

II DISCUSSION

A.

The basic purpose of a discharge in bankruptcy is to give debtors a fresh start. See Vill. of San Jose v. McWilliams, 284 F.3d 785, 790 (7th Cir.2002). Congress nevertheless has decided that various considerations of public policy require that certain debts be excluded from the general principle of discharge. Student loan debts are among those debts that Congress has singled out for such exclusion. This student loan exception is codified in the Bankruptcy Code at 11 U.S.C. § 523:

A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt ... for an educational benefit overpayment or loan made, insured or guaranteed by a governmental unit, or made under any program funded in whole or in part by a governmental unit or nonprofit institution, or for an obligation to repay funds received as an educational benefit, scholarship or stipend, unless excepting such debt from discharge under this paragraph will impose an undue hardship on the debtor and the debtor's dependents.

11 U.S.C. § 523(a)(8). Under this provision, debtors cannot discharge student loans in bankruptcy unless they show that paying on the loans would cause "undue hardship." Supporters of this limitation on the dischargeability of these loans sought to curb abuse by unscrupulous former students who, having obtained their education, sought to evade their commitment to pay for it by seeking immediate discharge of their loans.¹

The key phrase of the statutory provision, "undue hardship," is not defined in the...