U.S. Dept. of Health & Human Services v. Smitley

Decision Date20 October 2003
Docket NumberNo. 02-2056.,02-2056.
Citation347 F.3d 109
PartiesU.S. DEPARTMENT OF HEALTH & HUMAN SERVICES, Plaintiff-Appellant, and Great Lakes Higher Education Servicing Corporation, Agent for Associated Bank, Plaintiff, v. Zane Todd SMITLEY, Defendant-Appellee.
CourtU.S. Court of Appeals — Fourth Circuit

ARGUED: Anne Margaret Hayes, Assistant United States Attorney, Raleigh, North Carolina, for Appellant.

Douglas Quinn Wickham, HATCH, LITTLE, BUNN, L.L.P., Raleigh, North Carolina, for Appellee. ON BRIEF: Frank D. Whitney, United States Attorney, Neal I. Fowler, Assistant United States Attorney, Raleigh, North Carolina, for Appellant.

Before MICHAEL, MOTZ, and KING, Circuit Judges.

Reversed by published opinion. Judge DIANA GRIBBON MOTZ wrote the majority opinion, in which Judge KING joined. Judge MICHAEL wrote a dissenting opinion.



In this Chapter 7 case, the United States Department of Health and Human Services (HHS) appeals the district court order affirming the bankruptcy court's discharge of the Health Education Assistance Loans ("HEAL loans") of Zane Todd Smitley. Because the district court erred in holding that nondischarge of the HEAL loans would be unconscionable, as is required by 42 U.S.C.A. § 292f(g) (West 2003), we reverse.


From 1983 through 1985, Smitley obtained approximately $27,000 in HEAL loans in order to attend the Cleveland Chiropractic College. After Smitley graduated in September 1985, the holder of the loans, Student Loan Marketing Association (SLMA), provided Smitley a repayment schedule, with payments to start in September 1986. From August 1986 through May 1988, Smitley requested and received four forbearances; he made no payments during those times. After the forbearances, Smitley failed to keep his HEAL loan payments current.

Smitley's default resulted in assignment of the loans to HHS. In November 1991, HHS notified Smitley of the assignment, and the parties entered into a Repayment Agreement. At that time, the total debt amount equaled approximately $42,000. From March 1992 through August 1999, Smitley made monthly payments of $100, totaling $7,600. Despite his promise in the Repayment Agreement to "increase [his] monthly payment with the month following any increase in income," Smitley did not increase the monthly payments, even though his income substantially increased over those years (to more than $80,000 in one year).

On October 26, 1999, Smitley and his wife filed a Chapter 7 petition in the bankruptcy court. On February 11, 2000, they received a general discharge of over $100,000. On February 7, 2000, Smitley filed the instant adversary proceeding against HHS, the Educational Credit Management Corporation (ECMC), and the Great Lakes Higher Education Corporation.1 Smitley sought discharge of approximately $63,000 of principal and interest in HEAL loans and an additional $68,000 in principal and interest in educational loans owed to ECMC.2

On April 12, 2001, the bankruptcy court held a trial on the adversary proceeding. The parties agree that the facts of this case are undisputed. At the time of trial, Smitley was 47 years old, in good health, and lived in Raleigh, North Carolina. He had received an undergraduate degree in secondary education and worked as a secondary school teacher prior to seeking his chiropractic degree. After chiropractic school, Smitley purchased a practice from another chiropractor and practiced for approximately 13 years. During that time, Smitley had a fire in his office, suffered an injury that kept him out of work for six weeks, and incurred medical bills of $22,000, which Mrs. Smitley testified had been paid off at the time of trial. In 1999, he closed his chiropractic practice because of financial difficulties.

Since closing the practice, Smitley has worked part-time as a carpenter. Smitley now works 30-38 hours per week as a finish trim carpenter, earning $15 per hour. He testified that he had not "explored the possible hours [he] could get from another finish carpenter" job.

Both his chiropractic and secondary education licenses had lapsed at the time of trial. Smitley has made a few attempts to obtain part-time or evening jobs at retailers and grocery stores. He also applied for a few teaching jobs at the university level and testified that people at his church had looked for management jobs for him. But Smitley did not seek teaching positions at the high school level, positions as a factory foreman (for which he had prior experience), positions in other geographic areas (except for a teaching position at a college in Ohio), or employment counseling of any kind.

At the time of the trial, Smitley's wife was 45 years old. Mrs. Smitley works about 30-35 hours per week, for $12-$13 per hour, as an assistant to two dentists. She testified that she cannot work additional hours because of undiagnosed problems with her hands.

In April 2001, the Smitleys had four children under the age of eighteen: 17-year-old twins and two other children ages 14 and 8. The children have health insurance through the State, but Smitley and his wife do not have health insurance.

From 1995 through 2000, the Smitleys reported the following annual income to the Internal Revenue Service: $83,064 (1995), $58,053 (1996), $63,691 (1997), $58,354 (1998), $40,675 (1999), and (approximately) $42,000 (2000). The Smitleys made substantial donations to their church during some of those years — $5,800 in 1995, $4,700 in 1996, and $3,000 in 1997. The family rents a two-story, three-bedroom house for $1,250 per month in Raleigh, North Carolina. Mrs. Smitley has a retirement account of approximately $10,000, consisting of her employer's contributions. The family owns two automobiles, on one of which, a van, they owe a monthly payment of $434 per month.3 Members of the family's church occasionally donate money and other items to them. The Smitleys often pay bills a month behind, and owe about $14,000 in back federal and state taxes; the IRS has set-up a payment plan of $100 per month on the federal taxes.

Smitley stated the following basis for his "belief that the debt to the United States should be discharged based on unconscionability":

We are both working 33 to 38 hours a week, continuing to pursue our jobs to be able to support ourselves and our family. We are both employed, have good jobs. We are unable to pay our regular bills. Our children must earn their own money to do activities. Our teenage daughters are unable to get a driver's license because we cannot afford insurance. [We] cannot afford health insurance, and it is not offered by our employers. Therefore, we must pay all of our own medical bills. We have no way at this time to pay all of our bills, save for the future, or make plans for our children's futures.

Smitley testified that he had not made any efforts since the bankruptcy filing to consolidate his loans in order to reduce the monthly payments.

On April 13, 2001, the bankruptcy court issued an order, finding that Smitley "is probably underemployed as a carpenter, but he has no prospects for other employment." It stated that "[i]t is apparent to the court that Mr. Smitley cannot possibly repay his educational loans that total more than $170,000 [sic]."4 The court noted that inability to pay is not the test for dischargeability; rather it recognized that the test for the HEAL loans is "unconscionability" under § 292f(g) and that the test for the ECMC loans is "undue hardship" under 11 U.S.C.A. § 523(a)(8) (West 1993 & Supp.2003). The court held that, "although the debtor is unable to pay the full amount of the loans, he may be able to pay a part of the loans." Because Smitley had not availed himself of the lenders' programs for financially disadvantaged borrowers, the court concluded that it could not determine whether the debts should be discharged. It ordered Smitley to apply to the lenders for consideration under these programs and report back to the court.

After Smitley reported back that (based on a total loan amount of $135,000, an annual gross income of $42,000 and four dependents), the minimum payment under the lenders' programs would be $327.67 per month, the bankruptcy court ordered both the $63,000 in HEAL loans and the $68,000 in ECMC loans discharged. Assuming an interest rate of 8.19%, the court believed that interest would accrue on both loans at $11,000 per year and the minimum payment would amount to just under $4,000 per year ($327.67 × 12). The bankruptcy court recognized the differing standards governing discharge of the HEAL and non-HEAL loans, but concluded that it would be "unconscionable" to refuse to discharge both loans. The court reasoned:

Even if Mr. Smitley were to make the payments according to the repayment schedule submitted, not only would he never fully repay the loan, but he would also never reduce the principal due. Instead, the amount would continue to increase. The prospects for Mr. Smitley to make higher payments in the future are not good, and if the balance continues to increase, the chances of his ever repaying the loans are nil. In the context of the bankruptcy proceeding, the court finds that requiring the debtor to continue to pay this debt for the rest of his life, with no hope of a final payment, is unconscionable. The HEAL loan, therefore, shall be discharged.... [and] Mr. Smitley's loans from Educational Credit shall also be discharged.

The district court affirmed the bankruptcy court's discharge order, holding that "[b]ased on the reasoning of the Bankruptcy Court, and this Court's evaluation of Debtor's dire financial situation, this Court finds that nondischarge of Smitley's outstanding student loans would be unconscionable in this case." It held that Smitley had met both the undue hardship and the unconscionability standards.

This appeal involves only discharge of the HEAL loans; ECMC did not...

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