It is well known that students these days are drowning in debt. And there really isn’t any way around it, unless you’re one of the few who doesn’t have to take out student loans. I wanted to offer some information on the interplay between bankruptcy law and the dischargeability of student loans, because I’ve seen so much misinformation out there passing itself off as reliable guidance. My hope is that this brief introduction will serve as a stimulus for further investigation by those needing it. There is no way that an article of 1200 words can cover any legal topic in detail, but I will strive to hit the relevant points that readers should be aware of.
I want to say at the outset that this article is not meant to serve as legal advice for anyone’s specific situation. It is offered for informational purposes. If there is one thing I’d like readers to take away from this piece—and if you take away nothing else, I hope you take this—it is the necessity of seeking reliable legal advice from an experienced attorney practicing in your jurisdiction.
Bankruptcy law is complicated, and involves an interplay of federal and state law, as well as local procedures, and only an attorney knowledgeable in the case law of your location can truly help you. Do not try to venture into these waters alone. The most dangerous thing in the world is a oblivious man proceeding resolutely from inadequate premises; and the graveyards of litigation are packed with the corpses of those who thought they could just “wing it.”
We begin with a short overview. The U.S. Bankruptcy Code offers several “chapters” that specify various types of debtors that can seek relief. The most commonly encountered are: Chapter 7 (individuals and businesses seeking to liquidate), Chapter 13 (individuals with income seeking debt reorganization), and Chapter 11 (individuals and businesses seeking debt reorganization). The other chapters are not relevant here and will not be discussed. Most commonly filed are Chapters 7 and 13.
Many people have heard the rule that student loans cannot be discharged (i.e., wiped out) in a bankruptcy proceeding. While true for most situations, it is not a fully accurate statement of the law. Student loans can be discharged. But hurdles need to be overcome. It requires litigation (an adversary proceeding in bankruptcy court) and a judicial finding that repayment of the debt would create an “undue burden” for the debtor. But what is undue burden? This is the question that has generated a huge amount of litigation.
“Undue burden” is mentioned in 11 U.S.C. Section 523(a)(8), but case law has provided the case-by-case flesh on these bare bones. Courts around the country have enunciated several tests to evaluate what “undue burden” means. The Second Circuit’s three-part Brunner test is perhaps the most popular. Under this test, student loans can be discharged if the debtor can show that (1) he cannot maintain a minimal standard of living if he is required to repay the loan; (2) such a situation is likely to persist for good period of the repayment term; and (3) the debtor has made a good faith effort to repay the loan. All three parts of the test must be satisfied.
Besides the Brunner test, some courts have applied other ways to evaluate undue hardship. These include the Johnson test (looking at the debtor’s earning ability to repay the obligation while maintaining a minimum living standard), the “totality of the circumstances” test (considering all factors of repayment ability on a case-by-case basis), and the “Bryant Poverty Test” (looking at whether debtor’s net income exceeds the federal poverty line). All of these tests are very fact-specific, and in practice often come down to this: to discharge your debts, you don’t need to be totally destitute, but you will need to prove something more than just normal hardship.
To make things more complicated, some courts have ruled that either all or none of the debts can be discharged, while some courts have said that it is possible to discharge a portion of the debts. Different judicial circuits around the country have molded and modified these tests with case law. So it is essential that you consult with the attorney in your jurisdiction for the most up-to-date and complete state of the law.
One example is useful to describe. In 2008 (In Re Groves, 393 B.R. 673 (W.D. Mo. 2008)), a Chapter 7 debtor in 2008 had $185,000 in student loans she sought to discharge. She had been in a doctoral program and failed to complete it due to her poor grades and resulting depression. The court found that she could, however, still work in the field for which she possessed a master’s degree. She could, therefore, make some payments. The court discharged $148,000 of the loan balance and left the remainder for her to pay.
Another example shows a different outcome. In In Re Campton, 405 B.R. 887 (N.D. Ohio 2009), an unemployed man sought to have $12,500 in student loans discharged. The court here found that the debtor failed all three parts of the Brunner test: he had maintained luxury items like a boat, cable TV, and cigarettes; he could not show his unemployment would continue for the near future; and he failed to show good faith by not making any payments. Clearly, this debtor was unworthy of the student loan discharge.
The ongoing student loan crisis continues to challenge both the government and students. It is unlikely that the Brunner test (dating to 1987) could have contemplated the avalanche of student loan debt that exists now. There was a time (decades ago) when student loans were dischargeable like any other debt, with no need for any litigation.
While those days are unlikely to return any time soon, it does appear to those of us that follow this issue that bankruptcy courts are beginning to be more generous in finding student loans dischargeable. And this makes good sense. Courts have to respond to social realities. A balanced society cannot exists when the backs of the young are permanently burdened with debt from which there is no escape. With the rise of the for-profit lending industry, the trend has been to shift away from favoring the lenders, to favoring the debtors.
If you or someone you know is considering a bankruptcy filing, and student loans exist, it is important at least to be aware of these issues. Knowing what questions to ask is a critical prt of the process. Further, there are many different ways to handle student loans in a bankruptcy. Even if they are not dischargeable, they can be very favorably treated over other debts in Chapter 13 or Chapter 11 reorganizations. Debtors are often surprised at just how much power they really have. Creative application of the law can do wonders for a client.
Those interested in exploring this or other areas of bankruptcy law are recommended to consult with an attorney in their jurisdiction. Depending on where you’re located, further legal information on this and related bankruptcy topics can be found in these links: on the west coast, in the midwest, and on the east coast.