Student loans are statutorily nondischargeable in bankruptcy unless the debtor can make a showing of “undue hardship.” In this article, we provide an in-depth discussion of student loans in the context of bankruptcy.
HISTORY OF THE BANKRUPTCY CODE VIS-A-VIS STUDENT LOANS
Federally sponsored student loans began with the National Defense Act of 1958, Pub. L. No. 85-864, Title II, §§ 201-09 (1958), which established the Perkins Loan program. The Stafford Loan program, now known as the FFEL Program, was created by the Higher Education Act of 1965, Pub. L. No. 89-329 (1965) codified at 20 U.S.C. §§ 1071 – 1087-4. At their inception, government-backed student loans were fully dischargeable in bankruptcy. Tenn. Student Assistance Corp. v. Hood, 541 U.S. 440, 449 (2004). Thus, graduating students could discharge their unsecured student loans in bankruptcy while enjoying the higher earning power made possible by their education – and the loans used to attain it. Bankruptcy abuse, in effect, converted many student loans into scholarships.
Student loan bankruptcy abuse raised considerable concern in Congress, see, e.g., H.R. Doc. No. 93-137, pts. I & II (1973), reprinted in B. App. Collier’s, pt. 4(c), p. 4-432, and over time, Congress has repeatedly amended the Bankruptcy Code so that student loan debt is no longer readily dischargeable in bankruptcy, but is now presumptively nondischargeable.
Congress first acted to curtail abusive discharges of student loans in bankruptcy in 1976. Educational Amendments of 1976, Pub. L. No. 94-482, § 439A(a) (1976) (codified at 20 U.S.C. § 1087-3 (1976 ed.), repealed by Pub. L. No. 95-598, § 317 (1978)). That enactment made federally insured or guaranteed loans nondischargeable in bankruptcy for a period of five years after the loan first became due, unless payment from future earnings would impose an undue hardship on the debtor.
Ever since, Congress has made it progressively more difficult to discharge student loans. When the current Bankruptcy Code was adopted in 1978, section 523(a)(8) continued the prohibition on discharge within the first five years of the repayment period absent undue hardship, but expanded the previous statute’s scope – which had been limited to federally insured or guaranteed loans – to include any debt “to a government unit, or a nonprofit institution of higher education, for an educational loan.” Bankruptcy Reform Act of 1978, Pub. L. No. 95-598 (1978).
In the years that followed, amendments to section 523(a)(8) have reflected a clear congressional design to limit the dischargeability of student loans. In 1979, Congress again expanded the types of loans protected from discharge and also eliminated certain reasons for deferring payment. Pub. L. No. 96-56, § 3 (1979). In 1984, Congress deleted the words “of higher education” from the statute so as to extend protection against discharge to any nonprofit institution, not just nonprofit institutions “of higher education.” Bankruptcy Amendments and Federal Judgeship Act of 1984, Pub. L. No. 98-353, § 454(a)(2) (1984).
In 1990, more restrictions on discharge were added. The five-year waiting period was extended to seven years. Federal Debt Collection Procedures Act of 1990, Pub. L. No. 101-647, § 3621(2) (1990). And the exception to discharge of student loans was applied for the first time to Chapter 13 cases by incorporating section 523(a)(8) into section 1328(a). Student Loan Default Prevention Initiative Act of 1990, Pub. L. No. 101-508, § 3007 (1990).
In 1998, Congress amended section 523(a)(8) to eliminate the right to discharge student loans based solely on their age. Higher Education Amendments of 1998, Pub. L. No. 105-244, § 971(a) (1998). That amendment left undue hardship as the exclusive basis for discharging a student loan. Most recently, Congress acted in 2005 to include student loans funded by for-profit entities among those that are nondischargeable in bankruptcy. Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub. L. No. 109-8, § 220 (2005).
Over the last 30 years, then, Congress has acted again and again to restrict the ability of debtors to discharge student loan debt. The Bankruptcy Code now allows discharge of student loan debt for one reason, and one reason only – that “excepting such debt from discharge *** would impose an undue hardship on the debtor.” 11 U.S.C. § 523(a)(8).
THE CURRENT LAW
Under Title 11, section 1328(a)(2), student loan debt is nondischargeable in bankruptcy unless repayment would cause the debtor an “undue hardship.
The plain text of Chapter 13 expressIy excludes student loan debt from discharge, thus making it presumptively nondischargeable:
[A]fter completion by the debtor of all payments under the plan *** the court shall grant the debtor a discharge of all debts provided for by the plan *** except any debt
(2) of the kind specified in *** paragraph *** (8) *** of section 523(a).
11 U.S.C. § 1328(a) (emphasis added). Section 523(a)(8), in turn, provides that student loans are nondischargeable “unless excepting such debt from discharge under this paragraph would impose an undue hardship on the debtor and the debtor’s dependents.” The presumption created by section 1328(a) that student loans are nondischargeable is thus rebuttable only by proof of “undue hardship.”
In other words, under the current bankruptcy rules, a debtor may obtain a discharge of certain government-sponsored student loan debts only if failure to discharge that debt would impose an “undue hardship” on debtor and debtor’s dependents. See United Student Aid Funds, Inc. v. Espinosa, 559 U.S. 260, 268-69 (2010). Further, the bankruptcy rules require a party seeking to determine the dischargeability of a student loan debt to commence an adversary proceeding by serving a summons and complaint on affected creditors.
THE UNDUE HARDSHIP TEST
The courts have adopted the undue hardship test in order to determine whether a debtor has met the criteria warranting discharge of his student loan debt. Under this test, the debtor must establish each of the following three elements:
- That he cannot maintain, based on current income and expenses, a “minimal” standard of living for himself and his 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 of the student loans; and
- That he has made a good faith effort to repay the loans.
See, e.g., Brunner v. N.Y. State Higher Educ. Serv. Corp., 831 F.2d 395, 396 (2d Cir. 1987). The burden is on the debtor to prove each of the foregoing elements. This is a progressive test; if the debtor fails to meet his burden of proof on any element, the court’s inquiry ends and the debt is declared nondischargeable.
Element No. 1
This element requires more than a showing of tight finances or temporary financial adversity, and the proper inquiry is whether it would be ‘unconscionable’ to require the debtor to take steps to earn more income or reduce his expenses. See, e.g., United State Aid Funds, Inc. v. Nascimento, 241 B.R. 440,445 (B.A.P. 9th Cir. 1999). In other words, the bankruptcy court determines whether it would be unconscionable to make the debtor maximize his income or reduce expenses because it is the debtor’s duty to adjust his lifestyle to allow him to make the payments on his student loans. See, e.g., Oyler v. Educ. Mgmt. Corp., 397 F.3d 382, 386 (6th Cir. 2005) (no undue hardship where debtor made voluntary choice to work for low pay as a pastor of a start-up church); O’Hearn v. Educ. Credit Mgmt. Corp., 339 F.3d 559, 565 (7th Cir. 2003) (“Although [debtor] has been fortunate in finding a [lower paying] position . . . that he deems satisfying and that is socially useful, Congress has not provided that such considerations ought to be weighed in determining the discharge of student loans.”); United States Dep’t of Educ. v. Gerhardt, 348 F.3d 89, 93 (5th Cir. 2003) (debtor cannot remain in low paying position “and then claim that it would be an undue hardship to repay his student loans”); Educ. Credit Mgmt. Corp. v. Frushour, 433 F.3d 393, 401 (4th Cir. 2005) (same); Chapelle v. Educ. Credit Mgmt. Corp., 328 B.R. 565, 572 (Bankr. C.D. Cal. 2005) (no discharge where vocational expert testified to over “100 [job] openings” in the debtor’s geographic area, and debtor failed to “show that she ha[d] adequately pursued these alternative career paths or training”)
Case Law: Oyler v. Educ. Mgmt. Corp., 397 F.3d 382, 386 (6th Cir. 2005) (no undue hardship where debtor made voluntary choice to work for low pay as a pastor of a start-up church); O’Hearn v. Educ. Credit Mgmt. Corp., 339 F.3d 559, 565 (7th Cir. 2003) (“Although [debtor] has been fortunate in finding a [lower paying] position . . . that he deems satisfying and that is socially useful, Congress has not provided that such considerations ought to be weighed in determining the discharge of student loans.”); United States Dep’t of Educ. v. Gerhardt, 348 F.3d 89, 93 (5th Cir. 2003) (debtor cannot remain in low paying position “and then claim that it would be an undue hardship to repay his student loans”); Educ. Credit Mgmt. Corp. v. Frushour, 433 F.3d 393, 401 (4th Cir. 2005) (same); Chapelle v. Educ. Credit Mgmt. Corp., 328 B.R. 565, 572 (Bankr. C.D. Cal. 2005) (no discharge where vocational expert testified to over “100 [job] openings” in the debtor’s geographic area, and debtor failed to “show that she ha[d] adequately pursued these alternative career paths or training”); Fulbright v. United States Dep’t of Educ., 319 B.R. 650, 657 (Bankr. D. Mont. 2005) (debtor failed the first element because although his “expenses consume a large part of his income,” the court scrutinized expenses to determine whether he could repay the loans); Chapelle, 328 B.R. at 570 (scrutinizing debtor’s choice to live “in a high rent district”).
Element No. 2
This element focuses on the Congressional intent behind § 523(a)(8) in making the discharge of student loans more difficult than that of other non-excepted debt and reliably guarantees that the hardship be “undue.” The courts have held that “garden-variety hardship” is insufficient to prove the additional circumstance requirement. Also, mere existence of student loan debt or other financial adversity is insufficient to establish an additional circumstance. Rather, the debtor must prove a total incapacity in the future to pay his debts for reasons not within his control.
Case Law Examples: Educ. Credit Mgmt. Corp. v. Frushour, 433 F.3d 393, 399 (4th Cir. 2005) (“The required hardship under § 523(a)(8) must be more than the usual hardship that accompanies bankruptcy. Inability to pay one’s debts by itself cannot be sufficient; otherwise all bankruptcy litigants would have undue hardship.”); United States Dep’t of Educ v. Gerhardt, 348 F.3d 89, 92 (5th Cir. 2003) (defining “additional circumstances” as “circumstances that impacted the debtor’s future earning potential but which were either not present when the debtor applied for the loans or have since been exacerbated.”).
Element No. 3
Under this element, the debtor must come forward with evidence of efforts that reflect a sense of good faith under the circumstances of each particular obligor. Good faith is measured by the debtor’s efforts to obtain employment, maximize income and minimize expenses and to undertake all other reasonable efforts to ensure repayment.
Case Law Examples: United States Dep’t of Educ. v. Wallace, 259 B.R. 170, 185 (2000) (factors to be considered under the good faith element “include the number of payments the debtor made, proportion of loans to total debt, and possible abuse of the bankruptcy process”); Alderete v. Educ. Credit Mgmt. Corp., 412 F.3d 1200, 1206 (10th Cir. 2005) (the court denied discharge under the third element due to the debtors’ failure to make payments and the fact that they “had almost no debt other than the student loans”).