Courts Relax Rules for Bankrupting Student Loans

You can’t discharge student loans in bankruptcy. Everyone knows that. Nevertheless, recent federal court decisions indicate that restrictions on discharging student loans during bankruptcy are relaxing.

Most public and private student loans are excluded from discharge unless the bankruptcy debtor can show that repaying the loan would “impose an undue hardship on the debtor and the debtor’s dependents.” Because Congress did not supply a definition for “undue hardship,” it is left to the federal courts to develop tests to determine which debtors would receive a discharge of student loan debt.

The most popular test comes from the Brunner v. New York Higher Education Services Corp. a 1987 case. Under the Brunner test, the debtor must prove that:

  • He made good faith efforts to repay his student loans.
  • 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.
  • 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.

While many bankruptcy debtors are able to meet the first two prongs of the Brunner test, the third prong is considered an exceptionally high bar. One particularly insensitive judge in an Ohio case denied discharge of a student loan debt for undue hardship, and told a blind debtor receiving $811 each month in social security disability, “It remains to be seen . . . whether [the debtor] will find work or remain unemployed.”

Each year members of Congress propose legislation to ease restrictions for discharging student loans. The latest bill was presented in July by Senator Tom Harkin (D-IA), which proposes to make private student loans dischargeable in bankruptcy. The lobbying power of the private student loan industry was responsible for changing the bankruptcy laws in 2005 to exclude private student loans from discharge, so the prospects of this bill becoming law are considered dim.

According to the Consumer Financial Protection Bureau, student loan debt has climbed over $1.2 trillion. Of that, $1 trillion is federal student loan debt. Even if Senator Harkin’s bill is successful, allowing discharge of private student loans offers little to ease America’s student loan crisis.

Perhaps as a consequence of the Congress’s impotence, federal courts are “legislating from the bench” to provide relief to student loan debtors. One trend is to permit partial discharge of student loans, currently allowed in the Sixth, Ninth, Tenth, and Eleventh Judicial Circuits. These circuits allow their bankruptcy courts to reduce the total amount due on student loan debts to levels that debtors can afford to pay.

Federal bankruptcy courts are slowly eroding the protection surrounding student loans. Last June, the Eight Circuit Court of Appeals took another step forward by allowing a debtor to discharge individual student loans for undue hardship, rather than considering all of her student loans collectively. In that case, Conway v. National Collegiate Trust, the debtor owed over $110,000 between 15 student loans. The lender argued that the entire debt should be considered collectively. The Eighth Circuit disagreed, and remanded the case to the bankruptcy court to determine the debtor’s ability to repay each of the loans. This approach opens a new door for many debtors struggling with multiple student loans.

Until Congress makes a significant change to the bankruptcy code, discharging student loans will remain an extremely tough obstacle for debtors in bankruptcy. If you are burdened with student loans, speak with an experienced attorney and discuss your options under the federal Bankruptcy Code.