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Student Loans in Bankruptcy

Posted on February 4, 2020 in

The treatment of student loans in bankruptcy has received new attention recently, with indications that both Congress and bankruptcy courts are looking to give student borrowers more leniency on discharging crushing student loan debts than was previously available.  

The Student Loan Debt Problem

Nationwide, student loan debt is estimated to be $1.5 trillion and repayment defaults on student loans are rising. On average, 2016 graduates with a 4-year degree left school with $37,000 in student loan debt. 

Although many federal student loans can be repaid on income based repayment plans over 20 or 25 years, or graduated payments, once a borrower defaults (which can be as easy as a late payment or missed deadline following a forbearance period during which no payments are due), a debtor must make several months’ of higher payments before they become eligible again for income based repayment options again. Additionally, private student loans are not typically eligible for any payment relief or income based repayment options but are nonetheless non-dischargeable under the Bankruptcy Code.  Even the contentious student loan debtor can quickly find themselves over their head and in default.  

Student Loans in Bankruptcy 

Currently the Bankruptcy Code only allows discharge of student loan debt upon a debtor showing repayment of the student loans presents an undue hardship on the debtor or the debtor’s dependents. See 11 U.S.C. sec. 523(a)(8). Courts were tasked with interpreting what “undue hardship” means in this context. Generally, courts look at three factors to determine undue hardship:

  • Based on current income and expenses, the debtor cannot maintain a minimal standard of living;
  • Circumstances exist indicating the financial status will continue for a significant portion of the student loan repayment period; and 
  • The debtor has made a good faith effort to repay the loans.

See, Brunner v. N.Y. State Higher Educ. Servs. Corp. (In re Brunner), 831 F.2d 395, 396 (2d Cir. 1987).  Failing to meet any one of these three elements prevents a debtor from discharging student loan debt. Moreover, Courts have largely provided such a narrow view of these elements as requiring a “certainty of hopelessness” in ever making any repayment of the outstanding student loan debt. While this test was originally only applicable to federal student loans, the discharge protection was expanded to private student loans in the 2005 bankruptcy amendments.  Accordingly, discharge of any student loan debt has become something of a bankruptcy unicorn.  

Discussions on student loan debt discharge

In early January, presidential candidate and Representative Elizabeth Warren proposed a plan to roll back the changes made in the last major overhaul of the Bankruptcy Code in 2005, as well as change certain other rules of the Bankruptcy Code including the rules related to the discharge of student loans.  

Politicians are not the only people discussing a comprehensive change to student loan treatment in bankruptcy. In April 2019, the American Bankruptcy Institute (“ABI”) issued a report with recommendations to make changes to the Bankruptcy Code, including a comprehensive change of the way student loan debts are handled. ABI recommends, among other things, amendments that would allow a debtor to discharge remaining student loan debts being paid through a 5-year Chapter 13 plan, or loans first payable more than 7 years prior to filing a Chapter 7 bankruptcy. 

Finally, Bankruptcy Courts are starting to dial back the harsh and rigid application of prior case law in light of the current burdens placed on student loan debtors. On January 7, 2020, Bankruptcy Judge Celia Morris, U.S. Bankruptcy Court for the Southern District of New York, issued a ruling in favor of a student loan debtor, discharging $220,000 in student loan debt. In that case, Rosenberg v. N.Y. State Higher Education Services, Corp., Adv. Case No. 18-09023 (Bankr. S.D.N.Y. Jan. 7, 2020), Judge Morris acknowledged that the seminal case on student loan non-dischargeability, In re Brunner, may have been a case of bad facts making bad law as Brunner filed for bankruptcy protection a mere seven months after graduating. In her ruling, Judge Morris acknowledged the results of a rigid application of the Brunner test may be too harsh for individuals like the Rosenberg who struggled for years to make payments on their student loans.  

Judge Morris did apply the framework of the Brunner test to Rosenberg, but referencing ABI’s recommendation for a reform of the test, and without the cloud of prior case law requiring the factors to indicate a “certainty of hopelessness.” In her application, Judge Morris took the debtor’s mean test, a statutory formula used to qualify for Chapter 7 that calculates a debtor’s projected disposable income over 60-months (the length of a potential Chapter 13 plan).  Rosenberg’s means test and bankruptcy scheduled revealed that his expenses exceeded his income by approximately $1,500, which Judge Morris found sufficient to meet the first prong of the Brunner test. Judge Morris then took a pass on the second element, finding it had been met as the lender had accelerated the debt following the debtor’s default. Finally, the court reviewed Rosenberg’s payment history, which included partial payments during periods of repayment and some payments made during forbearance when no payment was due, and found the Debtor’s efforts were sufficient to constitute a good faith effort, and discharged the remainder of the debt. 

It will take some time to see if Congress takes up the issue of student loan discharge reform, or if Courts follow the lead of Judge Morris in Rosenberg, but it appears some changes to the handling of student loans in bankruptcy is on the horizon.

About the Author: Dana Quick practices in the area of insolvency and commercial litigation. Her experience includes prosecuting director and officer liability claims; representing trustees, creditors, creditor committees, and debtors in bankruptcy proceedings; state court insolvency litigation; and prosecuting and defending preference actions. Additionally, Dana has significant experience representing and counseling companies of all sizes on employment issues, including ADA, FMLA, and Title VII matters. Click here to find out more about Dana.

 

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