Student Loan Dischargability: A Debtor Attorney’s Perspective
By Law Offices of Walter Metzen & Associates, Michigan
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Student loan debt in the United States is the largest class of consumer debt today behind mortgages, and is higher than both credit card debt and automobile loans.
The amount of outstanding student loan debt is presently over 1.4 trillion dollars, divided among approximately 44 million borrowers with the average 2016 graduate owing over $37,000. Many young adults strapped with overwhelming debt are delaying marriage, raising a family, purchasing a car or home, or saving for retirement, all in an attempt to pay back their student loan debt. Some economists are concerned about possible future effects on the U.S. economy caused by such overwhelming debt loads held by younger members of society.
Most debtor attorneys are reluctant to take on an adversary proceeding attempting to discharge student loans during a bankruptcy proceeding. There are many practical reasons for this. The daunting prospect of facing a team of highly skilled creditor counsel as opponents, case law that basically requires your client to be disabled and homeless, not to mention the time and expense associated with prosecuting such a case, scares away the average debtor attorney who is barely making a living representing people who are usually living paycheck to paycheck. Debtor counsel are typically solo or small firm practitioners who, in addition to diligently working for their clients, must tend to the day to day demands of running a business with the inherent concerns of managing the office overhead, paying rent, staff and advertising. On the rare occasion when a client presents a good potential case for a student loan adversary, that client typically cannot afford to pay even a modest attorney fee for quality representation. Hence, most debtors are left with student loan debt that survives the bankruptcy discharge.
A Brief History of Student Loan Dischargeability in Bankruptcy
In 1958, the United States federal government, in response to the Soviet launch of Sputnik and the fear that our students were falling behind globally in the fields of science, math and engineering, started a student loan program. The National Defense Education Act of 1958 provided low-interest loans (aka Perkins Loans) for college students, with debt cancellation for those who became teachers after graduation. Since then, many other loan programs have come into existence. For the next couple of decades, these student loans could be discharged in bankruptcy, just like other general unsecured debt. In response to perceived fraud and abuse of the broad discharge provisions of the Bankruptcy Code at the time, and public perception that loopholes in the law were allowing students to defraud taxpayers by discharging their student loans immediately after graduating, Congress, through the 1978 Bankruptcy Reform Act, enacted 11 USC §523(a)(8). Instead of a total prohibition on the dischargeability of student loan debt, Congress included a 5-year waiting period, or an “undue hardship” provision. Later, in 1990 the 5-year waiting period was extended to 7-years and applied to both Chapter 7 and Chapter 13 bankruptcy cases. In 1998 Congress removed the 7-year waiting period and simply made student loans an exception to discharge, unless excepting such debt from discharge would impose an undue hardship on the debtor and the debtor’s dependents. With BAPCPA in 2005, Congress, under pressure from the banking industry and lobbyists, expanded the exception to discharge to include privately held student loans as well.
The Brunner Test
Section 523 – Exceptions to discharge
11 U.S.C 523(a)(8)
(a) A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt—
(8) unless excepting such debt from discharge under this paragraph would impose an undue hardship on the debtor and the debtor’s dependents, for—
(i) an educational benefit overpayment or loan made, insured, or guaranteed by a governmental unit, or made under any program funded in whole or in part by a governmental unit or nonprofit institution; or
(ii) an obligation to repay funds received as an educational benefit, scholarship, or stipend; or
(B) any other educational loan that is a qualified education loan, as defined in section 221(d)(1) of the Internal Revenue Code of 1986, incurred by a debtor who is an individual;
As happens far too often, Congress did not define “undue hardship” and instead left it up to the courts to decide. In most federal circuits throughout the country, the legal standard applied by the Court is referred to as the “Brunner Test” based on a 1987 case in which the United States Court of Appeals for the Second Circuit decided the case of Brunner vs. New York State Higher Educational Services Corp., 831 F. 2d 395 (2nd Cir. 1987). Unfortunately, Marie Brunner, the debtor in the case who had recently earned a masters degree, appealed the the U.S. District Court decision pro se, left case precedence that is used as a point of reference throughout much of the country. Presently, Brunner has been adopted and is used in the 2nd, 3rd, 6th, 7th and 9th Circuit Courts. Brunner basically involves a three prong test to determine whether a debtor has established undue hardship and may discharge their student loan debt. A debtor must demonstrate that "(1) the debtor cannot maintain, based on current income and expenses, a 'minimal' standard of living for [themselves and dependents] if forced to repay the loans; (2) 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 (3) that the debtor[s have] made good faith efforts to repay the loans. These three prongs are difficult hurdles for a consumer debtor to overcome , with debtors frequently failing the second prong, as it requires a showing of hopelessness into the future, as well as the third prong, as they are often struggling to pay for everyday living expenses and have been unable to pay any amount toward their student loans for some time.
Times Have Changed-The Law Needs to Catch Up
Judges are beginning to recognize that Brunner may be too harsh a standard and have been criticizing its use. In Roth v. Educational Credit Management Corp. (In re Roth), another pro se case in which the debtor sought to discharge her student loans after visiting her local law library and watching episodes of “Law and Order”, Hon. Jim D. Pappas, in his concurring opinion, recognized how the bankruptcy court felt restricted by the precedence in Brunner and opined that determining whether undue hardship exists utilizing Brunner’s three prong test is “too narrow” and “no longer reflects reality.” He encouraged the 9th Circuit to consider the totality of a debtor’s circumstances in deciding whether a discharge of a debtor’s student loan based on undue hardship debt is warranted. Judge Pappas noted that while Brunner may have been helpful when adopted for determining undue hardship, it is now “truly a relic of times long gone.” He noted that Brunner was adopted at a time in which a “debtor’s student loan debt could not be discharged unless either it first became due five years before the date of the bankruptcy filing or excepting such debt from discharge would impose an undue hardship”… “importantly, if a student loan had not been collected within the five years after it became due, Congress directed that it would be discharged in the student’s bankruptcy case.” Judge Pappas recognized that Congress, made more and more changes to Section 523(a)(8) throughout the years, each time “excepting a broader array of educational obligations from discharge in bankruptcy.” He noted:
"As can be seen, while at one time bankruptcy courts were required to focus on a debtor’s circumstances only during the five to seven years after student loans became due, after 1998, the relevant time for examining whether a debtor had made good faith efforts to repay a student loan had no limits. And after the 2005 amendment, the number and kinds of student loan debts potentially excepted from discharge skyrocketed."
Judge Pappas further noted the huge increase in the amount of student loan debt as well as the fact that bankruptcy courts had to deal with student loan dischargeability issues relatively infrequently, and when they did, the amount of debt was usually modest and the debtor would likely be able to repay it within a reasonable time. He pointed out that today, lenders compete to provide student loans and that much of the student loan debt goes to “for-profit” companies, rather than traditional colleges. He further criticized Brunner by noting that much of today’s student loan borrowers are burdened with debt that is decades old and whose balances have ballooned with accruing interest. He further noted that in bankruptcy courts today, it is often a family member who co-signed for the student, not the student themselves, who is seeking relief in the bankruptcy court. Judge Pappas denounced prong 2 of the Brunner test and stressed that bankruptcy courts “should be afforded flexibility to consider all relevant facts about the debtor and the subject loans” and “requiring that a debtor demonstrate that his or her financial prospects are forever hopeless is an unrealistic standard.” He also found fault with the 3rd prong finding that “requiring a debtor to clear this hurdle can condemn the student borrower to a lifetime of burdensome debt under one or more of the creditors’ long-term repayment programs:
"This aspect of the Brunner test also fails to account for the potentially devastating debt-forgiveness tax consequences to the debtor resulting from the “successful” completion of such a program, which is one reason that the repayment programs are not that popular with borrowers. At bottom, requiring debtors to participate in these creditor programs as a condition to obtaining a bankruptcy discharge simply means that creditors, not bankruptcy judges, will decide which loans can be repaid, and which should properly be forgiven. This is surely not what Congress intended in enacting § 523(a)(8)."
Judge Pappas urged the Ninth Circuit to reconsider its adherence to Brunner and should instead:
"…craft an undue hardship standard that allows bankruptcy courts to consider all the relevant facts and circumstances on a case-by-case basis to decide, simply, can the debtor currently, or in the near-future, afford to repay the student loan debt while maintaining an appropriate standard of living. This approach could allow the bankruptcy court, after weighing the facts of each case, to decide that a student-debtor, whose debt financed training that did not allow him or her to achieve any significant earnings, to discharge a large loan balance even in the absence of a debilitating illness or handicap. It could allow an elderly debtor to escape the burden of decades-old student loans when her prospects for repayment have disappeared, even though the debtor has not participated in a repayment plan with the creditor. And this hardship test would focus on the contemporary world of student loan debt, not circumstances that existed thirty or more years ago."
I have been practicing consumer bankruptcy representing debtors in Chapter 7 and Chapter 13 since the early 1990’s. During that time, the law, as well as the way we practice, has undergone some profound changes, certainly with more to come. When I first started my practice, a small company in Royal Oak, Michigan sold a DOS based bankruptcy preparation program. I recall going there in person to purchase the software for the first time. After I paid, I was handed about a dozen floppy disks which I had to load onto my computer in perfect numerical order, after which I was on my way to preparing bankruptcy petitions. I actually thought I was quite advanced at the time, as some of my older colleagues were using typewriters and carbon copies to prepare their client’s bankruptcy papers. After the petition was printed out, reviewed and signed by my client, I’d make five copies, as the bankruptcy court required the original, one for the Judge, one for the Trustee, and one for the general file in the clerk’s office. I additionally wanted a time stamped copy for my file as well as one for my client. Each petition used roughly a half a ream of paper or more. I typically filed my cases every Friday. I’d load my massive piles of papers into two or three boxes, usually the same boxes where the reams of paper came from, struggle to bungee cord them to my flimsy foldable cart, hoping not to get slapped in the face if one of the cords broke loose and lugged them off to the bankruptcy court down the street. Invariably, usually while going over a curb, the cart would flip over with some of my precious cargo spilling into the street. Eventually I’d make it to the bankruptcy intake office only to find a long line of other attorneys or law clerks, waiting to file their stack of petitions. I’d hand them over to the intake clerk, one by one, to be assigned a case number and be time stamped by hand. The whole process usually took about two hours and you had better not leave the clerk’s office, for if they called out your name and you did not come up to the desk, your time stamped copies would wind up in the paper shredder. I filed a lot of consumer bankruptcy cases back then, and helped my clients discharge a lot of student loan debt in the process.
How times have changed. Today, I can file a complete bankruptcy petition at 3:00 am on a Saturday night in my pajamas, but eliminating student loan debt through bankruptcy is no longer that easy. When I first started practicing, up until 1998, a debtor could obtain a discharge of student loan debt, as long as that debt was more than seven years old going back to the date when the loan first became due (in repayment). This seven year waiting period seemed to be a good balance between society’s interest in protecting the student loan system from fraud and the needs of honest but unfortunate debtors in pursuit of a discharge, as it ferretted out those seeking to abuse the system. Back in those good old days, I as like to refer to them, the amount of student loan debt in comparison to the other unsecured debt my typical client was seeking to discharge, was much lower than it is today. Presently in my consumer practice, I routinely see debtors, with in excess of $100,000 in student loan debt, who nevertheless want to file a Chapter 7 bankruptcy case to discharge perhaps $15,000 to $25,000 in other consumer debt such as credit cards, automobile deficiencies, medical debt, etc. I never feel as though these debtors are truly getting a fresh start, with so much debt surviving their discharge. Unfortunately, many of these clients with massive amounts of student debt were unable to earn a degree, or have a degree from an online, for profit institution and are struggling to enter the job market in their field of study, but nevertheless will likely fail at least one of the three prongs of the Brunner test, so I steer them toward other federal programs. Many of these clients’ student loans are in forbearance or deferment. A few of my clients have confessed to me that they have elected to re-enroll in classes to defer repayment, only increasing the amount of student loan debt they accumulate.
Despite all of the wonderful technological advances in the way bankruptcy petitions are processed, the evolution of student loan dischargeability seems to have headed in the opposite direction. Hopefully, however, with student debt at an all-time high, that trend may soon be reversing. Whether it be legislatively via amendments to the Bankruptcy Code or through well-reasoned judicial changes in bankruptcy case law as Judge Pappas urges, I believe that student loan debtors will once again find relief in bankruptcy.
ABOUT THE AUTHOR: Walter A. Metzen, Board Certified Consumer Bankruptcy Attorney
Walter Metzen is Board Certified in Consumer Bankruptcy by the American Board of Certification and represents consumer and small business debtors in bankruptcy cases in the Eastern District of Michigan. Mr. Metzen earned his undergraduate degree in Forensic Science at Michigan State University and his law degree from the University of Detroit School of Law. Mr. Metzen has served as a speaker for the Consumer Bankruptcy Association, the American Bankruptcy Institute and the Institute for Continuing Legal Education.
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Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.