Discharging Student Loans in Bankruptcy

We have assisted and been successful in discharging some if not all of our clients’ student loan debt.  However for all intents and purposes discharging student loans in bankruptcy is a very difficult prospect and something that is not within reach of most people.  Frankly speaking, due to the enormous legal hurdles which must be overcome this type of debt is very difficult to discharge.

Institutions of higher education are benefiting tremendously from “free money” given to bright eyed youths who have very little understanding as to consequences of carrying such incredible debt throughout their lives.   The result of this never ending supply of money is that such institutions raise prices to attract better professors, build better facilities, and generally make their product more attractive.  Even those colleges who wish to remain responsible and keep tuition prices stable are forced to upgrade lest they be bumped out of the rankings and lose students.

The end result is an entire generation of Americans who enter college debt free of obligations and exit with tens of thousands, sometimes hundreds of thousands, of debt that has no statute of limitations on collection and which absent an “undue hardship” can never go away.  The result is that people are deferring major life decisions such as purchasing homes, having children, getting married, and generally living life.  This creates an impact on the economy certainly but also materially lowers the quality of life of those saddled with such burdens.  Moreover the cost of college and the “education” received very rarely produces a skill set so as to let the students earn enough money to pay off the debt within a reasonable time.

For a very brief time from 1978 to 1979, due to a drafting error, student loans were dischargeable in bankruptcy.  However that was quickly remedied by congress and non-private student loans became  non-dischargeable.  However up and through 2005 private student loans were dischargeable in bankruptcy.  This served as somewhat of a check but when that was removed we once again witnessed an explosion of student-loan debt.

It is possible to discharge student loans in bankruptcy.  It’s just very difficult under the current law.  As of writing this article nine circuits follow the so-called Brunner test, based on Brunner v. New York State Higher Educ. Services Corp., 831 F.2d 395 (2nd Cir. 1987), when determining whether or not a student loan can be discharged.

Under the Brunner test the debtor must establish by a preponderance of the evidence that:

  • The debtor cannot maintain, based on the debtor’s current income and expense, a “minimal” standard of living for the debtor and his or her dependents if forced to repay the loan,
  • Whether “additional circumstances” exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period of the student loan; and
  • The debtor has made a good-faith effort to repay the loan.

It is usually the second prong that imposes an almost impossible obstacle for debtors seeking to discharge their student loans.  Usually this prong can only be met if a debtor can prove a  total incapacity in the future to pay his or her student loan debts.  Some circuits are attempting to set forth a more lenient approach to the Brunner test.  Here in the 10th circuit for example, one court has stated that “a showing of a certainty of hopelessness is not required to demonstrate that circumstances exist indicating that the debtor’s inability to maintain a minimum standard of living if forced to repay student loans is likely to persist for a significant portion of the loan repayment period; rather, bankruptcy courts should look at the debtor’s ability to provide adequate shelter, nutrition and other necessities, and inquiry into future circumstances should be limited to the foreseeable future, not to exceed the term of the loan”.   Educational Credit Management Corp. v. Polleys, 356 F.3d 1302 (10th Cir. 2004).  Although this provides some measure of respite from a test based on absolute hopelessness to repay, it is still a very high hurdle indeed.

Additionally the third prong is often very difficult to meet.  If the debtor hasn’t exhausted all of his or her options with the lender then this will usually not be met.  For example, if a debtor hasn’t tried and failed the various repayment programs offered by the lender such as deferred payments under the Income Contingent Repayment Plan or the Income-Based Repayment Plan, that may also sink the prospects of discharging a student loan in bankruptcy.

Practically speaking however such programs typically require a percent of payment for 20 years and after the 20 years would relieve the remaining debt.  Of course the forgiven debt would be taxable as income and likely require the debtor to go on another years long odyssey of paying back the IRS for taxes owing.  All of this notwithstanding the debtors life (marriage, family, home purchases, car purchase, other durable goods, job momentum, risk taking, travel, etc..) is severely arrested by the percent required to be repaid.  Moreover, assuming the individual perseveres on and makes it, who pays the bill to the university?  The taxpayer.

Finally another important thing to consider when discharging student loan dischargeability in bankruptcy is that the burden isn’t on the student loan lender to seek a non-dischargeability determination.  That rests soley with the debtor.  Practically speaking this means filing a separate adversary proceeding within the bankruptcy – i.e., filing a federal lawsuit which may cost tens of thousands of dollars in legal fees.  If someone could afford the legal fees to initiate, prosecute, and succeed against a well funded commercial lender they would be able to pay their student loans.

That said, it is not impossible to discharge student loan debt.  If the circumstances are right then they can be discharged.  Indeed, sometimes people find immeasurable relief by filing a Chapter 13 bankruptcy, putting the loans into abeyance, and buying themselves a 5 year respite from repayment.  A great many people find great relief in wiping out their other dischargeable debts and then focusing on the student loans.  It all just depends on the particular circumstances.

About the Author: Robertson Cohen

Rob Cohen is a Managing Partner of Cohen & Cohen, P.C., serving clients in Colorado and Wyoming. He’s a Chapter 7 Bankruptcy Panel Trustee, certified mediator, and has administered over 8,000 Chapter 7 bankruptcy estates.

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