Currently, there is an estimated $1.75 trillion in total outstanding US student loan debt. This financial burden incurred during the pursuit of higher education affects approximately 46 million Americans—one out of every eight people. Despite the staggering nature of the student loan debt crisis, historically this type of debt has been exceptionally difficult to discharge in bankruptcy filings. Student loan debt faces a heightened standard of scrutiny requiring debtors to prove that repayment of their loans would present an “undue hardship,” unlike other forms of debt, such as consumer credit cards and medical expenses, which are much more easily discharged. Further, the term “undue hardship” is not defined in the bankruptcy code, so it’s been left to judges’ discretion to create tests to determine which debtors meets that standard.
In 1987, the Second Circuit established one of these tests in Brunner v. New York State Higher Education Services Corporation,i which created a three-part standard under 11 USC § 523(a)(8) for determining the level of “undue hardship” required to except a student loan from discharge in a Chapter 7 bankruptcy case. Commonly referred to as the Brunner Test, the court required the borrower to prove that:
(1) If forced to repay the loan, the debtor would be unable to maintain, based on current income and expenses, a “minimal” standard of living for the debtor and their dependents.
(2) Additional circumstances existed which indicated that that state of affairs would be likely to persist for a significant portion of the repayment period of the student loan.
(3) The debtor had made good faith efforts to repay the loan. In the subsequent 35 years, Brunner has become the prevailing test for undue hardship in bankruptcy courts nationwide.
Today, criticism of the difficulty of discharging student loans is gaining traction socially and politically. One platform on which President Biden campaigned was reforming the bankruptcy system, and thus his administration has faced increased pressure to address the treatment of student loans in bankruptcy. The administration recently extended the freeze on student loan repayment to August 31, 2022—another extension to the pause on collection and interest accumulation since the outbreak of the COVID-19 pandemic in March 2020. Since taking office, President Biden’s Department of Education has provided over $17 billion in targeted loan relief to over 700,000 borrowers through a reengineering of the Public Service Loan Forgiveness program, disability relief, and the Paycheck Protection Program, among other initiatives.
Bankruptcy reform advocates have suggested the administration consider even more widespread relief, such as not opposing federal student loan debtors in bankruptcy adversary proceedings if they can demonstrate, for example, ongoing reliance on public benefits as their primary or only means of support. While the Biden administration cannot change the bankruptcy code itself (as that would require an act of Congress), the Department of Education’s discretion by electing not to oppose the debtor in an adversary proceeding undoubtedly would result in a tremendous financial, logistical, and emotional relief for many borrowers as well as a reduction in the use of the courts’ resources.
Many advocacy groups continue pressuring Congress to reform the bankruptcy code to address the student debt crisis more uniformly in court. In two rulings earlier this year, Wolfson v. DeVos (In re Wolfson)ii and Wheat v. Great Lakes Higher Education Corp. et al (In re Wheat,iii bankruptcy courts in Delaware and Alabama, respectively, approved a borrower’s discharge request of over $100,000 in student loan debt over the Department of Education’s opposition. Both judges based their rulings, in part, on the individual debtor’s or dependent’s long-running personal medical problems, which constituted an undue hardship. In both cases the Department of Education immediately appealed the rulings; however, following widespread public outcry, the department abruptly withdrew the appeals in both cases. These actions by the department have sent debtors and the greater American public conflicting messages about what reforms, if any, may be coming to how student loans are treated in bankruptcy.
Various forms of legislation are pending before Congress regarding how to best address student loan dischargeabilty. Most notably, a bipartisan bill titled the Fresh Start Through Bankruptcy Act seeks to amend the bankruptcy code to permit student loan discharges without proof of undue hardship, but rather by requiring that borrowers wait 10 years before seeking a discharge. This harkens back to how student loan debt was treated in bankruptcy prior to the code’s amendments after 1998, when debtors could seek relief after a significant waiting period and student loans were treated like other types of unsecured debt in bankruptcy. Interestingly, the proposed bill contains a claw back provision aimed at increasing institutional accountability by mandating colleges with more than one-third of their students receiving federal student loans to partially refund the Department of Education if a graduate’s loan is later discharged in bankruptcy. This provision would apply if a school had consistently high student loan default and low repayment rates at the time of a student’s attendance.
As a final note, it should be mentioned that most proposed reforms are geared toward addressing federally incurred student loan debt, with private student loan borrowers left out of proposed reforms entirely.
Barclay Damon’s Restructuring, Bankruptcy & Creditors’ Rights Practice Area issues alerts on an ongoing basis to keep clients and friends up to date on important developments in the insolvency space. If you have any questions regarding the content of this alert, please contact the author, Caitlyn Ford, associate, at cford@barclaydamon.com; Jeff Dove or Janice Grubin, co-chairs of the Restructuring, Bankruptcy & Creditors’ Rights Practice Area, at jdove@barclaydamon.com and jgrubin@barclaydamon.com, respectively; Robert Wonneberger, partner, at rwonneberger@barclaydamon.com; or Frank Heller, partner, at fheller@barclaydamon.com.
i(831 F.2d 395).
ii(2022 Bankr. LEXIS 103).
iii(2022 Bankr. LEXIS 168).