The Difficult Case for Dischargeability of Student Loans
The Bencher—September/October 2021
By Stephen W. Sather, Esquire
Education has long been considered the path to the middle class. Unfortunately, the cost of a college education has grown exponentially over the years. Students have relied on student loans to cover the cost of college to a significant extent.
As of 2020, there was over $1.6 trillion in outstanding student loans, according to the Federal Reserve Bank of New York’s “Quarterly Report on Household Debt and Credit,” (2020: Q3, p. 3.) This number is higher than the amount owed on either credit cards or auto loans and is second only to the amount owed on mortgage loans. See Denhart, “How the $1.2 Trillion College Debt Crisis Is Crippling Students, Parents and the Economy,” Forbes (August 7, 2013), accessed at www.forbes.com/sites/specialfeatures/2013/08/07/how-the-college-debt-is-crippling-students-parents-and-the-economy. While the education provided by a student loan may provide an entry into the middle class, the debt incurred in obtaining this education cannot easily be shed in bankruptcy.
Before 1976, student loans were dischargeable the same as any other unsecured debts. From 1976 to 2005, the dischargeability of student loans was restricted to the point where substantially all student loans are now excluded from discharge, absent a finding of undue hardship. Here’s how it’s changed over the years:
1976: Government-backed student loans are non-dischargeable for five years unless undue hardship proven.
1984: Private loans funded or guaranteed by a governmental unit or nonprofit are added to the list of non-dischargeable debts.
1990: Period to discharge a student loan extended from five years to seven years.
1998: Seven-year period to discharge a student loan is eliminated, leaving undue hardship as the only basis for a discharge.
2005: Private student loans become non-dischargeable regardless of whether they are made, insured, or guaranteed by a governmental entity or nonprofit; the test now turns on whether interest would be deductible under the Tax Code.
Policy reasons for making it difficult to discharge student loans include ensuring that funds will be available to make future student loans, according to the Congressional Research Service, Bankruptcy and Student Loans, R45113 (updated July 18, 2019), p. 6, https://fas.org/sgp/crs/misc/R45113.pdf. Another policy reason is to avoid the moral hazard posed by a person obtaining a valuable education and then discharging the cost of obtaining that education. (Rajeev Darolia, “Should Student Loans Be Dischargeable in Bankruptcy?,” Brown Center Chalkboard (September 29, 2015), www.brookings.edu/blog/brown-center-chalkboard/2015/09/29/should-student-loans-be-dischargeable-in-bankruptcy.
What Is the Definition of Non-Dischargeable?
The statute governing dischargeability of student loans is 11 U.S.C. §523(a)(8), which provides:
(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.
The debts that cannot be discharged are:
1. An educational benefit overpayment 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. 11 U.S.C. §523(a)(8)(A)(i).
An educational benefit overpayment made, guaranteed, or insured by a governmental unit or a nonprofit is the least complicated exception to understand. An “educational benefit overpayment” is an overpayment from a program such as the GI Bill, under which students receive periodic payments while they are enrolled in school. But, if the students receive payments after they have left the school, that is an educational benefit overpayment.
Matter of Murphy, 282 F.3d 868, n. 7 (5th Cir. 2002)
2. An educational 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. 11 U.S.C. §523(a)(8)(A)(i).
Loans made, insured, or guaranteed by governmental units are similarly straightforward.
3. An obligation to repay funds received as an educational benefit, scholarship, or stipend. 11 U.S.C. §523(a)(8)(A)(ii).
This subsection covers agreements wherein a person receives a stipend or scholarship to attend college in return for an agreement to provide some form of public service, such as teaching in an underprivileged area or serving in the U.S. Public Health Service. If the person fails to honor the commitment made, the amounts advanced become repayable and are nondischargeable under section 523(a)(8)(A)(ii). Burks v. Louisiana (In re Burks), 244 F.3d 1245 (11th Cir. 2001); U.S. Dept. of Health and Human Services v. Smith, 807 F.2d 122 (8th Cir. 1986).
4. Any other educational loan that is a qualified education loan under section 221(d)(1) of the Internal Revenue Code. 11 U.S.C. §523(a)(8)(B).
This subsection was added to include private student loans. The key to the exception is the definition of “qualified educational loan.” A qualified education loan is:
- indebtedness incurred by the taxpayer;
- to pay “qualified higher education expenses;”
- incurred on behalf of the taxpayer, the taxpayer’s spouse or a dependent of the taxpayer;
- which qualified higher education expenses are paid or incurred within a reasonable time after the loan is incurred; and
- attributable to education furnished while the student was an “eligible student;”
- but does not include any indebtedness owed to a person who is related to the taxpayer.
See 26 U.S.C. §221(d).
What Debts Can Be Discharged?
Broadly speaking, there are two types of debts that can be discharged: those that fall outside the maze of definitions and those for which an “undue hardship” is established.
First, let’s discuss debts outside the definitions. While the definition of non-dischargeable debts is broad, it is not all-encompassing. In re Chambers, 348 F.3d 650, 657 (7th Cir. 2003). To be non-dischargeable, there must be a “loan.” A debt for unpaid tuition owed to the educational institution is not a “loan” because no funds are advanced. In re Chambers, 348 F.3d 650, 657 (7th Cir. 2003). In re Renshaw, 229 B.R. 552 (2nd Cir. BAP 1999); In re Oliver, 499 B.R. 617 (Bankr. S.D. Ind. 2013).
Part of the definition of a qualified educational loan is that the student attends a qualified educational institution. A loan made for a bar review course not offered by a qualified educational institution has been found to be dischargeable, Crocker v. Navient Solutions, Inc. (In re Crocker), 941 F.3d 206 (5th Cir. 2019), as were loans to attend for-profit truck driving schools, Scott v. Midwestern Training Center (In re Scott), 287 B.R. 470 (Bankr. E.D. Mo. 2002); United Resource Sys. v. Meinhart (In re Meinhart), 211 B.R. 750 (Bankr. Colo. 1997); and McClure v. Action Career Training (In re McClure), 210 B.R. 985 (Bankr. N.D.Tex. 1997).
It is beyond the scope of this article to identify every educational loan that does not fall within the statutory definition. However, it is an area where careful attention to detail may provide a benefit to borrowers in a limited number of situations.
The other type of loan that can be discharged is for undue hardship. If a student loan or other obligation falls within the language of Section 523(a)(8), the only way to obtain a discharge of the obligation is a finding of “undue hardship.” While undue hardship is not a defined term, most courts follow a similar test.
The Second, Third, Fourth, Fifth, Sixth, Seventh, Ninth, Tenth and Eleventh Circuits follow the Brunner test for undue hardship. Under the Brunner test, the debtor has the burden of proof to establish that:
- he cannot maintain, based on current income and expenses, a “minimal” standard of living for himself and his dependents if required 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; and
- the debtor has made good faith efforts to repay the loans.
The Eighth Circuit applies a totality of the circumstances test that considers similar factors. Educational Credit Management Corp. v. Jesperson, 571 F.3d 775, 779 (8th Cir. 2009). The First Circuit has declined to adopt a specific test. Nash v. Connecticut Student Loan Foundation, 446 F.3d 188 (1st Cir. 2006).
The undue hardship test has been criticized. The Tenth Circuit stated that “(m)any subsequent courts employing the Brunner analysis, however, appear to have constrained the three Brunner requirements to deny discharge under even the most dire circumstances. Pollys, at 1308. One outspoken judge described the Brunner test as “let’s make it as tough as humanly possible to discharge a student loan.” Speer v. Educational Credit Management Corp. (In re Speer), 272 B.R. 186, 193 (Bankr. W.D. Tex. 2001) (finding undue hardship where debtor lived in a travel trailer and his only luxury was $48 per month for cable TV). Another judge has stated that Brunner is “too narrow, no longer reflects reality, and should be revised.” Roth v. Educational Credit Management Corp., 490 B.R. 908 (9th Cir. BAP 2013) (Pappas, J., concurring).
While it is difficult to discharge a student loan under the undue hardship test, there are cases where a request has been successful. In Trejo v. Navient (In re Trejo), 2020 Bankr. LEXIS 1030 (Bankr. N.D. Tex. 2020), a debtor earned a GED and later tried to improve her life by earning a college degree. She took classes over six years without earning a degree. She also took out a Parent PLUS loan so her older daughter could complete her final semester of college. She owed over $90,000 at the time of trial. The court found that she could not afford to make payments on the loans and maintain a minimal standard of living. Trejo had not been able to hold full-time employment for at least 15 years and was unemployed at the time of trial. The most she had made in the previous years was $15,900, which did not meet her monthly expenses of $1,750.
The court found that her inability to pay was likely to continue, finding that “Ms. Trejo’s future earnings potential is stalled due to the physical, medical, and psychological challenges of her dependent children, her severely limited education, and the dearth of her usable job skills.” Trejo at *18-19. Finally, the court found that she had made a good faith effort to repay. Although she had not made any payments, she had spent the past five to seven years trying to work out payment arrangements. She went through what can only be described as “customer service hell” as she was repeatedly transferred, told her loan was not in the system, and instructed to apply online despite the fact that she did not own a computer.
The Trejo case illustrates the difficulty of satisfying the undue hardship test. Although she had limited means, she had to hire an attorney to bring an adversary proceeding in order to discharge the debt. The Court’s 28-page opinion contained extensive fact-finding and indicates that Navient strenuously opposed the discharge. While not stated from the record, it seems likely that Trejo could not have discharged her debt without the assistance of pro bono counsel.
The difficulty with the undue hardship test is that a debtor who can afford to bring an adversary proceeding to establish undue hardship will have trouble meeting the test. Requiring the assistance of pro bono counsel to obtain a benefit under the Bankruptcy Code is contrary to the policies behind the Code and creates a right that may often be illusory in practice.
Stephen W. Sather, Esquire, is a director of Barron & Newburger, P.C. in Austin, Texas, and head of its bankruptcy and insolvency section. He is a Master of the Bench member of the Larry E. Kelly Bankruptcy American Inn of Court.