On May 19, 2019, Senator Dick Durbin introduced Senate Bill 1414, which proposes a simple solution to the ongoing question of how student loans should be handled in bankruptcy. It would strike § 523(a)(8) in its entirety from the Bankruptcy Code, thereby making any governmental or private student loan immediately dischargeable. It is unlikely that this bill will be passed in this Congress, at least not without significant amendments. However, given that Senators Warren, Harris, Klobuchar and Sanders were co-sponsors of the bill, it seems likely that the dischargeability of student loans will be a topic of discussion in the 2020 election and that reform might be on the way.
So what might actual reform to the treatment of student loans in bankruptcy look like? The Final Report of the American Bankruptcy Institute’s Commission on Consumer Bankruptcy provides a template. The Report recognizes that there is a legitimate rationale behind making some student loans nondischargeable, but the Report also recognizes that some historical amendments to the Code are not supported by that legitimate rationale. The Report further suggests that reform might be possible via all three branches of the federal government.
On the legislative front, the Report suggests that there is a legitimate interest in protecting government-issued, insured or guaranteed loans from discharge. Government student loan programs make higher education available to low-income and first-generation college students because those loans are available to any qualifying applicant, regardless of their ability to meet underwriting requirements. Requiring some repayment of government-issued student loans is necessary to protect the viability of these programs. However, the Report does not find that private loans require the same protection. The Report found that since 2005, when private loans were first made nondischargeable, there has been no significant change in the interest rates offered by private lenders to student borrowers. Because nondischargeability has not made private lending more affordable or available, the Report found that private loans should be dischargeable as they were before 2005.
The Report also suggested a return to a rule that would allow a debtor to discharge a government student loan after seven years. One justification for making student loans nondischargeable is the concept that higher education will increase the debtor’s income and the debtor’s ability to pay the loan after graduation. If this proves true, after seven years the debtor will have made significant progress toward paying the loan and will not need to file bankruptcy on account of the loan. However, if, seven years into the term, a debtor is in default, it is likely because that debtor’s degree did not increase his or her earning power. The debtor’s circumstances are unlikely to change, and the loan will continue to impose a hardship on the debtor.
Additionally, the Report proposes allowing third-party co-signers to discharge their obligation to pay a student loan. The third-party co-signer did not receive the benefit of potential higher earning capacity through the loan, so there is no reason to burden their fresh start with ongoing obligations to pay the loan.
Finally, the Report proposes to give government student loans eleventh-priority status, which would place those loans just above general unsecured creditors. Not only would this allow chapter 7 debtors to have their loans paid in part through their estate, it would provide extra benefit to chapter 13 debtors. Presently, some courts will not confirm a plan that pays more to student loan creditors than general unsecured creditors, because the plan discriminates unfairly against the general unsecured creditor class. If student loans are entitled to even slight priority, however, a plan that pays more to student loans could be confirmed. The Report, recognizing that student loan debt can be substantial, also suggests that student loans, unlike some other priority debts, need not be paid in full in a chapter 13 plan for the plan to be confirmable.
With regard to the executive branch, the Report suggests that the Department of Education should adopt bright-line rules to determine when “undue hardship” exists. Under the Report’s recommendations, the Department of Education should not contest the discharge of a student loan where the debtor qualifies for Social Security or Veterans Disability benefits, or if the debtor falls below certain federal poverty thresholds. The Report further recommends that the Department of Education develop an informal method for evaluating evidence of undue hardship without requiring debtors to incur the expense of pursuing an undue-hardship discharge through an adversary proceeding. Both proposals are intended to simplify the process of discharging a student loan and reduce costs for both debtors and the federal government. The Report also explores the potential for the Department of Education to accept payments outside a chapter 13 plan as alternative-minimum payments for the purposes of income-based alternative-repayment plans.
Finally, the Report suggests that the judicial branch should adopt a new interpretation of the “undue hardship” standard. Presently, some courts will not discharge a student loan if the debtor possibly could repay the loan in the distant future through an income-based repayment plan. The Report proposes that judges should instead ask whether the debtor is capable of making payments under the original terms of the contract. If a debtor can demonstrate that it would impose an undue hardship to pay a standard 10-year student loan within the 10-year term, the debt could be discharged.
The Report also proposes that if Congress will not amend the Code to give student loans priority status, a bankruptcy judge could still exercise authority under § 1322 to determine that a plan proposing to pay more to student loan creditors than other general unsecured creditors does not constitute “unfair discrimination.” This would allow student loan debtors to stay on track with student loan payments and still receive a discharge of other debts at the end of the plan.
Valid policies support some limitation on the discharge of student loans. However, the Report reflects the reality that these policy objectives are not being met by the current law regarding the treatment of student loans in bankruptcy. While it may be politically popular to propose a full repeal of § 523(a)(8), the Commission’s recommendations seem better suited to protect valid policy while still providing a significant degree of relief to debtors who are struggling with student loan debt.