Emerging Cracks in the Student Loan Wall

If you are a young or new attorney, there is a good chance that you have at least some (and perhaps significant) student loan debt. You may also be aware that discharging student loan debt in bankruptcy, unlike most other unsecured debt, is extremely difficult. This has not always been the case, however, and may not be the case in the future, as there is a growing push to provide more relief for student loan debt in bankruptcy and beyond.

History of Student Loan Dischargeability in Bankruptcy

Discharge of student loan debt is governed by § 523(a)(8) of the Bankruptcy Code, which in its present form states:[1]

(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 dependent(s) for —

(A)(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.

When the Bankruptcy Code was enacted in 1978, student loans were eligible for discharge after five years had elapsed since the repayment obligation commenced, or if repayment would impose an undue hardship on the debtor or his/her dependents. In 1990, the five-year waiting period was extended to seven years.

In 1995, the National Bankruptcy Review Commission (the NBRC) was formed pursuant to an act of Congress to make recommendations for improving the Bankruptcy Code. In its report released in 1997, the NBRC suggested eliminating § 523(a)(8) of the Bankruptcy Code and to treat discharging student loan debt like any other unsecured debt.[2] Congress, however, elected in 1998 to eliminate the seven-year waiting period, leaving undue hardship as the only means to discharge student loan debt. The congressional record provides little insight on why Congress made this change. Upon speculation, it may have been motivated by concerns that the bankruptcy process could be abused to discharge student loan debt. This concern may have been fueled after the student loan program was expanded in the early 1990s to create unsubsidized loan options that were not restricted by financial need, resulting in a large new pool of borrowers. The proliferation of student loans from private lenders may have also been a factor, leading to the addition of subparagraph (B) to § 523(a)(8) in 2005, which made qualified private student loans also exempt from discharge absent a showing of undue hardship.

In assessing whether repayment of a student loan obligation imposes an “undue hardship,” most jurisdictions follow the test erected by the Second Circuit in Brunner v. N.Y. State Higher Educ. Servs. Corp.[3] The “Brunner Test” provides that student loan debt can be discharged if the debtor establishes by a preponderance of the evidence that:

1.         The debtor cannot maintain, based on current income and expenses, a minimal standard of living for him or herself and her dependents if forced to repay the loans;

2.         Additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period; and

3.         She has made good-faith efforts to repay the loans.

The Brunner Test has proven to be a difficult burden for debtors to overcome, with discharge of student loan debt often granted only for debtors who demonstrate dire circumstances.

Relief on the Horizon?

The ABI Commission on Consumer Bankruptcy in its Final Report, released in April 2019, observed that student loan debt has become “one of the most significant economic problems facing the United States.”[4] The Report noted that student loan debt has tripled since 2006 to over $1.5 trillion, and that student loans have the highest delinquency rate among household debts, with 10.9% of student loans over 90 days delinquent.[5] Further, student loan debt has increased by nearly 160% since the Great Recession, vastly outpacing other major consumer debts such as mortgages, auto loans and credit cards.[6]

Studies show that student loan debt constrains economic activity and results in (1) lower earnings for college graduates; (2) lower levels of home ownership; (3) lower automobile purchases; (4) increases in household financial distress; (5) lower probability that students will choose public-service careers; (6) poorer psychological functioning; (7) delayed marriage; and (8) lower probability of attending graduate school.[7]

As the issue has grown to big too ignore, glimmers of potential relief have emerged from several quarters. For starters, the ABI Consumer Commission made several recommendations for reforming the treatment of student loans in bankruptcy. Most notably, the Commission advocated revising the Bankruptcy Code to allow for discharge of student loans that are:

• made by non-governmental entities;
• incurred by a person other than the person receiving the education (e.g., a guarantor);
• paid through a five-year chapter 13 plan; or
• first payable more than seven years before a chapter 7 case is filed.

The Commission also recommended streamlining certain procedures and applications of law to “facilitate reasonable relief from student loan indebtedness,” and proposed adding a priority claim category for student loans under § 507(a).

Although it is unclear whether Congress will follow any of the Commission’s recommendations, courts have exhibited an increased willingness to more flexibly apply the Brunner Test in order to provide some relief to debtors. For example, there have been recent cases that have resulted in a partial discharge of student loan debt based on an analysis of the debtor’s budget.[8] Change may also come following the 2020 presidential election, as several candidates have made proposals to address the cost of education and student loan debt.[9]

In another recent development, the IRS blessed an employer’s proposed amendment to its 401k plan to offer a student loan benefit program. Under the program, the employer would make a “matching” contribution to an employee’s 401k plans premised on the employee making a student loan repayment rather than contributing to the plan.[10] This may pave the way for employers to provide incentives to their employees tied to repayment of their student loans.

Alternatives

While it remains to be seen what kind of relief there may be for student loan borrowers in the near future, there are some programs and scenarios through which borrowers may be eligible for a discharge, including:

• Teacher Loan Forgiveness Program: Teachers who meet certain requirements may be eligible for forgiveness of up to $17,500 of their student loans.
• Public Service Loan Forgiveness: Borrowers who make a set minimum of qualifying payments under certain types of loans while employed in the public sector may be eligible to have the remaining balance of their student loan debt forgiven.
• Consolidation and Flexible Payment Options: There are several consolidation and flexible payment programs, including the Income Based Repayment Program, William D. Ford Loan Consolidation Program, Income Contingent Repayment Option, and Revised Pay as You Earn (REPAYE).
• Total Permanent Disability (TPD) Discharge: Potential to discharge federal student loan debt for total and permanent disability based on a physician’s certification to certain criteria.
• Closed School Discharge: Potential for discharge if the borrower’s school closed prior to the borrower completing their study program.
• False Certification Discharge: Student loans may be discharged if the school falsely certified certain information pertaining to the student’s eligibility for a federal student loan, if someone signed the borrower’s name for the loan without authorization, or if the loan was obtained by identity theft.
• September 11 Survivors Discharge: Survivors of eligible victims of the September 11, 2001, attacks may request a discharge of their loans under the Direct Loan Program.

Conclusion

While it is unclear what shape reform may take, it is clear that the impetus for change is growing and that the Bankruptcy Code and its application may play a critical role in how student loan debt is treated in the future.