Could Bankruptcy Discharges of Student Loans Be Getting Easier?

As many practitioners already know, it can be enormously difficult for student loan borrowers to discharge their loans in bankruptcy. But through a combination of new case law, potential upcoming administrative action and a series of bankruptcy reform bills, it might be getting just a little bit easier for some student loan borrowers.

Recent Case Shows It’s Not Impossible to Discharge Student Loans in Bankruptcy

To discharge student debt in bankruptcy, most student loan borrowers have to try to show that they meet the Bankruptcy Code’s “undue hardship” standard by initiating an adversary proceeding. Most jurisdictions use the Brunner test to determine whether a borrower has met that standard, although some use the “totality of the circumstances” test. Regardless of the specific test, adversary proceedings to discharge student loans can be a long, exhausting and invasive process for both debtors and attorneys; many don’t even try.

But a recent case out of Iowa is a reminder that attempting to discharge student loan debt in bankruptcy might not be futile. In In re Ashline, a case out of the U.S. Bankruptcy Court in the Northern District of Iowa that was decided this past September, a bankruptcy judge agreed to discharge $220,000 of mostly federal student loan debt.[1]

The U.S. Department of Education tried to argue in that case that discharge was inappropriate for the borrower’s federal student loans because she could have repaid those loans under an income-driven repayment plan. Income-driven plans offer borrowers monthly payments tied to their income and family size, and any remaining balance is forgiven at the end of the repayment term (which is 20 or 25 years, depending on the plan). The Department routinely opposes borrowers seeking a bankruptcy discharge of their federal student loans, often arguing that the existence of income-driven repayment, which provides borrowers with both an affordable payment and an eventual light at the end of the tunnel in the form of loan forgiveness, makes discharge inappropriate.[2] But income-driven repayment programs come with annual administrative requirements (borrowers must recertify their income every 12 months), and the eventual loan forgiveness can be a taxable event for the borrower. Because monthly payments are not required to cover monthly interest accrual, a long-term, low-payment plan through income-driven repayment can result in negative amortization and massive balance growth over a 20- or 25-year term.

In Ashline, the bankruptcy court rejected the Department’s arguments, noting that the borrower would be in her 70s by the time her loans were forgiven under the income-driven repayment program. The court also noted that she could face a significant balance growth and eventual tax liability on the canceled debt at the end of the repayment term. The court ruled in favor of discharge, finding that the borrower had “maximized her earnings potential,” that her circumstances were unlikely to improve, and that she had made good-faith efforts to repay the loans.

DOE Is Considering Changing Its Approach to Adversary Proceedings

The Department of Education’s treatment of the debtor in the Ashline case might not last forever. In remarks before the House Committee on Education in October, Richard Cordray, COO of Federal Student Aid, suggested that the DOE’s approach toward student loan borrowers seeking to discharge their federal loans through bankruptcy isn’t working and might need to change. “The process doesn’t work well,” he said. “It needs to be reformed … and we’re committed to doing that.”[3]

Cordray said that the administration is looking into potential alternatives to simply opposing all federal student loan borrowers who are looking to discharge their federal student debt in bankruptcy. He did not provide much in the way of specifics, but he did indicate that the administration was committed to reform, and that more information on potential administrative action would be forthcoming.

Advocates of student loan bankruptcy reform have suggested a number of different ways that the Department, as a matter of administrative policy, can change its position to be more borrower-friendly in bankruptcy cases, potentially allowing for far more federal student loan bankruptcy discharges in certain defined circumstances without subjecting borrowers (and their attorneys) to adversary proceedings. The Department could, for instance, consider a borrower’s history of poverty-level wages, or a long-term reliance on public benefits such as Social Security, as sufficient evidence of “undue hardship” such that the government would not oppose discharge. The Department has not publicly indicated which options it is seriously considering, but more information may be released in the coming months.

Bankruptcy Reform Legislation

If bankruptcy reform happens legislatively, some borrowers might not even have to prove undue hardship at all. Several bankruptcy-reform bills have already been introduced in Congress. Earlier this year, House Democrats unveiled H.R. 2648, also known as the Student Borrower Bankruptcy Relief Act, which would simply eliminate the undue-hardship standard for student loan discharges. Senate Democrats released the Medical Bankruptcy Fairness Act of 2021 in February, which would make a number of reforms to the Bankruptcy Code, including wiping out the undue-hardship standard for student loans.

A potentially more promising bankruptcy reform bill was released in August. Co-sponsored by Senator Richard Durbin (D-Ill.) and Senator John Cornyn (R-Texas), the bipartisan “Fresh Start Through Bankruptcy Act” would also eliminate the undue-hardship requirement (and the need for an adversary proceeding) for federal student loan borrowers. But to qualify, borrowers would have to have been in repayment on their federal loans for at least the prior 10 years. The 10-year waiting period, designed to prevent situations where a borrower files for bankruptcy days after graduating, is similar to requirements that were in place decades ago, before the undue-hardship standard was established.

None of the bills have advanced to a full Senate vote yet. The Fresh Start Through Bankruptcy Act and the Medical Bankruptcy Fairness Act of 2021 have been referred to the Senate Judiciary Committee, and no bankruptcy reform bill seems poised to pass Congress in the immediate future. Lawmakers are presently focused on more pressing matters such as the budget, the debt limit, voting rights, and President Biden’s proposed climate initiatives and expansion of several social programs. But the Fresh Start Through Bankruptcy Act does enjoy at least some bipartisan support, and President Biden has endorsed the need for bankruptcy reform for student loan borrowers.