The question of whether you can use bankruptcy to reduce or eliminate student loans is a very hot topic in the bankruptcy world. For many years the conventional wisdom was that your options were few when dealing with student loans in a personal bankruptcy. A quick reading of Bankruptcy Code Section 523(a)(8) seems to suggest that you cannot discharge a student loan unless you can show that not discharging the debt would constitute an “undue hardship.”
In the Northern District of Georgia (which is part of the 11th Federal Circuit), bankruptcy judges follow a Second Federal Circuit decision called Brunner v. New York Higher Education Services Corp, which sets out a three part test to determine undue hardship:
1. the debtor must show that he cannot maintain, based on current income and expenses, a minimal standard of living for himself and dependents if forced to pay his student loans; and
2. the debtor must prove that additional circumstances exist indicating that this state of affairs (i.e. his current budget) is likely to persist for a significant portion of the repayment period of the student loans: and
3. the debtor must prove that he has made good faith efforts to repay the loans
As a practical matter, judges have been reluctant to grant undue hardship discharges. In reviewing several decisions in the Northern District and elsewhere where the Brunner test is used, the sticking points seem to be:
- what is a minimal standard of living? Is this the federal poverty level? Does one need to be receiving Medicaid or Section 8 housing? Do deferment programs allow the debtor to maintain a minimal standard of living even as interest and penalties add up? Do non-judicial wage garnishments of 15% of take home pay prevent a minimal standard of living?
- how can a debtor prove that his capacity for earning more or spending less is “likely to persist for a significant portion of the repayment period?” If a debtor incurred student loans, does that not mean that he has education and skills that would allow for more than an entry-level unskilled job?
- how can a debtor prove that he has made a good faith effort to repay the loans? Is it reasonable to refuse to move to a different state where better jobs are available? Can a teacher (who was an English major) turn down an opportunity to move to North Dakota to work a high paying job in an oil field?
In the few cases where judges found undue hardship, the debtor was afflicted with a serious medical problem that precluded most work. There have also been a few decisions where a judge forgave a portion of the debt but not all of it because of the remote possibility that an out of work debtor might miraculously find a high paying job.
Bankruptcy Judges are Showing More Flexibility
In recent years, bankruptcy judges in different jurisdictions throughout the country have begun to show more flexibility when it comes to discharging or partially discharging student loan debt. In an increasing number of cases, bankruptcy judges are recognizing that a middle class debtor will never be able to pay off thousands or hundreds of thousands of dollars of student loan debt. It seems that no longer do you have to be terminally ill to qualify for a full or partial bankruptcy discharge.
Judges are also no longer seeing discharge as an “all or nothing” proposition. A judge might not be willing to wipe out all of your student loan debt but he/she may be open to discharging a percentage of your educational debt is you can show that your expected income is not likely to increase in the foreseeable future.
Relief from the Department of Education
If your student loans were issued or guaranteed by the U.S. Department of Education, you may have non-bankruptcy options which may allow for reduced payments or even loan forgiveness.
Private Student Loans
Recently a very creative colleague of mine named Austin Smith (a lawyer in New York) developed an argument that many private student loans are actually dischargeable debts because they do not actually qualify as “student loans” as defined in the Bankruptcy Code. So far I have been able to use this argument to negotiate very favorable settlements with private student loan lenders on behalf of several clients. My guess is that banks that issue private student loans are trying to avoid unfavorable court decisions so we’ll have to see how this argument plays out over time.
If you have a private student loan debt and you either need to file or have already filed a Chapter 7 or Chapter 13, I’d like to talk to you.
Chapter 7 and Student Loans
If you file Chapter 7, you will have to litigate the question of whether your government or private student loan is fully or partially dischargeable. If you have already filed and received a discharge, we may be able to reopen your case to get a determination on this issue. If the amount of debt you are able to discharge is significant, it may make sense to look into paying these costs over time.
Chapter 13 and Student Loans
Generally you will pay your student loan directly to the loan creditor when you are in Chapter 13. Trustees in the Northern District generally do not object to direct payments of student loans in Chapter 13.