Articles Posted in Student Loans

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Student loans are not dischargeable in Chapter 7 or Chapter 13 bankruptcy, except in narrowly defined circumstances. A debtor must establish that continued payment of the student loan debt would cause “undue hardship” to them and their dependents. 11 U.S.C. § 523(a)(8). Most U.S. jurisdictions apply a three-part test to determine whether a debtor has met this burden. A student loan debtor is currently appealing the denial of discharge in a Chapter 7 case to the U.S. Supreme Court, arguing in part that the three-part test is improper, or alternatively that it should be modified. Tetzlaff v. Educ. Credit Mgt. Corp. (“Tetzlaff Petition”), No. 15-485, pet. for writ of cert. (Sup. Ct., Oct. 15, 2015).

Most federal appellate courts, including the Ninth Circuit, have adopted the Brunner test to determine whether a student loan debtor has met the statutory requirement of proving “undue hardship.” A debtor must prove, by a preponderance of evidence, that:

1. Based on their current levels of income and expense, repayment of the loans would prevent them from supporting themselves or their dependents at a “minimal standard of living”;
2. This situation is likely to continue for most or all of the repayment period; and
3. They have “made good faith efforts” to make timely payments on the debt. Brunner v. N.Y. State Higher Educ. Svcs. Corp., 831 F.2d 395, 396 (2d Cir. 1987).

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Under the federal Bankruptcy Code, certain debts are not eligible for discharge by a bankruptcy court at the end of a case. Nondischargeable debts include certain tax debts, 11 U.S.C. § 523(a)(1); spousal and child support, id. at § 523(a)(5); and debts that resulted from fraud, theft, and other deceptive or unlawful acts, id. at §§ 523(a)(2), (4), (6). For many, perhaps most nondischargeable debts, a rationale based on public policy seems clear. This might not be the case, however, with regard to student loans, including both public loans, which are backed by the federal government, and private loans. Rather than attempting to deduce a public benefit from making student loans nondischargeable, it is worth looking into how they became nondischargeable in the first place.

Student loans are only subject to discharge in bankruptcy if a debtor proves that continuing to make payments would cause an “undue hardship” to them and their dependents. 11 U.S.C. § 523(a)(8). No single legal standard applies throughout the country for determining whether a debtor has established “undue hardship.” The Ninth Circuit, which includes California, has adopted a three-part test known as the Brunner test, found in Brunner v. N.Y. State Higher Educ. Serv. Corp., 831 F.2d 395, 396 (2d Cir. 1987). Other circuits have adopted a test known as the “totality of the circumstances,” first developed in In re Andrews, 661 F.2d 702, 704. (8th Cir. 1981). Both tests require a court to examine a debtor’s financial situation and determine whether it is possible that conditions might improve enough to allow the debtor to continue paying the loans. In other words, bankruptcy courts must attempt to predict the future.

Student loans therefore differ in at least one important way from other nondischargeable debts because there is an exception provided in the statute itself. As noted earlier, most nondischargeable debts have some obvious justification, such as the fault of the debtor in the case of a debt incurred through fraud, or the need of a dependent in the case of child support. Student loans, as it turns out, became nondischargeable quite incrementally.

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A federal appellate case has the potential to make substantial changes to the way American bankruptcy courts handle student loans. Federal bankruptcy law does not allow courts to discharge student loan debt, unless the debtor can show that they and their dependents would suffer “undue hardship” if they were forced to repay the debt. 11 U.S.C. § 523(a)(8). The statute does not define “undue hardship,” so courts have had to apply their own interpretations. Most federal circuits have adopted the Brunner test, named for Brunner v. N.Y. State Higher Educ. Servs. Corp., 831 F.2d 395 (2d Cir. 1987), which uses a three-part test to establish “undue hardship.” The current case, Murphy v. Sallie Mae, et al., No. 14-1691 (1st Cir., Jun. 30, 2014), is in a circuit that has not expressly adopted any standard for “undue hardship.” This has made the case the center of a battle between consumer advocates on one side and student-loan lenders, with the support of the federal government, on the other.

The elements that a debtor must prove under the Brunner test made sense in 1987, but they are not necessarily as widely applicable in the world of 2015. A debtor must prove that they would not be able to maintain a basic standard of living, based on their current income and expenses, without discharge of the loans; that their current financial hardship is likely to continue for most of the repayment period; and that they have attempted to repay the loans in good faith. The second part of the test seems especially difficult, since it asks the court to predict the future, but the third part has also produced results that seem remarkably unjust.

The debtor in Murphy is 65 years old and has been out of work since he lost his job as the president of a manufacturing company in 2002. He has been unable to find work since that time. According to the district court that heard his case in 2014, he blamed his ongoing unemployment on his age and level of qualifications, as well as “the shrinking American manufacturing base.” Murphy v. Educ. Credit Mgt. Corp., 511 B.R. 1, 2 (D. Mass. 2014). From 2001 to 2007, he took out multiple loans, totaling more than $220,000, to finance his three children’s college educations.

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Current and former students in the U.S. reportedly owe more than $1 trillion in public and private student loans. For many, the burden of student loan debt nearly eliminates any benefit of the education obtained with the loan proceeds. Making matters worse is the fact that federal bankruptcy law specifically excludes student loans from discharge. The U.S. Department of Education (DOE) recently announced two changes to student loan repayment rules, which apply to loans made through various DOE programs. The new rules do not affect a student loan debtor’s rights in bankruptcy in any way, but they may ease their debt burden in other ways.

Consumer Protections

Federal and state regulators have gone to great lengths to prevent financial marketing that could potentially mislead students. The Credit Card Accountability Responsibility and Disclosure (Credit CARD) Act of 2009, for example, largely prohibits credit card marketing on college campuses.

The first new rule announced by the DOE addresses prepaid debit cards and similar financial products. Numerous colleges have deals with banks that allow them to market prepaid cards to students as a convenient means of accessing student loan funds, sometimes without clearly disclosing overdraft and other transaction fees.. The DOE’s new rule requires schools to let students choose where to deposit their student loan funds, and it prohibits them from creating an impression that students must use a particular kind of account for their funds. 80 Fed. Reg. 67125 (Oct. 30, 2015).

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Student loan debt is among the largest financial burdens Americans face, with many estimates placing the total amount of debt at more than $1 trillion. Bankruptcy law, unfortunately, only offers limited relief. Since 2005, nearly all student loans are excepted from discharge in bankruptcy cases, except in very limited circumstances. Many debtors must consider other options in addition to bankruptcy if their student debt becomes overwhelming. A series of debt relief measures recently announced by the federal Department of Education (DOE) may offer relief to some debtors. One can hope that the DOE’s actions also offer hope for additional reforms in the future.

The Bankruptcy Code identifies certain debts that are not dischargeable in bankruptcy. 11 U.S.C. § 523. These exceptions could be broadly categorized as (1) debts owed to the government or subject to a court order, such as certain tax debts or child support obligations; and (2) debts incurred through some fault of the debtor, such as those arising from civil judgments for fraud or other injury.

Student loans do not quite fit into either category. Prior to 2005, the only student loans excepted from discharge were those “made, insured or guaranteed by a governmental unit,” or made by an organization that receives government funding. 11 U.S.C. § 523(a)(8) (2004). The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub. L. 109-8, amended that section to include private student loans as well.

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A federal district court in California considered a request to discharge federally guaranteed parent loans, which the debtors took out to pay for one of their children’s education. In re Mees, No. 2:13-cv-01892, order (E.D. Cal., Jul. 22, 2014). Student loan debt is not dischargeable in bankruptcy except in rare case of “undue hardship.” 11 U.S.C. § 523(a)(8). The bankruptcy court ruled that the parent loans were not dischargeable, applying the same legal standard used for student loans. The debtors appealed, arguing in part that the bankruptcy court erred in applying this standard. The district court considered this question but ultimately remanded the case to the bankruptcy court, finding that it applied the test incorrectly.

The debtors, a married couple, took out federally guaranteed parent loans for their son, the older of two, to pay for his college education. Parent loans, known as PLUS Loans, typically have a much higher borrowing limit and might be used to cover any gaps in financial aid available directly to the student. Unlike a student loan co-signed by parents, the student is not liable on a PLUS loan. No payments are due until the student completes or leaves school.

The debtors’ son never completed his degree. The balance of the parent loans is about $35,000. By the time of the court’s ruling, both of the debtors had been unemployed for substantial periods of time:  three years for the husband and 30 years for the wife. Their younger son is still a minor. The debtors filed for Chapter 7 bankruptcy in September 2011. They filed an adversary proceeding several months later, seeking discharge of the parent loans. The bankruptcy court ruled against them, citing the three-prong test for determining “undue hardship,” known as the Brunner test after Brunner v. New York State Higher Educ. Svcs., 831 F.2d 395 (2d Cir. 1987). Continue reading

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Personal bankruptcy under Chapters 7 and 13 offer ways for people to obtain financial relief when their income is not high enough to continue making required payments on their debts. The federal Bankruptcy Code deals with different types of debt in different ways. The Bankruptcy Code establishes that certain types of debt have priority over others, and these creditors are therefore entitled to payment from the bankruptcy estate first. While many debts may be subject to discharge at the end of a personal or business bankruptcy case, some debts are expressly excepted from discharge, such as debts for recent taxes or child support obligations. However, these priority debts can be paid back via a Chapter 13 over a period of 3 to 5 years. Understanding how bankruptcy law treatss various types of debt is critical to planning and preparing for a bankruptcy filing.

Secured vs. Unsecured Debt

A key distinction in bankruptcy is between secured and unsecured debts. A secured debt has one or more specific items of property attached to it, known as collateral. See 11 U.S.C. § 506. A secured creditor has the right to take possession of the collateral if the debtor defaults on their repayment obligation. A mortgage, for example, is typically secured by the real property purchased with the mortgage loan.

Unsecured debt does not have collateral. The Bankruptcy Code divides unsecured debts into priority and nonpriority debts. 11 U.S.C. § 507. Many priority unsecured debts are also included in the list of debts excepted from discharge. 11 U.S.C. § 523.

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As of late 2015, about 40 million people in the United States owed a total of $1.2 trillion in student loan debt, an average of $30,000 in debt per student loan borrower. Reform of the student loan system is likely to be a significant issue in the upcoming presidential election, and student loans have become a topic of much discussion in the media, much of it of questionable accuracy. The arrest of a man in Houston, Texas in February 2016, supposedly due to student loan default, made headlines around the country, but the situation was not as straightforward as initial reporting made it seem. The use of federal marshals to enforce student loan debt at all still seems troubling, but this might at least be one area in which bankruptcy, through the automatic stay, can offer some immediate assistance.

Part of what makes student loan debt so pervasive is its distinctive treatment by the federal Bankruptcy Code. Certain types of debt are not subject to discharge at the end of a bankruptcy case. Most of these types of debt are based on factors like the fault of the debtor, such as cases of fraud or embezzlement, certain tax debts, and domestic support obligations like child support.

Student loan debt, both public and private, is also included on the list of nondischargeable debts, 11 U.S.C. § 523(a)(8), although the rationale for its nondischargeability may not be as clear. The only exception is when repayment would cause “undue hardship” to the debtor or the debtor’s dependents, but courts interpret this very narrowly. See Brunner v. N.Y. State Higher Educ. Svcs. Corp., 831 F.2d 395 (2d Cir. 1987); In re Pena, 155 F.3d 1108 (9th Cir. 1998).

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Student loans present one of the greatest challenges for debtors in Chapter 7 and Chapter 13 personal bankruptcy cases. Federal law prohibits the discharge of almost all student loan debt, except when a debtor proves that denying a discharge would cause “undue hardship” to them and their dependents. 11 U.S.C. § 523(a)(8). Most courts have interpreted “undue hardship” very narrowly, using the three-part Brunner test. See Brunner v. N.Y. State Higher Educ. Servs. Corp., 831 F.2d 395 (2d Cir. 1987); In re Pena, 155 F.3d 1108 (9th Cir. 1998). While this has been the standard in most of the country for years, a few voices of dissent have emerged. A 2013 decision from the Ninth Circuit’s Bankruptcy Appellate Panel (BAP), for example, criticized the Brunner test as “too narrow,” stating that it “no longer reflects reality and should be revised.” In re Roth, 490 B.R. 908, 920 (BAP 9th Cir. 2013) (Pappas, J. concurring). Whether these voices have a lasting impact remains to be seen.

Most jurisdictions, including the Ninth Circuit, use the Brunner test, which requires a debtor to establish (1) that continued payment of the student loans would prevent them from maintaining even a basic standard of living, (2) that this state of affairs is likely to continue for the foreseeable future, and (3) that the debtor has attempted to make payments on the loans in good faith. Brunner, 831 F.2d at 396. Other jurisdictions use a “totality of the circumstances” test, which takes an individual debtor’s circumstances more into account. See In re Long, 322 F.3d 549 (8th Cir. 2003).

The “good faith efforts” requirement of Brunner can cause problems for debtors, since it invites a bankruptcy judge to second-guess how a debtor has prioritized debt payments before filing for bankruptcy. The term “good faith” is inherently ambiguous, which can also make it difficult to evaluate different debtors in different circumstances. This difficulty played a key role in the Roth case.

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Student loans present a uniquely difficult obstacle to debtors in bankruptcy. Federal law completely excepts student loans from discharge, unless a debtor can show “undue hardship” to themselves and their dependents. 11 U.S.C. § 523(a)(8). Most courts around the country use a three-prong test to determine if a debtor has established “undue hardship,” known as the Brunner test after Brunner v. N.Y. State Higher Educ. Svcs., 831 F.2d 395 (2d Cir. 1987). The Ninth Circuit, which includes California, adopted the Brunner test in In re Pena, 155 F.3d 1108 (9th Cir. 1998). A California bankruptcy court recently considered a debtor’s claim of undue hardship in an order that includes an in-depth review of the Brunner test. In re Shells, No. 11-26042, Adv. No. 14-2111, mem. dec. (Bankr. E.D. Cal., May 7, 2015).

The debtor in Shells obtained student loans for her bachelor’s and master’s degrees. According to the court, she consolidated several private loans into a single U.S. Department of Education (DOE) loan in 2007, with a principal balance of over $96,000 at 7.375 percent. She has reportedly been employed full-time by the county since 1998, and she claimed a net monthly income of just under $6,000. Her husband is disabled, and the two of them have three children.

At the time of the court’s order in May 2015, the student loan balance had grown to more than $137,000. The court noted that the debtor had obtained an Income-Contingent Repayment (ICR) plan in late 2008, which reduced her monthly payment. She reportedly defaulted on the ICR plan twice. She filed for Chapter 7 bankruptcy in March 2011 and received a discharge, which did not include the student loans, that June. She received an Income-Based Repayment (IBR) plan in March 2013 but reportedly defaulted again. After reopening her Chapter 7 case in April 2014, the debtor filed an adversary proceeding against the DOE to discharge the student loan debt. The DOE moved for summary judgment.

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