Saturday, October 19, 2013

Debunking the Myth that Student Loan Debt is Nondischargeable in Bankruptcy

There is a belief out there, which widespread even in the legal community, that student loan debt is not dischargeable in bankruptcy.   After watching a Frontline documentary on for profit schools, which also discussed the not unrelated ballooning student debt load people are carrying, I decided to do some research.

My belief (and the belief of other attorneys I know) was that that in order to get a discharge of student loan debt, it had to be shown in bankruptcy that the education one obtained as a result of the student loans was completely worthless.  It turns out that is not the standard.

11 U.S.C. § 523(a)(8)(B) permits the discharge of such loans when failure to do so would "impose undue hardship on the debtor and the debtor's dependents."

In the case, Matter of Robinson, 999 F.2d 1132, 1134-1135 (7th Cir. 1993), the Seventh Circuit looked at that statutory language and adopted the following test for determining "undue hardship," which test was first set forth by the Second Circuit in Brunner v. New York State Higher Education Services Corp., 831 F.2d 395, 396 (2d Cir.1987) (per curiam):
"[U]ndue hardship" requir[es] a three-part showing (1) that the debtor cannot maintain, based on current income and expenses, a "minimal" standard of living for [himself] and [his] dependents if forced to repay the loans; (2) that additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period of the student loans; and (3) that the debtor has made good faith efforts to repay the loans."
This year the 9th Circuit reversed and ordered a reinstatement of the bankruptcy court's discharge of a law student's student loan debt, actually a partial discharge - $50,000 forgiven of $80,000 owed.  The case, Hedlund v. Education Resources Institute, Inc., received some press which suggested a new era was dawning in the discharge of student loans.  My examination of the case though revealed the 9th Circuit had simply concluded that intermediate appellate bodies were improperly reweighing evidence and not giving proper deference to the bankruptcy court which found discharge was proper. 

Nonetheless, articles on that case led me to others discussing discharge of student loans in bankruptcy.  This one below takes the form of a reader letter and response written by Steve Rhode, the "Get Out of Debt" guy who blogs for the Huffington Post:
Dear Steve,

I"m going through bankruptcy but my attorney said no to trying to discharge student loans.

I currently have almost 300,000 in student loan debt with Sallie Mae, most of which is 'private loan' vs 'government backed'...

I started these loans, with my father as a co-signer, in 2001 until 2008. As of 2011, I started re-paying them in a 'reduced interest' program to lower my payment. Without the program my payment would be $2500+ a month. Now I pay $1090....even that is too much. I 'll be paying it off till the day I die and its still so high that I have filed for bankruptcy. I cannot afford a car ....much else...its depressing. I have my 341 hearing on Aug 7th. my attorney flat out told me my loan wont be discharged.

...

Michael


Dear Michael,

I am not a bankruptcy attorney. I am a writer and researcher. So what I can tell you definitively is not if your bankruptcy attorney is right or wrong but what the cases I've reviewed and written about show.

In These Private Student Loans Can Be Easily Discharged in Bankruptcy I go into detail about the accreditation, provide a link to check and give examples of what is not a qualified higher education expense.  (Note: there is an issue of a possible lack of accreditation with respect to Michael's higher institution, which lack of accreditation would make it much easier to get a discharge.)

I also provide actual case examples that show loans matching these criteria being discharged without a fuss.

...

...my recent research showed quite a number of federal student loans discharged in 2012. And even if the loans are not full discharged, there still appears to be a benefit to pursuing an adversary proceeding to work out a better deal.

The 2012 data on federal student loans in bankruptcy showed 47% were discharged in full, 21% resulted in a better payment, and 12% settled for less than was due.

It also seems critically important to understand if there still is a cosigner on your loans or the cosigner was released.

...

Here are a couple of more research articles to review, here and here.

Please post a comment with updates so I can stay tuned on what happens.



Get Out of Debt Guy

______________________________________________

Rhode has written on this subject for the Huffington Post on other occasions.

I am struck by Mr. Rhode's analysis that, with regard to federal student loans in bankruptcy, 68% of the time there is an improved situation for the borrower, and 47% of the time there is a complete discharge.  One would think private student loans would have an even higher discharge rate.

Nonetheless, it appears that student loan debt discharge requires not only the filing of the bankruptcy, but the initiation of an adversarial proceeding within the bankruptcy court, a process many attorneys outside of those doing bankrutpcy on a regular basis probably would not know.

To conclude, federal law allows the discharge of certain student loan debt when there is an "undue hardship" and the Seventh Circuit as well as others have identified as requiring that three things be proven:
(1) that the debtor cannot maintain, based on current income and expenses, a "minimal" standard of living for [himself] and [his] dependents if forced to repay the loans;

(2) that additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period of the student loans; and

(3) that the debtor has made good faith efforts to repay the loans.
In this era of drastically increasing student loan debt, debt that often leads not to a profitable degree but rather a lifetime of impoverishment, bankruptcy might prove to be the only ticket out.

Note: The Huffington Post has been all over the looming student loan debt crisis and related stories.  Here is a sampling:

Student Loan Defaults Surge To Highest Level In Nearly 2 Decades, September 30, 2013

Student Loan Forgiveness Program Available To Millions Who Aren't Utilizing It, CFPB Says, August 28, 2013

Average Student Loan Debt Could Cost A Household $208,000 Over A Lifetime: Study, August 4, 2013

12 Student Loan Debt Numbers That Will Blow Your Mind, April 11, 2013

38 comments:

Guest said...

As a landlord what I have seen is students are racking up excessive debt not due to the cost of schooling but they are putting their living expenses on their student loans. I was told by one would be tenant that I didn't understand how it works when questioned as to how he could afford the rent along with school. I may be wrong about putting housing in their loan requests but that is my impression.

Paul K. Ogden said...

Guest, you are absolutely correct. Many are putting living expenses and their rent on their student loans. In the days when I was in college and law school, I don't remember ever seeing my student loan money. It went directly to the school.

A lot of times to students will enroll in college to get the student loans, then drop out. How they get away from paying it, I'm not sure.

Chris Long said...

I do not think that it will be that difficult to prove that the education became completely worthless for a person (there are many of such people by the way). It is enough to take a look at fast-food: so many people with diplomas work there not because they like doing it, but because there is no other option for them at this moment: the employment market has not so much to offer these days. It is sad actually, people were studying so hard: doing all of their projects, writing term papers (find out more) and other. And now they are with debt and very little job prospects.

Unigov said...

I had read of the case Paul referred to and found it fascinating, like a thriller novel. It's so drummed into our heads that such debts are non-dischargeable, yet there's the case.

I of course have a completely wild take on this!

The US Constitution gives Congress the power to establish "uniform Laws on the subject of Bankruptcies". Congress has used that power - i.e., there is a financial mechanism in our country called "bankruptcy". But Congress omitted student loans and child support from this process.

The omission of student loans was meant to be, and has been, a huge "welfare program" for universities. Students can borrow way beyond their means, but the schools derive the greatest benefit cause they get most of the money.

My take is that the word bankruptcy means bankruptcy - a tool of last resort by which those who cannot pay their debts get a second chance in life. The intent of the law is to prevent lifetime debt serfdom. IMO it is as unconstitutional for student loans to be excluded from the bankruptcy process, as it would be for Congress to curtail free speech by banning cursing. Many people in their 20's and 30's are debt serfs to their alma mater.

But debt is debt. Student loan debt should and must be viewed by bankruptcy courts like any other debt, if the original intent of the Constitution is to be met. The only extent to which the usefulness of the education in landing work should be gauged are extreme cases like someone getting an MD and then refusing to work, so they can go bankrupt...but this is no different from instances where someone has, say, their CDL license but refuses to work in order to go bankrupt (or get their child support reduced).

In short, college debt must be treated like other debt, for the time-honored concept of bankruptcy to work.

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