Discharging Student Debt Through Bankruptcy In 2024

Although student loans are exempt from discharge in bankruptcy, under the current Bankruptcy Code, student loans can still be discharged under certain circumstances. The Bankruptcy Code permits debtors to be excused from their obligation to repay their loans but only if they can show undue hardship. Unfortunately, the burden of proving “undue hardship” is not an easy task. Consequently, due to this burden, most people who attempt to discharge their student loans are not successful, and even more people do not even dare to try. In November 2022, the Department of Justice (DOJ) and the Department of Education (DOE) issued a new guidance. The Guidance instructs DOJ attorneys on how they should approach a request to discharge student loans in bankruptcy and it encourages them to focus on how collectable the debt really is. This new guidance is supposed to make discharging student loans through bankruptcy more attainable and provide for more consumer favored outcomes. The guidance is an attractive administrative approach to discharging student debt. However, not many cases in bankruptcy regarding the discharging of student loans have mentioned the DOJ and DOE guidance. The guidance is supposed to reduce the burdens of litigation on the debtor; one reason as to why the guidance isn’t mentioned in many cases, after its release, may be due to the guidance suggesting that these cases should be resolved through a settlement. Additionally, commentators argue that many attorneys are still unwilling to take on these kinds of cases. This impacts the effectiveness of the guidance’s ability to help more consumers discharge their student debt. For these reasons, it is challenging to quantify how effective this guidance has been at making the discharge of student debt easier.

The Basics of Discharging Student Debt Under The Bankruptcy Code

The Law: Under 11 U.S.C. Section 523(a)(8), student loans cannot be discharged unless “excepting such debt from discharge under this paragraph would impose an undue hardship on the debtor and the debtor’s dependents…” Basically, this provision allows for student loans to be discharged when it causes an undue hardship. Student loans can cause unimaginable hardship, and this provision gives a debtor a chance to be liberated from their unmanageable debt if they can prove undue hardship. Discharging student loans because of undue hardship is the exception and not the rule, that is why many people do not believe it is possible to discharge their student debt. However, as will be discussed below, there seems to be a change in the way the bankruptcy system will approach the discharging of student debt.

The Loans: 11 U.S.C. Section 523(a)(8)(A) does not allow debtors to discharge four categories of educational loans (1) educational benefit overpayments or loans made, insured or guaranteed by a governmental unit; (2) educational benefit overpayments or loans made under any program partially or fully funded by a governmental unit or nonprofit institution; (3) funds received as “qualified educational loans defined in Section 221(d)(1) of the IRS Code; and (4) funds received as an educational benefit, scholarship, or stipend. In re Mazloom, 648 B.R. 1, (2023). Whether a ‘private’ loan falls within scope of 11 U.S.C. Section 523(a)(8) the creditor must establish that a non-profit or governmental unit made a meaningful contribution. Id. Further, 11 U.S.C. Section 523(a)(8)(B) exempts “qualified educational loans” from being discharged unless the debtor would otherwise suffer an undue hardship. Qualified educational loans, defined by Section 221(d)(1), are incurred solely to pay qualified higher educational expenses. Qualified education expenses are the costs of attending an eligible educational institution.  Id. A qualified high educational institution is one which process U.S. Federal Student Aid. Whether a loan was incurred as a “qualified educational loan” depends on the initial purpose for the loan.

Undue Hardship: Financial hardship is common amongst people who file for bankruptcy. Therefore,the debtor has the burden of showing that paying off their student loans would result in undue hardship to them and, if applicable, their dependents. Undue hardship is based predominately on factual questions, in a proceeding to discharge student loans, the bankruptcy court takes case-specific facts and considers them to decide whether to discharge the student debt. In re Love, 649 B.R. 556, (9^th Cir. 2023). In New York, courts use the Brunner Test to find whether undue hardship exists. The law in New York requires the debtor to prove undue hardship by satisfying the three elements of the Brunner Test. Remarkably, a debtor can show that they would suffer an undue hardship without being in poverty. In re Calvell, 611 B.R. 504, (Bankr. S.D.N.Y. 2020).

The Brunner Test: Historically, the standard set forth by the Brunner Test has been difficult to meet. Under the Brunner Test, student loans can only be discharged once the debtors show (1) they cannot maintain a “minimal” standard of living; (2) additional circumstances indicating that the debtor’s situation is likely to persist for a significant portion of the repayment period; and (3) they have made “good faith” efforts to repay the loans. The Brunner Test, as applied, has been criticized for its harshness. The harshness of the Brunner Test rests in the second element, the second element is often interpreted by judges to require a showing of “hopelessness.”

The Department of Justice & Department of Education Guidance

Unlike the Bankruptcy Code, the new guidance encourages the discharging of federal student loans. Under the Guidance, the debtor, after filing for bankruptcy and filing a suit against the government to discharge their federal student loans, completes and sends an attestation form. The attestation form can be found on the Department of Justice’s website. The attestation form is then evaluated by the DOJ’s attorneys. The purpose of the guidance is to provide consistency and equality regarding the discharge of student debt. The Department’s attorneys shall recommend to the court that the debtor’s student loan be discharged if three conditions are satisfied “(1) the debtor presently lacks an ability to repay the loan; (2) the debtor’s inability to pay the loan is likely to persist in the future; and (3) the debtor has acted in good faith in the past in attempting to repay the loan” Guidance For Department Attorneys Regarding Student Loan Bankruptcy Litigation, November 17, 2022. With the new guidance debtors must still satisfy the undue hardship requirement of 11 U.S.C. § 523(a)(8). Thus, in New York debtors must still prove undue hardship under the Brunner Test.

Present Inability to Repay the Loan: The debtor must show that based on their current finances, if required to make student loan payments, their standard of living will fall below the minimum level. Rosenberg v. Educ. Credit Mgmt. Corp, No. 20-CV-00688 (PMH), 2021 WL 2241341 (S.D.N.Y. Sept 29, 2021). The debtor’s present inability to repay the loan is determined by an assessment of the debtor expenses in comparison to the debtor’s household gross income. Under the guidance, the debtor’s expenses cannot exceed the IRS National Standards. When completing the attestation form, if the debtor’s expenses exceed the IRS’s standard, they should list the need for such expenses so the DOJ can consider whether those expenses are reasonable. Unlike the “means test” that is used in Bankruptcy, under the guidance, gross income includes Social Security and unemployment benefits. The income of a spouse or other household members to the extent to which such income meets the needs of the household shall also be considered. Carney v. Educ. Credit Mgmt. Corp. (In re Carney), 2023 Bankr. LEXIS 709. Under the guidance, the DOJ attorneys, when determining the debtors present in ability to pay should consider reasonable expenses that have not yet been incurred. If a debtor’s gross household income minus their expenses cannot support a minimal standard of living if required to repay their student loans, there is likelihood that they’ll be eligible for discharge of their student loans. Where the debtor’s income, after expenses, allows for insufficient payment to cover monthly student loan payments, partial discharge of the student loan debt is encouraged under the 2022 guidance.

The Debtor’s Inability to Pay is Likely to Persist in the Future: The guidance and the Brunner Test both require the debtor to show that their inability to pay will likely persist during the life of the loan. The rationale behind this policy may be because New York Court’s typically view student loans as a “long term investments” and the expected return on this kind of investment is not instant. Under the Brunner Test, when evaluating a debtor’s future inability to pay in the future, Courts have considered the debtor’s assets, career, income or potential for increased career and financial opportunities. Rosenberg v. Educ. Credit Mgmt. Corp, No. 20-CV-00688 (PMH), 2021 WL 2241341 (S.D.N.Y. Sept 29, 2021). However, the court in re Cavell, said that a low income driven repayment plan payment may show that the debtor cannot afford to pay back the student loan at all. In re Cavell, 611 B.R. 504, 515 (Bankr. S.D.N.Y. 2020) In the past, there was only a presumption that student loans would be discharged under certain circumstances such as the debtors age being older than 65; the debtor has a chronic disability or illness that affects their earning potential; or the debtor’s unusually long history of unemployment. These circumstances are still considered to carry a lot of weight when considering a debtor’s future inability to pay in the future. However, the guidance and recent case law is leaning towards a more holistic evaluation. Additionally, the guidance provides that in the assessment of “future circumstances” the department attorneys should consider whether “the loan has been in repayment status other than “in-school” for at least ten years.” The length of repayment time includes periods in repayment on the original underlying loans of consolidation. Overall, the guidance encourages DOJ attorneys to consider circumstances surrounding the entire life of the loan.

Good Faith Attempt to Repay the Loans: As provided by the Brunner Test and the guidance, the debtor must show that they’ve made a good faith attempt regarding repayment. Good faith regarding repayment depends on the debtor’s actions related to their student loan obligation. Evidence of good faith includes but is not limited to making a payment; applying for an income driven repayment plan; applying for federal loan consolidation; or engaging meaningfully with the DOJ or their loan servicer. A debtor cannot willfully or negligently cause his own hardship, as the purpose of the undue hardship requirement is to protect the integrity of student loans. Other factors New York Courts have considered are the debtor’s efforts to maximize his income and minimize his expenses. Rosenberg v. Educ. Credit Mgmt. Corp, No. 20-CV-00688 (PMH), 2021 WL 2241341 (S.D.N.Y. Sept 29, 2021). The guidance provides for good faith to be satisfied where the debtors’ personal or family obligations significantly reduce their employment opportunities or increase their expenses. Generally, good faith requires undue hardship to be caused by factors that are beyond the debtor’s reasonable control. Id.

The New Guidance encourages the Department of Justice Attorneys to recommend a settlement as per the Guidance’s recommendations. The guidance does not create any enforceable rights. Therefore, it is up to the debtor’s attorney to urge the DOJ and DOE to follow the guidance. Furthermore, courts are not obligated to accept the guidance and the DOJ attorney’s recommendation is not binding. Thus, the effectiveness of this guidance depends on bankruptcy attorneys’ ability to zealously advocate for their clients. 

A New Trend Regarding Discharging Student Debt?

 Recently, there have been a few outliers in New York Bankruptcy Courts. In re Clavell, the judge evaluated Mr. Clavell’s ability to discharge his student loan debt under the Brunner Test. The court stated that “‘the Bankruptcy code requires bankruptcy courts to decide how much personal sacrifice society expects’ from debtors who have unpaid student loans.” In re Cavell, 611 B.R. 504, 517 (Bankr. S.D.N.Y. 2020). The court found that the debtor is not required under the first prong of the Brunner Test to give up necessary and reasonable expenses, including a modest amount of recreation and entertainment that is incident to modern life. The court used their commonsense knowledge, gained through their observations in daily life and general experiences, to determine what is reasonable and necessary. The court then said that it is possible for undue hardship to exist even if it would not immediately deprive the debtor or their dependents of food and shelter. Id. The court in In re Cavell also disregarded the certainty of hopelessness and total incapacity standard, a common approach to the second prong of the Brunner Test. This may be evidence of modern courts taking a more open-minded approach to evaluating undue hardship under the Brunner Test. Historically, the second prong has required a showing of a certainty of hopelessness, which is nearly impossible for most people to prove. Additionally, this opinion, which was decided before the DOJ guidance, allowed for partial discharge of Mr. Cavell’s student debt. Partial discharge did not give the debtor a “fresh start,” but it made his obligation to pay back his loans more reasonable. Most people would agree, partial discharge is better than no discharge whatsoever. When evidence does not permit the debtor’s entire student loan to be discharged, this case law and the guidance should give debtors hope in obtaining some form of relief. Additionally, although the decision was overturned and the case was remanded due to a technical error, In re Kevin Jared Rosenberg, nevertheless reflects a shift in how some bankruptcy judges view undue hardship. However, most judges, like In re Hlady, maintain the traditional Brunner Test approach and give substantial weight to the availability of income driven repayment plans. Governmental attitudes on the other hand are sympathetic to the burdens of student debt. It seems like the government is acknowledging that there is a societal issue caused by enormous amounts of student debt. They are trying to remediate this situation the best they can. Evidence of the government’s attempt to remediate the student loan crisis includes; the DOJ and DOE 2022 guidance for discharging student debt; and the Attorney General of New York’s lawsuit against one of the Nation’s largest student loan servicers for deceitful practices. She obtained $6.8 Million dollars in restitution payments for 25,000 federal loan borrowers and received over $110 Million dollars in private loan debt cancellation. Nationwide 39 Attorney Generals received $1.7 Billion dollars of private loans cancelled and recovered $95 million for students nationwide. It seems that there is a collective effort outside of bankruptcy courts to help discharge student loans. This also supports the conclusion that bankruptcy courts are not equipped to deal with relieving student loan debt.

Is There a Better Way to Deal with Student Loans in Bankruptcy?

“The Brunner Test should be applied by courts as it was originally intended,” however the Brunner Test is 30 years old. 30 years ago, student loans were vastly different. When the Brunner case was decided, Brunner had $9,000 in graduate and undergraduate student loans. This is not the reality of many debtors today due to the increasing costs of higher education. Also, since Brunner was decided the bankruptcy code has been amended. The law when Brunner was decided was that student loans were only to be excluded for 5-years. However, when the Bankruptcy Code was amended in 2005, student loans became excluded from Bankruptcy indefinitely. Today, student loans are excluded indefinitely except for when it results in undue hardship, so, how under present circumstances can the Brunner test be justly applied? Moving forward, courts should be urged to consider in their undue burden analysis under the Brunner Test the new burdens that debtors face. New burdens caused by student debt are like debtors’ inability to buy a home, start a business, or obtain other types of wealth building credit. The foreclosure of discharging student loans indefinitely presents greater challenges than when debtors were only foreclosed from discharging their student loans for 5-years. When bankruptcy courts consider the discharge of student debt, they should be interpreting the Brunner Test to fit the needs and circumstances of debtors today.

Conclusion

The decision to discharge student debt cannot truly be decided by bankruptcy courts. Whether student debt is dischargeable must be decided by legislators and government actors, as they are better equipped to deal with changes in society. Outlier cases which have issued favorable decisions reflect the opinions of judges, which are not a reflection of the law. Presently there is nothing more judges, or bankruptcy courts can do to help people drowning in student debt, especially if Congress does not legislate this issue. The bankruptcy courts’ resources are limited, on their own, they are unable to provide relief. The solution to the student debt crisis must come from a change in society’s views on student loans, and the costs and burdens of obtaining a higher education; this theory is supported by how these “outlier” cases have been decided. Whether student loans will be forgiven will reflect our societal beliefs, and the change will come from policies developed to reflect those beliefs. Unfortunately, the issues surrounding student debt will have to be resolved over time. In conclusion, don’t rely on bankruptcy to discharge student debt. Looking to bankruptcy to resolve the student debt crisis is a distraction from a larger issue, which is, how do we deal with the national educational debt crisis, when most of the debt is owed by students who aren’t equipped to pay their debt but have skills rendering them unable to satisfy the undue burden tests. The answer to this question will, hopefully, come with time. One positive change that will help to reduce the educational debt crisis is the movement towards employers hiring based on skill instead of education. For many years employers have required a degree for jobs that don’t necessarily require a degree, which has likely contributed to debtors’ inability to pay back their loans despite having a degree, as most people are overqualified for their jobs. Societal forces, like technology, will also eventually change the educational landscape in America, making higher education more accessible and affordable. Similarly to how it has changed the way we shop, work, communicate, and enjoy entertainment. It is only a matter of time before education follows suit. Technology has the potential to drive down the cost of education like it has driven down the cost of watching movies or even running a business. As a result, less people will be obligated to take out hundreds of thousands of dollars in student debt.