Our country has a huge ticking time bomb: an ocean of student loan debt. And as tuition and other educational costs continue to shoot up, students must take out ever larger student loans to finance their educations. It is not uncommon for a doctor to finish medical school with $200,000 to $300,000 in student debt. And undergraduates are receiving their bachelor’s degrees along with bills for $50,000 in student loans, without any hope of getting jobs that will pay enough to both service the debt and provide a better standard of living than the high school graduate enjoys.
I. The Bankruptcy Code On Discharging Student Debt
As everyone knows, student debt can’t be discharged: it says so right there in 11 U.S.C. § 523(a)(8). Or can student loans be discharged in bankruptcy?
While it is true that most student debt is not dischargeable, there is a special carve-out in the wording of § 523(a)(8) (with emphasis added):
A discharge . . . does not discharge an individual debtor from any debt . . . unless excepting such debt from discharge under this paragraph would impose an undue hardship on the debtor and the debtor’s dependents, for—
(i) an educational benefit overpayment or loan made, insured, or guaranteed by a governmental unit, or made under any program funded in whole or in part by a governmental unit or nonprofit institution; or
(ii) an obligation to repay funds received as an educational benefit, scholarship, or stipend; or
(B) any other educational loan that is a qualified education loan, as defined in section 221(d)(1) of the Internal Revenue Code of 1986, incurred by a debtor who is an individual . . .
So what constitutes an “undue hardship”? How tough a time must I be having before I can discharge a student loan?
Courts have struggled with these questions, and have usually denied the discharge of student debt. Why is there such hostility toward the discharge of student debt?
When Congress (the opposite of Progress?) excluded student debt from discharge, it was concerned about the availability of student loan money for future generations. It concluded that if debtors could easily discharge student loans, banks would be reluctant to make student loans. Therefore, to ensure that future generations would enjoy the right to ruin their futures with exorbitant student loan debt, Congress made it very hard to get rid of student debt. And bankruptcy judges followed suit.
Indeed, if student loans were easily discharged in bankruptcy, I would have a line miles long outside of my office. I just checked: no such line. Okay, flippancy aside, what constitutes undue hardship?
II. The Case Law On Discharging Student Debt: The Brunner Test
The seminal case on point is In re Brunner, 46 BR 752, 756 (S.D. N.Y. 1985), in which the Court put forward a three-part test:
[O]btaining a discharge of student loans in bankruptcy prior to five years after they first come due requires a three-part showing: 1) that the debtor cannot, based on current income and expenses, maintain a “minimal” standard of living for himself or herself and his or her dependents if forced to repay the loans, 2) that this state of affairs is likely to persist for a significant portion of the repayment period of the student loan, and 3) that the debtor has made good faith efforts to repay the loans.
Thus, the battlefield has been in the application of these three prongs. If the lender can establish that even one of the prongs does not apply to the debtor, then the student debt is not discharged. See In re Rifino, 245 F. 3d 1083, 1087-88 (9th Cir. 2001):
Under this test, the burden of proving undue hardship is on the debtor, and the debtor must prove all three elements before discharge can be granted. In re Faish, 72 F.3d 298, 306 (3d Cir.1995). If the debtor fails to satisfy any one of these requirements, “the bankruptcy court’s inquiry must end there, with a finding of no dischargeability.” Id.
A. Minimum Standard Of Living
There is a lack of unanimity on the interpretation and application of the first Brunner prong. The Rifino Court observed:
Some courts have declined to discharge student loan debt where the debtor’s budget included items such as cable television, a new car, and private schooling for a child.
Id. at 1088.
However, even though Rosemary Rifino’s “budget contain[ed] unnecessary items such as tanning, cable television, and a new car,” the Ninth Circuit “conclude[d] that the bankruptcy court did not clearly err in finding that Rifino’s standard of living would fall below a minimal level if she were required to repay her student loans.” Id.
Consequently, satisfying the first prong will depend, not only on the operative facts of the case, but also on who the judge is. In particular, there is one alleged-human judge I am aware of, who would probably require the debtor to be living in a cardboard box under a bridge and eating recycled dog food before ruling that the first Brunner prong was satisfied.
B. The Persistence Of Impecuniousness
The Rifino Court held that the second prong:
is intended to effect the clear congressional intent exhibited in section 523(a)(8) to make the discharge of student loans more difficult than that of other nonexcepted debt.
Id. at 1088-89 (internal quotes omitted).
The Court then held:
[A]lthough salaries for social workers tend to stay a little flat over the beginning years of the career, salaries typically increase after approximately five years of employment. . . . [A]t the time of the adversary proceeding . . . Rifino was only three years into her employment as a social worker and had already received two salary increases. . . . We hold that Rifino’s student loans are not dischargeable pursuant to 11 U.S.C. § 523(a)(8).
Id. at 1089.
On the other hand, in In re Pena, 155 F. 3d 1108 (9th Cir. 1998), the Ninth Circuit held that the debtors had satisfied the second prong:
Julie described her serious, ongoing mental disability which continues to prevent her from obtaining meaningful permanent employment. . . . The bankruptcy court did not clearly err in its conclusion that Julie has an ongoing disability which prevents her from being employed. . . . The bankruptcy court did not err in considering that Ernest’s income was not likely to increase as a result of his ITT education.
In re Pena, 155 F. 3d at 1114.
The difference between the holdings regarding the second Brunner prong in Rifino and Penais that Ms. Rifino had a bleak present, but a rosy future due to her employment prospects, whereas the Penas had a bleak present and a bleak future because Mrs. Pena was unemployable and Mr. Pena was only marginally employable. Thus, the key here is the debtor’s future employment prospects.
In sum, given that most people owing student debt pay on that debt for decades, in order to satisfy the second Brunner prong a debtor will have to satisfy the first Brunner prong and have little or no chance of improvement for many years to come. Therefore, this prong will typically be the most difficult to satisfy.
C. Good Faith Repayment Efforts
The Penas also satisfied the third prong, and were thus able to discharge the student debt. The Court contrasted their good faith repayments with those of the test’s eponym:
The debtors have made payments on the loans. After being laid off from Honeywell, the debtors were given a 90-day deferment, but then were unable to meet their obligations and filed chapter 7. These facts support the bankruptcy court’s finding of good faith. They are quite different from the facts found in Brunner. There, the debtor failed to establish good faith because she filed for discharge within a month of the date for the first payment of her loans came due, . . . made virtually no attempt to repay, [and never] requested a deferment of payment, a remedy open to those unable to pay because of prolonged unemployment.
Id. (Internal quotes omitted).
How many payments must be made, or for how long must they be made, before this third prong is satisfied is not entirely clear. It will undoubtedly be decided on a case-by-case basis.
III. The Partial discharge
Thus far we’ve considered an all or nothing proposition: discharge the entire student debt, or none of it. Suppose, however, that a debtor has a large student debt, and can reasonably make some payments, but not to the extent required to pay the entire debt. Can a portion of the debt be discharged in bankruptcy?
The Ninth Circuit said, yes, in In re Saxman, 325 F. 3d 1168, 1170 (9th Cir. 2003) (with emphasis added):
This case presents the question of whether an educational loan may be partially discharged consistent with 11 U.S.C. § 523(a)(8) of the Bankruptcy Code. We conclude that bankruptcy courts may partially discharge student debt pursuant to their equitable authority under 11 U.S.C. § 105(a).
Thus, if the debtor satisfies the Brunner test regarding the portion of the debt to be discharged, then the Bankruptcy Court can partially discharge the student loan.
This holding may provide some relief to debtors with gargantuan student debt, though doctor’s may have difficulty satisfying the second Brunner prong.
IV. A Sneaky Chapter 13 Student Loan Discharge
When discharging a debt that is of the kind not usually dischargeable, the debtor is supposed to obtain the discharge after successfully prosecuting a special kind of law suit called an adversary proceeding. However, one enterprising Chapter 13 debtor (actually it was his counsel) successfully discharged a student debt without an adversary proceeding.
In United Student Aid Funds, Inc. v. Espinosa, 130 S. Ct. 1367 (2010) the debtor included the student debt in his Chapter 13 plan as general unsecured debt. The plan proposed to pay the student debt at the same relatively low percentage as the other general unsecured debt, with the unpaid portion to be discharged upon plan completion.
The creditor received notice of, but did not object to, the plan, and failed to file an appeal after the Bankruptcy Court subsequently confirmed the plan. Years later the creditor initiated an action to have the order confirming the plan voided because the debtor had failed to prosecute the adversary proceeding.
The Supremes (sans Diana Ross) held:
Given the Code’s clear and self-executing requirement for an undue hardship determination, the Bankruptcy Court’s failure to find undue hardship before confirming Espinosa’s plan was a legal error. . . . But the order remains enforceable and binding on United because United had notice of the error and failed to object or timely appeal. United’s response—that it had no obligation to object to Espinosa’s plan until Espinosa served it with the summons and complaint the Bankruptcy Rules require . . . is unavailing. Rule 60(b)(4) does not provide a license for litigants to sleep on their rights. United had actual notice of the filing of Espinosa’s plan, its contents, and the Bankruptcy Court’s subsequent confirmation of the plan. In addition, United filed a proof of claim regarding Espinosa’s student loan debt, thereby submitting itself to the Bankruptcy Court’s jurisdiction with respect to that claim. . . . United therefore forfeited its arguments regarding the validity of service or the adequacy of the Bankruptcy Court’s procedures by failing to raise a timely objection in that court.
United Student Aid Funds, Inc. v. Espinosa, 130 S. Ct. at 1380.
How likely is it that anyone else will be able to pull an Espinosa-like student loan discharge? Not very. Lenders are undoubtedly aware of this case and will make a point of reviewing all of the Chapter 13 plans they receive. However, there is always the possibility that the lender’s employee tasked with reviewing the plan will be careless or incompetent. That said, any debtor’s attorney seeking to discharge student loans in any bankruptcy should file the adversary proceeding as a matter of course.