An Empirical Assessment of Student Loan Discharges and the Undue Hardship Standard

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Every week, it seems, newspapers publish profiles of recent graduates who cannot afford to pay back their loans.1 Given the sheer amount of outstanding federal and private student loan debt ($1 trillion)2 and the high tenyear default rate (10%),3 these profiles are representative of a substantial number of graduates. The recent recession has only further exacerbated the problem.

Generally, one solution to insurmountable debts is to declare bankruptcy. However, student loans cannot be discharged through normal bankruptcy proceedings.4 Instead, Congress requires debtors to file an adversary proceeding.5 During the adversary proceeding, debtors have the additional burden of proving that repaying their student loans would constitute an "undue hardship."n More specifically, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 states that a bankruptcy proceeding "does not discharge an individual debtor from any [educational] debt . . . unless excepting such debt from discharge under this paragraph would impose an undue hardship on the debtor and the debtor's dependents."7 Because Congress failed to define "undue hardship," courts have been forced to provide their own interpretations.8

Although judges devised numerous tests,9 in recent years, the Brunner standard has come to dominate the field. This test, first set forth in Brunner v. New York State Higher Education Services Corp.,10 requires the debtor to establish the following three elements:

(1) that the debtor cannot maintain, based on current income and expenses, a ""minimal" standard of living for herself and her 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.11

Detailed treatment of these provisions can be found elsewhere.12 For present purposes, the reader need only know that the three prongs require the debtor to show (1) a current inability to repay the loans, (2) a future inability to repay the loans, and (3) a good faith effort to repay the loans.13 When interpreting these elements, many courts have held that the debtor must have more than "temporary financial adversity," but the situation need not be one of "utter hopelessness."14

The Brunner test has been officially adopted in nine circuits.15 The two holdouts are the First and Eighth Circuits. Whereas the Eighth Circuit employs a more holistic totality of the circumstances test,16 the First Circuit has not settled the issue, thus allowing lower courts to use either approach.17 Although the tests are doctrinally quite distinct, my analyses did not find any statistically significant differences between outcomes in Brunner circuits and the Eighth Circuit. Identical debtors filing in a Brunner circuit and a totality of the circumstances circuit should expect similar outcomes.18 For this reason, the article will focus its discussion on the Brunner standard.

In the legal literature, scholars have devoted substantial time to arguing both the merits of the Brunner test and Congress' decision to impose the undue hardship standard on student loans.19 Nearly all authors agree that the undue hardship requirement is both unduly burdensome and inconsis' tently applied.20 Instead of rehashing these debates via normative arguments, this paper uses quantitative analysis to determine whether the undue hardship standard warrants such harsh criticism. To date, this area has been largely unexplored. In the past few years, Rafael Pardo and Michelle Lacey have conducted the most extensive empirical work on student loan discharges.21

In their first empirical study of student loan discharge, Pardo and Lacey examined published court opinions22 and found three statistically significant differences between debtors who received discharges and those who did not. Successful debtors (1) had lower monthly incomes, (2) had lower monthly expenses, and (3) were more likely to have a medical problem or have a dependent with a medical problem.23 Given the few dissimilarities between successful and unsuccessful discharge seekers, they concluded that the undue hardship standard is applied inconsistently and is largely based on a judge's personal sentiments.24 Unfortunately, because judges choose not to publish opinions for most adversary proceedings, this study's generalizability is rather limited.25 Indeed, for more than ninety percent of the proceedings in my sample, judges declined to publish a court opinion.

In a more recent piece, Pardo and Lacey examined student loan discharges in the Western District of Washington.26 Seeking to fill some gaps in their original study, they looked beyond published opinions, this time relying on filings in adversary proceedings. Because that method is not limited to judicial opinions, it yields a sample that is more representative of the population of student loan debtors who sought discharges. However, the results are only generalizable to the extent that this single district is representative of the nation as a whole.27 In that study, Pardo and Lacey found that discharge decisions largely depend upon which judge rules on a given case. Additionally, they found that debtors with "highly experienced" attorneys were more likely to obtain discharges. The influence of these nondoctrinal case characteristics on discharge outcomes led Pardo and Lacey to conclude that financial hardship is a less important factor than it should be.28

My study expands upon prior research in several respects. First, I draw my data from a nationwide sample of adversary proceedings. This broader geographic scope means that my results are more generalizable. In addition, this method allowed me to determine how frequently people in bankruptcy actually attempt to discharge their student loans. The answer was surprising: barely 0.1 percent of student loan debtors in bankruptcy sought to discharge their educational debts. This figure illustrates the central flaw in the system: 99.9 percent of bankrupt student loan debtors do not even try to discharge their student loans.

Second, I include all adversary proceeding outcomes in my study. Existing research has been limited to cases that were either settled or reached a trial verdict.29 However, because default judgments and dismissals occur nearly as often as settlements and trial verdicts, omitting these alternative outcomes leaves the researcher with an incomplete view of student loan discharge.30 After all, someone whose case was dismissed received just as little relief as a person who lost at trial. Likewise, a default judgment provides the same amount of relief as a trial victory. In fact, it is even better for debtors because they do not have to spend time litigating the dispute.

This article's third contribution is that it compares the financial and demographic characteristics of discharge seekers with those of non-discharge seekers. Throughout this paper, I refer to those debtors who filed an adversary proceeding with the hope of discharging their student loan debt as "discharge seekers." Likewise, I use "non-discharge seekers" to signify the debtors who filed for bankruptcy but did not seek to discharge their student loans.

The comparison between these two groups reveals that tens of thousands of non-discharge seekers are as bad off financially as the typical discharge seeker. This suggests that many more debtors could obtain relief if they filed an adversary proceeding to request a discharge. Instead of arguing about the burdensome nature of the undue hardship standard, academics, policymakers, journalists, and consumer advocates alike should encourage more non-discharge seekers to file adversary proceedings to discharge their student loans.

My study's final contribution is its examination of whether differences exist among three broad groups of discharge-seeking debtors: those who received (1) no discharges, (2) partial discharges, or (3) full discharges. Previous research used much finer distinctions and was, therefore, unable to find much consistency in decisions. By examining coarser gradients, I make it easier to determine whether any financial or demographic characteristics are truly predictive of receipt of a discharge. I chose the three aforementioned groupings because they closely align with a judge's decision-making process. When ruling on a student loan case, judges must generally decide whether the debtor should receive any relief, and if so, whether the debtor should get a full or partial discharge.31

Given the small sample size available, it is difficult to find meaningful differences between debtors who received similar amounts of relief. After all, even the most eloquent judge would find it hard to articulate precisely why there were minor differences in discharge percentages between two debtors. Admittedly, having a sufficiently large sample size would resolve this problem. Unfortunately, there are simply not enough student loan discharges to iron out that issue. Prior to my research, the most comprehensive study examined just 46 cases.32 Even at 207 cases, my sample size is too small for a regression to detect fine-grade differences in discharge outcomes.

However, by using the three groups identified above, my regressions do identify three variables that are predictive of discharge: (1) whether the debtor has a medical hardship, (2) whether the debtor is employed, and (3) the debtor's income the year before filing bankruptcy. These variables match the first two prongs of the Brunner test quite closely33 and show that there is some degree of consistency in the judicial decisions. Debtors in bad economic positions are more likely to get relief. This finding of judicial consistency bolsters my argument that the major flaw in the system is not inconsistent application of the undue hardship standard, but rather the fact that...

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