Chapter I. Effectuating the Fresh Start

• Jurisdiction: United States

I. Effectuating the Fresh Start

Discharge and Dischargeability

§ 1.01 Student Loans

(a) Bankruptcy Code Amendments.

(1) Section 523(a)(8) should except from discharge only student loans that

(A) were made, insured, or guaranteed by a governmental unit,

(B) were incurred for the debtor’s own education, and

(C) absent a showing of undue hardship, first became payable less than seven years before the bankruptcy case was filed, regardless of any suspension of payments.

(2) Section 507(a) should have a new, eleventh priority for claims excepted from discharge under § 523(a)(8).

(3) Section 1322(a) should allow the plan to provide for less than full payment of all amounts owed for a claim entitled to the student loan priority only if the plan provides that all of the debtor’s projected disposable income for a five-year period beginning on the date that the first payment is due under the plan will be applied to make payments under the plan.

(4) Section 1322(b)(10) should provide that it does not apply to priority unsecured debts.

(b) Promulgation and Interpretation of Regulations. Through regulations or interpretive guidance, the Department of Education should provide the following with respect to governmental student loans:

(1) Bright-line Rules. Creditors should not oppose discharge proceedings where the borrower meets any of a set of the criteria below. These criteria should be set out in federal guidelines that indicate household financial distress and therefore undue hardship:

(A) Disability-based guidelines. The borrower (i) is receiving disability benefits under the Social Security Act or (ii) has either a 100% disability rating or has a determination of individual unemployability under the disability compensation program of the Department of Veterans Affairs.

(B) Poverty-based guidelines.

(i) In the seven years before bankruptcy, the borrower’s household income averaged less than 175% of the federal poverty guidelines.

(ii) At the time of bankruptcy, the borrower’s household income is less than 200% of the federal poverty guidelines and (I) the borrower’s only source of income is from Social Security benefits or a retirement fund or (II) the borrower provides support for an elderly, chronically ill, or disabled household member or member of the borrower’s immediate family.

(2) Avoiding Unnecessary Costs. Creditors should accept from the borrower proof of undue hardship based on the above criteria without engaging in formal discovery.

(3) Alternative Payment Plans. Payment of the loans in bankruptcy should be effective (i) to satisfy any period of forgiveness or cancellation of the loans under an income-driven repayment plan, (ii) to rehabilitate a loan in default, and (iii) in chapter 13 cases, to prevent the imposition of collection costs and penalties.

(c) Best Interpretation of Current Law.

(1) Standard for Dischargeability.

(A) The three-factor Brunner test should be understood to require the debtor to establish only that

(i) the debtor cannot pay the student loan sought to be discharged according to its standard ten-year contractual schedule while maintaining a reasonable standard of living,

(ii) the debtor will not be able to pay the loan in full within its initial contractual payment period (ten years is the standard repayment period) during the balance of the contractual term, while maintaining a reasonable standard of living, and

(iii) the debtor has not acted in bad faith in failing to pay the loan prior to the bankruptcy filing.

(B) Standard of Proof. Each of these factors should be understood to require proof by a preponderance of the evidence.(C) Appellate Review. The determination of the bankruptcy court as to each of the factors should be recognized as a finding of fact subject to deference in appellate review and in the consideration of whether to appeal by the Department of Education, any guaranty agency, eligible lender, or holder of a federal student loan, and any agent of these parties.

(2) Treatment of Nondischargeable Student Loans in Chapter 13.

(A) Section 1322(b)(1) should be interpreted to allow separate classification and payment of nondischargeable student loans at a higher dividend than other general unsecured claims as long as the other unsecured claims are paid at least as much as is required under the best interest test of § 1325(a)(4), including cases where the best interest test would not require any payment.

(B) If precedent requires rejection of the recommendation in subparagraph (A) and a higher payment of nondischargeable student loans is held not to be generally available under § 1322(b)(1), courts should use the following best interpretations:

(i) If another person is liable for payment of a nondischargeable student loan, § 1322(b)(1) should be interpreted to allow a plan to provide for its payment at a higher rate than other general unsecured claims, as long as the other unsecured claims are paid at least as much as is required under the best interest test of § 1325(a)(4), including cases where the best interest test would not require any payment;

(ii) Section 1322(b)(5), providing for the cure and maintenance of long-term unsecured claims, should be interpreted to apply to student loans; and

(iii) Section 1322(b)(10), disallowing payment of interest on nondischargeable debts, should be interpreted as not applying to claims being treated under § 1322(b)(5).

Scope of the Problem. Student loan debt is one of the most significant economic problems facing the United States. According to Federal Reserve data, outstanding student loan debt has tripled since 2006, from under $500 billion to over $1.5 trillion today.¹ In 2003, both credit card and auto loan indebtedness were several times the amount of student loan debt, but now student loan debt greatly exceeds both.² Among all types of household debt, student loans have the highest delinquency rate.³ The most recent data show 10.9% of student loans as 90+ days delinquent,⁴ and various reports suggest that the true default rate is higher because government figures look only at defaults in the first three years after graduation.⁵

Student loan overindebtedness causes overall economic activity to decline and constrains the post-college options that students have. Academic studies have associated student debt with (1) lower earnings of college graduates,⁶ (2) lower levels of homeownership,⁷ (3) lower automobile purchases,⁸ (4) higher household financial distress,⁹ (5) lower probability of students choosing public-service careers,¹⁰ (6) poorer psychological functioning,¹¹ (7) delayed marriage,¹² and (8) lower probability of continuing education through graduate school.¹³ Student loan debt thus affects not only those who owe the loans but also has consequences that ripple through our communities and our nation.

History. Congress first excepted student loans from the bankruptcy discharge in the Education Amendments of 1976.¹⁴ A debtor in bankruptcy could discharge a student loan after five years had passed since the beginning of the repayment period, not counting any period during which repayment had been suspended. Before the end of the five-year period, a debtor could discharge a student loan only upon a showing of undue hardship to the debtor or the debtor’s dependents. To be excepted from the discharge, the student loan had to be (1) from certain financial institutions like a bank, a state agency, an institution of higher education, or a vocational school, and (2) insured by the federal government, a state government, or a nonprofit private institution. This amendment went into effect on September 30, 1977.¹⁵

When Congress enacted the Bankruptcy Code in 1978, section 523(a)(8) retained the basic rule that a student loan was freely dischargeable after five years and dischargeable before that time upon a showing of undue hardship.¹⁶ There were a few changes. The nondischargeability provision applied to any debt to a “governmental unit, or a nonprofit institution of higher education, for an educational loan.” Gone was the requirement that the loan be insured, although because at the time most every student loan was insured, the change made little practical difference. The Bankruptcy Code framed the undue-hardship standard as whether there was an undue hardship on the debtor and the debtor’s dependents, arguably a change from the previous rule that required a showing of undue hardship either as to the debtor or the debtor’s dependents. The Bankruptcy Code now measured the running of the five-year period as beginning when the student loan “first became due” and did not toll the running of the period during any time payment was suspended. Finally, and most importantly, student loans were dischargeable in chapter 13 through its “superdischarge” (presuming the loan was “provided for by the plan”).¹⁷

The next major legal development happened not through a legislative enactment but through decisional law. Marie Brunner graduated in 1982 with a master’s degree in social work and $9,000 in student loans. Less than a year later, she filed bankruptcy. The bankruptcy court allowed a discharge, finding undue hardship in Ms. Brunner’s “shaky finances and her unsuccessful efforts to find work following her graduation.”¹⁸ The Second Circuit rejected Ms. Brunner’s attempt to get an early discharge of her student debt. In doing so, the Second Circuit announced what has become the widely accepted Brunner test to define undue hardship:

(1) 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) 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) the debtor has made good faith efforts to repay the

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