Student-loan Discharge - an Empirical Study of the Undue Hardship Provision of § 523(a)(8) Under Appellate Review

Publication year2013

Student-Loan Discharge - An Empirical Study of the Undue Hardship Provision of § 523(a)(8) Under Appellate Review

Ryan Freeman



Prior to the enactment of the Bankruptcy Code, student-loan debtors could receive an automatic discharge of their debts in bankruptcy. Now, they cannot. Since the Code's enactment, Congress has pursued progressively harsher standards, continually narrowing the scope of when a student-loan debtor could obtain discharge. Following the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act in 2005, student-loan debtors now encounter the toughest obstacles to discharge they have ever faced. By extending the protection of the discharge exception of 11 U.S.C. § 523(a)(8) to private lenders, Congress effectively placed all students who take out loans to pay for their education at the mercy of a harsh system whose narrow exceptions for discharge force debtors to prove that they face a "certainty of hopelessness" in their future.

The harshness of this system is well documented by empirical studies analyzing the results of bankruptcy courts applying the undue hardship provision in § 523(a)(8). These studies paint a portrait of inconsistency and subjectivity across the many judicial districts. Attempted application of the undefined term "undue hardship" has resulted in multiple judicially-created tests, the most predominant of which is the Brunner test, requiring a finding of non-dischargeability if the debtor fails any of the test's three prongs.

This Comment presents findings from an empirical study of ten years of bankruptcy appellate decisions dealing with the undue hardship provision, an area yet unexplored. Its findings reveal an enormous inequity in the treatment of debtors and creditors in these cases. These findings suggest a reconsideration of the current approach of the bankruptcy system toward student-loan debt and whether the judicially-created tests have narrowed this exception beyond what the Code intended. Furthermore, it recommends careful assessment for practitioners considering an appeal on behalf of a debtor of an unfavorable bankruptcy court decision.

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Thomas Edison once said of his electric light, "None of my inventions has cost me as much time, labor and study."1 When Edison developed his light bulb, the idea of electric light was nothing new. In fact, the idea had become prevalent in scientific communities more than seventy-five years prior to Edison's invention.2 The effects of electricity had been studied for years, but as the new age of science was ushered into being,3 Edison found purpose and commercial application in the harnessing of electric light through a long-lasting filament.4 He looked behind the veil of data and previous experiments and discovered a way to make light a practical option for millions across America. Speaking about his methods, Edison stated:

It has been said of me that my methods are empirical. That is true . . . . So, when I am after a chemical result that I have in mind I may make hundreds or thousands of experiments out of which there may be one that promises results in the right direction. This I follow up to its legitimate conclusion, discarding the others, and usually get what I am after. There is no doubt about this being empirical; but when it comes to problems of a mechanical nature, I want to tell you that all I've ever tacked and solved have been by hard, logical thinking.5

This response showed the time and effort it took Edison to really understand and apply his knowledge to craft an invention that would revolutionize the world.

The herculean effort Edison applied to the light bulb is not so different from what is required to fully understand the Bankruptcy Code ("Code") and its application by courts. Indeed, Edison's methods of empirical investigation and hard, logical thinking should be applied to study and decipher the effects of the Code's application. Much like electric light, many of the effects of the Code's application have already been studied and reported. Specifically, researchers and authors have produced significant data and results as it relates

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to how bankruptcy courts have applied the "undue hardship" provision from § 523(a)(8)'s exception to discharge.6 The challenge moving forward is to find, much like Edison, a way to use and expand on that data to provide practitioners and judges guidance and information that adds value to their decision-making processes in this area of the law. This Comment, through an empirical study of ten years of appellate decisions governing undue hardship determinations, seeks to pull back the veil and provide an analysis of those courts whose precedents have set the tone for student-loan discharge.

A look at recent news articles from around the United States reveals a predominantly negative perspective on the financial outlook of a student-loan debtor.7 Noting that student-loan debt has surpassed the $1 trillion mark, one writer for the Chicago Sun-Times speculated that "student loans are about to become a larger financial crisis than the mortgage disaster."8 However, this "sky is falling" perspective on student loans is nothing new. Since the Code's enactment in 1978, debtors have faced ever-tightening standards making student loans harder to discharge. Prior to the Code's enactment, student-loan debt could be discharged automatically like many other loans in the bankruptcy context.9 The Code imposed a new conditional discharge standard10 upon student-loan debt, theoretically targeting rampant abuse of the bankruptcy system. Legislators conjured images of college graduates freshly emerging from their universities with advanced degrees in hand and bright futures who might then seek to discharge their significant debt before accepting a high-

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paying job.11 Even in the face of a study proving the contrary, Congress enacted the new provision and has never looked back.12

An unfair debtor stereotype based on assumptions directly contradicted by empirical evidence13 was only the beginning of the difficulty faced by student-loan debtors under the new undue hardship standard.14 The Code does not define "undue hardship,"15 and the task has now fallen to the bankruptcy courts to determine how to apply this standard. In response, bankruptcy courts developed two predominant tests to assess whether a debtor's student-loan debt imposed an undue hardship: the totality of circumstances test and the three-factor Brunner test.16 Both tests analyze the same core considerations,17 and likewise, both suffer from the same maladies—inconsistency and subjectivity. The result is that these tests, which lean heavily on the court's ability to predict the future as to the debtor's potential future income or wage earning ability,18 have created a system with an unsettling amount of judicial discretion and subjectivity.19

Despite the broad-sweeping negative public outlook on student-loan debt, the prejudicial stereotype faced by student-loan debtors, and the inconsistency

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produced by judicially created tests, a 2009 study of 115 bankruptcy filings in the Western District of Washington indicated that 57% of those who filed adversary proceedings seeking discharge of their student loans were able to get some or all of their loans discharged.20 So, why does the negativity associated with attempting to discharge student loans persist? The same study further concluded that, even in light of the data showing that more than half of the debtors studied received discharge of at least some of their student-loan debt, the Code's undue hardship discharge provision has failed to optimize the financial health of debtors in distress.21 Furthermore, because the study found that courts relied more heavily on extralegal factors than legal factors to make relief determinations, it also asserted that the discharge determination process exhibited "hallmarks of a system that has run amok."22 Thus, even with some measureable degree of success for student-loan debtors in dire need of financial relief, the bankruptcy system remains plagued by an inconsistent message from the bankruptcy courts and, ultimately, Congress—anyone can receive educational loans, but it takes a very special person to discharge them.

This Comment will build on research that has documented the symptomatic problems that bankruptcy courts have had in applying the Code's undue hardship provision. Ultimately, this Comment aims to provide practitioners with new information about the approach appellate courts have taken when considering lower court determinations of undue hardship. To accomplish this goal, this Comment will present findings from an empirical analysis of ten years of bankruptcy appellate opinions spanning from January 1, 2002, to December 31, 2011.

This Comment is organized into four parts. Part I explains the background and development of law surrounding the application of the undue hardship

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provision. Part I.A discusses discharge in bankruptcy proceedings generally, the undue hardship discharge provision and the legislative history prior to its enactment, and the rapid expansion of the exception to discharge. Part I.B examines the two judicially-created tests that courts use to determine whether a debtor has met his or her undue hardship burden and the problems these tests present. Part I.C analyzes the procedural requirements of the undue hardship provision and how they comport with the Code's overarching principles concerning the scope of a debtor's opportunity for a fresh start.

Part II addresses the bankruptcy appellate system as a whole. Part II.A outlines the function of this Comment's study. Part II.B provides an overview of the unique structure of the bankruptcy appellate system. Part II.C delineates the appellate process. Finally, Part II.D...

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