Time for a Fresh Look at the 'Undue Hardship' Bankruptcy Standard for Student Debtors

• Author: G. Michael Bedinger VI
• Position: J.D. Candidate, The University of Iowa College of Law, 2014; B.A., The University of North Carolina at Chapel Hill, 2010
• Pages: 1817-1839

Time for a Fresh Look at the “Undue Hardship” Bankruptcy Standard for Student Debtors G. Michael Bedinger VI  ABSTRACT: In 1978, Congress enacted 11 U.S.C. § 523(a)(8), thereby restricting the availability of student-loan discharge for student debtors. The statute required a student debtor to establish that repaying the loan would cause “undue hardship” in order for a court to grant discharge. “Undue hardship” lacked a definition in § 523(a)(8), however, and courts derived a number of different tests to measure a debtor’s inability to make future loan payments. Circuits were split over two tests: the Brunner test and the totality test. Additionally, regardless of which test a court applied, some courts required the debtor to prove a “certainty of hopelessness” for any future loan repayment. This Note examines different circuits’ approaches to the “undue hardship” determination and advocates for a congressional solution that would codify the Eighth Circuit’s totality test and create a partial discharge provision for debtors who have met the “undue hardship” requirement. The Note argues, in the absence of congressional action, courts should interpret “undue hardship” in a fashion consistent with this Note’s proposed amendments to § 523(a)(8). Alternatively, courts should look to Congress’s definition of “undue hardship” in 11 U.S.C. § 524(m) to provide a basis for interpreting § 523(a)(8). These solutions would provide more clarity to the “undue hardship” standard in changing economic and social times while respecting Congress’s intent and the “fresh start” purpose of the Bankruptcy Code.  J.D. Candidate, The University of Iowa College of Law, 2014; B.A., The University of North Carolina at Chapel Hill, 2010. I would like to thank the dedicated editors and writers of Volumes 98 and 99 of the Iowa Law Review for their creativity and support. 1818 IOWA LAW REVIEW [Vol. 99:1817 I. INTRODUCTION .................................................................................... 1819 II. EVOLUTION OF 11 U.S.C. § 523(A)(8) ............................................... 1819 A. L EGISLATIVE H ISTORY : E XCEPTIONS TO THE D ISCHARGE OF E DUCATIONAL L OANS ..................................................................... 1820 B. T HE C OURT ’ S R OLE : W HAT IS “U NDUE H ARDSHIP ”? ........................ 1821 1. The Majority Approach: The Brunner Test ......................... 1823 2. The Minority Approach: The Totality Test ........................ 1824 3. Two Diverging Tests Find Common Ground: A “Certainty of Hopelessness” ............................................. 1825 C. T HE T IME I S R IPE FOR A R E -E XAMINATION OF THE “U NDUE H ARDSHIP ” A NALYSIS ..................................................................... 1826 III. TOTALITY TEST: CERTAINLY A BETTER CHOICE THAN B RUNNER , BUT STILL HOPELESS ................................................................................... 1828 A. W HY D O A M AJORITY OF C OURTS F OLLOW THE BRUNNER T EST ? ..... 1829 B. T HE T OTALITY T EST ’ S P OTENTIAL D OWNFALLS ............................... 1831 C. A C ERTAINTY OF H OPELESSNESS : A RE T HERE N O P RISONS ? N O W ORKHOUSES ? ......................................................................... 1833 IV. POTENTIAL SOLUTIONS ....................................................................... 1835 A. C ONGRESSIONAL S OLUTION ............................................................ 1836 B. J UDICIAL S OLUTION ........................................................................ 1838 V. CONCLUSION ....................................................................................... 1839 2014] TIME FOR A FRESH LOOK 1819 I. INTRODUCTION Congress passed 11 U.S.C. § 523(a)(8) in 1978 to make the discharge of educational loan debt more difficult for student debtors. 1 The language of the statute required that loan payments impose an “undue hardship” on a debtor or a debtor’s dependents before a court could grant a discharge. 2 Congress did not define “undue hardship” in § 523(a)(8), however, and courts created numerous tests to apply this standard. 3 Some courts have required that a debtor exhibit a “certainty of hopelessness” of ever repaying the loan before the court will offer a discharge. 4 This Note examines the repercussions of a court applying either the Brunner test or the totality test to the “undue hardship” requirement and the effects of the “certainty of hopelessness” standard. Part II discusses the history of § 523(a)(8), the various standards courts use to apply the statute’s “undue hardship” test, and the reasons why it is crucial that Congress and the courts re-examine the statute without delay. Part III addresses the benefits of applying the totality test instead of the Brunner test and the dangerous nature of the “certainty of hopelessness” requirement. Part IV then proposes both congressional and judicial solutions to clarify the ambiguity of § 523(a)(8)’s “undue hardship” test and offers a model statute to remedy current issues. II. EVOLUTION OF 11 U.S.C. § 523(A)(8) In 1978, Congress enacted § 523(a)(8) with the intention of making the discharge of educational loans difficult for student debtors. 5 Originally, Congress allowed two opportunities for a student debtor to discharge student debt through bankruptcy: after five years of repayment or upon a showing that the debt posed an “undue hardship” on the debtor. 6 However, Congress left “undue hardship” undefined in the context of § 523(a)(8), leaving courts to devise their own interpretations. Two primary tests emerged in different circuits—the Brunner test and the totality test—each of which relies upon separate factors to determine whether an “undue hardship” exists. 7 Some courts, applying either of the two tests, imposed an 1. 11 U.S.C. § 523(a)(8) (1978). 2 . Id. 3. See Long v. Educ. Credit Mgmt. Corp. ( In re Long), 322 F.3d 549, 554 (8th Cir. 2003) (citing Andrews v. S.D. Student Loan Assistance Corp. ( In re Andrews), 661 F.2d 702, 704 (8th Cir. 2003)) (confirming application of the totality test); Brunner v. N.Y. State Higher Educ. Servs. Corp., 831 F.2d 395, 396 (2d Cir. 1987) (establishing the Brunner test). 4. Barrett v. Educ. Credit Mgmt. Corp. ( In re Barrett), 487 F.3d 353, 359 (6th Cir. 2007); Mulherin v. Sallie Mae Servicing Corp. ( In re Mulherin), 297 B.R. 559, 564 (Bankr. N.D. Iowa 2003). 5. Cline v. Ill. Student Loan Assistance Ass’n ( In re Cline), 248 B.R. 347, 351 (B.A.P. 8th Cir. 2000) (Schermer, J., dissenting). 6. 11 U.S.C. § 523(a)(8). 7. See supra cases cited note 3. 1820 IOWA LAW REVIEW [Vol. 99:1817 additional, harsher requirement that student debtors exhibit a “certainty of hopelessness” of repaying their debt before a court could find an “undue hardship” and discharge the loan. 8 Subsequently, in 1998, Congress removed the provision allowing discharge after a certain number of years, leaving the showing of “undue hardship” as a student debtor’s only possibility of relief. 9 The judicially created Brunner test, totality test, and “certainty of hopelessness” requirement, however, have remained unchanged despite the evolving nature of the statute. These three standards, crafted by courts for use in a twentieth-century world under a twentieth-century statute, require immediate attention in the wake of the 2008 economic recession that significantly altered the United States’ economic and social circumstances. Subpart A discusses the legislative history of § 523(a)(8), and Subpart B outlines the emergence of the Brunner test, the totality test, and the certainty of hopelessness standard. Subpart C then places the “undue hardship” inquiry in the larger economic context of the post-2008 student debtor. A. L EGISLATIVE H ISTORY : E XCEPTIONS TO THE D ISCHARGE OF E DUCATIONAL L OANS In 1973, reports of “deadbeat” dropouts and graduates trying to shirk their federal loan payments prompted the Federal Department of Health, Education, and Welfare to approach the Congressional Committee on Bankruptcy Laws. 10 To protect the federal loan system, the Department encouraged the Congressional Committee to pass legislation making it more difficult for debtors to discharge federal educational loans through bankruptcy. 11 In response, Congress amended the Federal Higher Education Act in 1976 to prohibit a debtor from discharging a federal educational loan during the first five years of repayment unless the debtor could establish that the loan imposed an “undue hardship” on the debtor or the debtor’s dependents. 12 In other words, after five years, a court would not require a debtor to show “undue hardship” to discharge an educational debt. In 1990, Congress extended the five-year period to seven years, 13 and in 1998, 8. See infra Part II.B.3. 9. Higher Education Amendments of 1998, Pub. L. No. 105-244, 112 Stat. 1581. 10. 51 CAUSES OF ACTION 2D 512 (2012) (“It was thought that an unfavorable public image might discredit and threaten the newly formed student loan system.”). But see Rafael I. Pardo & Michelle R. Lacey, The Real Student-Loan Scandal: Undue Hardship Discharge Litigation , 83 AM. BANKR. L.J. 179, 181 (2009) (“Tragically, Congress disregarded empirical evidence from a General Accounting Office study which found that less than one percent of all federally insured and guaranteed student loans were discharged in bankruptcy.”). 11. CAUSES OF ACTION 2D, supra note 10, at 512. 12. 11 U.S.C. § 523(a)(8) (1978); BANKRUPTCY LAW MANUAL § 8:13 (2013) (citing 20 U.S.C. § 1087-3 (1976)). 13. CAUSES OF ACTION 2D, supra note 10, at 512; BANKRUPTCY LAW MANUAL, supra note 12, § 8:13 (“Subsequent amendments relentlessly expanded the coverage of this exception to discharge.”). 2014] TIME FOR A FRESH LOOK 1821 Congress completely abolished the amendments that allowed discharge without a showing of “undue hardship” after a prescribed number of years. 14 Consequently, all educational loans are currently excepted from...