Hope for the Hopeless: Discharging Student Loans in Bankruptcy

Publication year2015
Hope for the Hopeless: Discharging Student Loans in Bankruptcy
Vol. 84 J. Kan. Bar Assn 10, 25 (2015)
Kansas Bar Journal
December, 2015

November, 2015

Kurtis Wiard, J.

After spending years pursuing their juris doctor degree and often graduating with the commensurate student loan debt, attorneys can typically empathize with clients who are burdened with student loans. Bankruptcy attorneys, in particular, understand their clients' bleak prospects for discharging student loans all too well. One of the most oft-cited policies of the Bankruptcy Code (Code) is to provide honest but unfortunate debtors with a "fresh start" by eliminating or restructuring their debts.[1] But over the years, Congress has pieced together a long list of discharge exceptions.[2] While some- such as domestic support obligations[3] - reflect sound policy decisions, other exceptions are so highly detailed and narrow that they smack more of effective lobbying efforts.[4]

In the early 1970s, a few highly publicized cases where recent graduates filed for bankruptcy and discharged their student loans shortly before beginning lucrative careers prompted lawmakers to except certain student loans from discharge.[5] Several years later, a congressionally-established commission published a report confirming that-despite those isolated cases-there was never a rash of recent graduates who abused bankruptcy proceedings by unloading their student debts shortly after graduation.[6] Regardless, the damage was done, and the Code excepts most student loan debt from discharge unless doing so "would impose an undue hardship on the debtor and the debtor's dependents."[7] The courts, however, have struggled for nearly 40 years to determine what Congress intended when it drafted that phrase.

The topic of student loan dischargeability has gained recent import because of broader concerns regarding how the national student loan debt is affecting the economy and potentially hindering its recovery. In 2015, the total student loan debt ballooned to $1.2 trillion and the average student loan debt associated with obtaining a bachelor's degree exceeded $35,000.[8] Economists fear that student loans will have the same negative impact on the economy as did the housing bubble, and many experts question whether the risk of a college degree is worth the reward.[9] Since the 1970s and the subsequent narrowing of possibilities for student loan discharge, judges and legal commentators have criticized the Code's treatment of student loans.[10] The Code's rather unforgiving standard, combined with the crushing debt incurred by an increasing number of mostly young Americans, has given rise to the claim that it is effectively impossible for the vast majority of debtors to discharge their student loans. Admittedly the standard is high, but discharge is still possible for honest but unfortunate debtors who can demonstrate that there are reasonable and relevant factors outside their control.

The Dischargeability Standard

Currently, the Code excepts a debtor's student loan obligation from discharge unless doing so would impose an "undue hardship on the debtor and the debtor's dependents."[11] The obligation also extends to any cosigners.[12] Before 1976, the Bankruptcy Code treated student loans like all other unsecured debt, permitting debtors to regularly discharge them along with their credit card debt.[13] Initially, debtors only had to demonstrate an undue hardship if the debt had first become due within five years of filing a petition for relief.[14] In 1990, the waiting period was extended to seven years, but Congress abolished the waiting period altogether in 1998.[15] In a similar vein, Congress originally excepted only government-backed loans from discharge, thereby permitting debtors to discharge their private student loans. But in 1984, Congress added various private student loans to the discharge exception.[16] Essentially, all qualified student loans today are subject to the undue hardship standard.

Although Congress has limited the situations in which debtors can discharge their student loans over the past 40 years, it has not seen fit to better define what it meant by the vague concept of "undue hardship." That has left to the courts the difficult task of fashioning the most equitable test.[17] The Johnson test, one of the earliest standards, required courts to ask highly subjective questions, such as whether the debtor had been negligent or irresponsible in maximizing income, minimizing expenses, and searching for employment as well as whether the education financially benefitted the debtor.[18] Many later courts opted for the Bryant poverty test, which simply granted a discharge if the debtor lived at or below the federal poverty line.[19] Currently courts use two different tests: the totality of the circumstances test and the Brunner test.[20]

In 1987, the Southern District of New York created the more widely accepted test in Brunner v. New York State Higher Education Services Corp. {In re Brunner).[21] Under the Brunner test, debtors must prove three elements to discharge their student loan debt: (1) they cannot currently make payments on the loan while also maintaining a minimal standard of living for themselves and their dependents; (2) the hardship will likely continue for a significant portion of the loan's repayment period; and (3) the debtors have attempted to repay the loan in good faith.[22] Nine circuits, including the Tenth Circuit, have adopted the Brunner test.[23]

But the test's wide acceptance is deceiving because there are significant disagreements between the circuit courts on how to apply the Brunner test. For instance, a district court in the Eleventh Circuit chastised a bankruptcy court for incorporating the Tenth Circuit's version of the Brunner test and applying Brunner "in a manner that will promote the Bankruptcy Code's 'fresh start' principle," stating that the approach "stands in stark contrast to the position taken by the Eleventh Circuit" that found no Congressional intent to rely on the "fresh start" principle to create an exception to the undue hardship requirement.[24] Therefore, it is important for debtors' attorneys to focus on decisions from their circuit and district when it comes to applying the Brunner test.

The Tenth Circuit adopted the Brunner test in Educational Credit Management Corp. v. Polleys (In re Polleys).[25] In Polleys, a 45-year-old single mother filed an adversary proceeding in her bankruptcy, asking the bankruptcy court to discharge nearly $51,000 in student loans she accrued while obtaining an accounting degree.[26] The debtor, however, was unable to maintain steady employment as an accountant. She claimed that her employer laid her off upon learning that she was taking antidepressant medication.[27] In fact, the debtor demonstrated a history of mental illness: she suffered from cyclothymic disorder, was prescribed antidepressant medication, had once been involuntarily committed, and had once attempted to commit suicide.[28]

Before adopting the Brunner test, the court in Polleys rejected the totality of the circumstances test, reasoning that considering all of the facts of a case "has an unfortunate tendency to generate lists of factors that [. . .] grow ever longer as the case law develops."[29] Rather, the court opted for the Brunner test and instructed courts to begin with the first element-which focuses on the debtor's current ability to make payments on the loan and maintain a minimal standard of living-because such information is "concrete and readily obtainable."[30]

Regarding the second element-which centers on additional circumstances indicating that the debtor's current financial condition is likely to persist for a significant portion of the repayment period-the Polleys court notably distinguished itself from the Second Circuit's approach. It stated that lower courts need not demonstrate a "certainty of hopelessness" but that they should instead take a "realistic look" into a debtor's circumstances and base their estimation on specific, articulable facts rather than "unfounded optimism."[31] Lastly, under the good faith portion of the test, the Polleys court warned lower courts not to confuse the element with an opportunity to impress their own views on a debtor's past decisions.[32]

Ultimately, the panel found that Polleys' debt was dischargeable primarily because of her extensive emotional health issues that made it difficult for her to maintain steady employment.[33] Significantly, the court was not concerned that the debtor had never made a payment on her student loans because there was evidence that she consolidated the loan, entered into deferral programs, and tried to negotiate with the student loan creditors before filing for bankruptcy[34] In sum, the Polleys court was well aware of Brunner s criticism, so it went to great lengths to instruct lower courts on how to equitably apply the test.

Meeting the Undue Hardship Standard in Kansas

From a client's perspective, convincing a bankruptcy court to discharge student loans can feel like a demeaning process.[35] Adding insult to injury, those who most need to discharge their student loans can rarely afford the expense to litigate the matter in a separate adversary proceeding.[36]From a legal perspective, convincing a court to discharge a debtor's student loans is a similarly daunting task, albeit less humiliating. The silver lining may be, however, that by virtue of the circumstances leading to bankruptcy, most debtors can satisfy the first element of the Brunner test. As such, case law in the District of Kansas regarding the second and third elements is the most important to practicing attorneys. In meeting those standards, the case law speaks most to two factors: a debtor's late age and mental health. While mental health is a salient factor in meeting the Brunner test, a debtor's late age, standing...

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