Student Loans

Last week, I came across an article in the Washington Examiner while I was riding the metro to work. This article noted that residents of Maryland carry more student loan debt than any other state in the country at $33,087. Virginia ranked sixth at $30,855. The average is $29,088. Compared to the debt load I will be carrying due to law school, these numbers actually seem rather modest to me, but they still go to show that student loan debt is on the rise, especially in this geographic region. I try to put my thoughts of future student loan payments at ease by reminding myself that I am getting a degree in a (hopefully) lucrative field, but it is not only law students who are racking up substantial amounts of student debt. The debt, of course, can get crippling for young graduates. In connection with this, I have heard many espouse the false statement that student loans cannot be discharged in bankruptcy. The statement is false for its overbreadth; while student loans generally cannot be discharged in bankruptcy, the Bankruptcy Code does contain an exception in certain situations.

To explore this, I ask that you open up your copy of the Bankruptcy Code to section 523(a)(8). It reads:

“A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt — unless excepting such debt from discharge under this paragraph would impose an undue hardship on the debtor and the debtor’s dependents, for — an educational benefit overpayment or loan made, insured, or guaranteed by a governmental unit, or made under any program funded in whole or in part by a governmental unit or nonprofit institution; or an obligation to repay funds received as an educational benefit, scholarship, or stipend; or any other educational loan that is a qualified education loan, as defined in section 221(d)(1) of the Internal Revenue Code of 1986, incurred by a debtor who is an individual.”

So what does this mean? Probably the two most important words in that paragraph are “undue hardship.” It’s the key to this whole thing. The Bankruptcy Code does allow individuals to discharge their student loan debt; they just have to prove that they have an undue hardship.

What does undue hardship mean? First, I’ll tell you what it does not mean. I recall once hearing a former Bankruptcy Judge discuss an individual who attempted to have his student loans discharged in a case before him. This individual was a dentist. When said Judge asked him why a man with a good job and (presumably) good earnings would have an undue hardship in paying his student loans back, he responded that it was too difficult to balance paying off his student loans with the payments for his new expense sports car (I think it was a Porsche).

The judge did not consider this to be an undue hardship.

I should mention before I go further that I was inspired to write this blog in part because of an excellent podcast I recently listened at the American Bankruptcy Institute’s website (www.abiworld.org). I recommend that you check it out. Said podcast discussed the different tests that the Circuits use to determine what constitutes undue hardship. Since I suspect that most people reading this live within the Fourth Circuit (Virginia, Maryland, West Virginia, North Carolina, and South Carolina), I’ll discuss that rule first, which also happens to be the majority rule in the United States. The Fourth Circuit, like most other Circuits, has adopted the rule from the 1987 case of Brunner v. New York State Higher Education Services Corp., decided in 1987. Brunner contains a three-prong test to determine whether a debtor in bankruptcy meets the test for undue hardship:

(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 had made good faith efforts to repay the loans.”

Under Brunner, a debtor must satisfy all three of those qualifications in order to qualify for undue hardship. There are some additional factors that courts use in making these determinations; for example, did the debtor successfully graduate from her program, or does she simply have looming loans from four years’ worth of college and no degree? Can the debtor pay back at least a portion of the loans? What are the debtor’s career prospects and earning potential?

Not all courts have used this test, though. The Eighth Circuit (Arkansas, Iowa, Minnesota, Missouri, Nebraska, North Dakota, and South Dakota) instead uses a totality of the circumstances test to determine whether a debtor would have an undue hardship in paying off educational loans, which is obviously a less strict test than the majority of courts use.

For whatever reason, a good portion of the population seems to believe that there is no way that student loans can be discharged in bankruptcy, but 523(a)(8) and cases modeled after Brunner clearly state the contrary. Interestingly, before the current Bankruptcy Code was passed in 1978, there was no bankruptcy statute which limited the ability to discharge student loans. Don’t be mistaken though: although it is indeed possible to discharge student loans in bankruptcy, it is by no means an easy thing to do. Debtors who plan on attempting to do so would be ill-advised to buy expensive automobiles beforehand – remember, Brunner talks about a minimal standard of living.

Restrictive as it may be, I agree with the participants from ABI’s podcast – it is a good thing that some form of discharge from student loans exists under the Bankruptcy Code. A test such as the one used in the Eighth Circuit would no doubt be more useful to the debtor in bankruptcy, but in the current economy, some form of discharge for student loans is essential. By this, I am speaking in part about the new wave of for-profit universities which do just at their name indicates – try to make a profit, which is necessarily at the expense of the students. Unfortunately, these students all too often find themselves in tremendous debt, with degrees in areas which are not overly marketable in the first place, and even less so in an economy with an 8.1% unemployment rate.

Please let me know what you think. I hope I was thorough enough to give a clear understanding as to how the undue hardship exception works. Next week, I’ll be writing about the ability to discharge medical malpractice debts, based largely off the Supreme Court’s 1998 decision of Kawaauhau v. Green. I promise I will talk about things besides discharge after that. Thanks for reading.

J.P.

Introduction

Thanks for taking the time to check out a blog whose topic probably seems boring and depressing to a lot of people. My goal here is to show that bankruptcy can actually be very practical and interesting, and for many people it instills a sense of relief, rather than depression.

Just to make it clear, I am an individual, not a bank. I am also a law student, in the summer before my 3L year at the Catholic University of America's Columbus School of Law in Washington, D.C. Unfortunately, I seem to be among the minority of students who have an interest in the topic of bankruptcy, but I have truly come to enjoy it as an academic and career interest; the other area of law in which I have substantial interest is the often-related field of tax law. 

My goal is to make this blog relatively devoid of legalese, and accessible to those without a knowledge of bankruptcy specifically, or law generally. The blog will not be carefully cited with footnotes throughout. I want to expose people generally to relevant, practical, and current topics having to do with bankruptcy, and show that it is worth the time to read about. Do I expect that many people will read this? Probably not. But at least I can try.

For those who do read this though, please keep in mind what I wrote above: I am a law student. I am not an attorney. Please do not substitute my writings for consultation with an attorney, which is a highly-advised course of action in the often complicated world of bankruptcy. I make no warranties as to the accuracy or completeness of the information provided, and no attorney-client or other relationship is being created, and I do not have the intent to plagiarize any information.  

With that being said, there are some very basic bankruptcy concepts that should be useful as you are reading. With only a few exceptions (such as determining state property law for exemptions from a bankruptcy estate), Bankruptcy Law is federal law. Article I, Section 8 of the Constitution lists the power of Congress to make "uniform Laws on the subject of Bankruptcies throughout the United States," as an enumerated power. The Bankruptcy Code is Title 11 of the United States Code, and contains several different Chapters; people often ask me what the different Chapters mean, often enough in fact that that is probably the most common aspect of bankruptcy law about which I am asked. 

Chapters 1, 3 and 5 are not mentioned in daily conversation as much as some of the latter Chapters, but they contain general information, instructions on case administration, and information on some of the parties to a bankruptcy case: the creditors and the debtor (the bankrupt person). Though it is difficult to pick out only a couple fundamental terms, I should mention that at the moment a debtor files for bankruptcy, all of his or her nonexempt property becomes part of a bankruptcy "estate," and an automatic stay is in place - creditors are instantly prohibited from attempting to collect on their debts. 

Chapter 7 is liquidation. This applies to both individuals and business entities. A business entity may end its operations, or an individual debtor may have the assets in his estate sold off to satisfy part of the debt owed to his or her creditors. It is, by far, the commonest form of bankruptcy.

Chapter 9 is municipal bankruptcy. I must confess that it is an area in which I know little, as it was not heavily discussed in my bankruptcy class, and I have not encountered it in my independent studying.

Chapter 11 is the form of bankruptcy that likely gets the most media attention - reorganization. This is often discussed in conjunction with the bankruptcies of major corporations (General Motors), and lately with several different Roman Catholic Dioceses. It can also be used by individuals, though - Mike Tyson filed for Chapter 11 in 2003. Here, I should mention that some people have come to me with the notion that all people who file for bankruptcy are "poor." This is not necessarily true; it just means that they are insolvent. Basically, this means one of two things: either their liabilities exceed their assets, or they are unable to pay their debts as they come due.

Chapter 12 is a relatively new Chapter which provides for debt adjustments for family farmers and family fisherman. It was made permanent in 2005 by the ultra-important Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). 

Chapter 13 provides for debt adjustment for individuals with regular income. It is not open to business entities. It is meant to be attractive to individuals in that a Chapter 13 debtor will get to keep her assets (her home, in particular), and will pay a portion of the debt off to her creditors over either a three- or five-year period, depending on the circumstances. BAPCPA further provides a "means test," in which debtors with a certain amount of income will be barred from proceeding under Chapter 7, and will instead have to use Chapter 13. The Bankruptcy Code has a preference for Chapter 13.

Chapter 15 is for cross-border cases. This is another area not covered at length in my bankruptcy class, but one I am studying independently at the moment. It is modeled after the United Nations Commission on International Trade Law (UNCITRAL) of 1997.

With the (very) basics out of the way, I plan on adding a new blog entry on a weekly basis. Those entries will, of course, have more specified topics than the current one. Next week I plan on writing about the ability to discharge student loan debt in bankruptcy, in which I hope many will take an interest. I was inspired about that topic because of a recent podcast I listened to from the American Bankruptcy Institute. 

So until next week (or whenever I decide to write again), thanks for reading, and please come back for more insolvency enlightenment!

J.P. Morgan