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.