Treatment of Student Loans in Bankruptcy

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Student loans are a leading type of debt among Americans.  It is no secret that the cost of higher education in America has been on a sharp rise in recent years, and as a result, the amount a student may borrow for his or her undergraduate college education can easily exceed $100,000, and if the student pursues graduate school, that amount can be much higher.  With the rising cost of tuition, many economists predict that student loans will be the next big credit bubble to burst as many borrowers will simply not be able to repay their large student loan debt.  As a result, many student loan borrowers may look to file bankruptcy for relief from their debt.

Student loans are addressed in Section 523 of the United States Bankruptcy Code.  Under Section 523(8), student loan debt is generally excepted from a debtor's discharge.  In other words, even if an individual files for bankruptcy and receives a discharge, they will still be liable for their student loan when their bankruptcy case is over unless they receive a specific discharge for the student loan debt.  In order for a bankruptcy debtor to receive a discharge of their student loan debt, they must affirmatively show that they would suffer an "undue hardship" if the debt is not discharged.

The term "undue hardship" is not defined in the United States Bankruptcy Code, but it has been examined and discussed by many bankruptcy courts.  Bankruptcy courts commonly use a test known as the Brunner test[1] to evaluate undue hardship.  Under the Brunner test, a debtor must meet the following conditions for a hardship discharge:

1)  The debtor cannot maintain a minimal standard of living for himself (and dependents) if required to repay the student loan;

2)  Additional circumstances exist such that the debtor's state of affairs is not likely to improve during the repayment period; and

3)  The debtor made good faith efforts to repay the loan.

With respect to the first condition, the bankruptcy court will review the debtor's current financial condition, including income, expenses, and whether he will be able to maintain a minimal standard of living if required to repay the student loan debt.  For example, a bankruptcy court would likely deem this condition satisfied if a debtor could show that he is unable to pay essential and reasonable expenses such as rent, food, and transportation if required to repay the student loan debt.

With respect to the second condition, the bankruptcy court will review the debtor's current state of affairs and whether the inability to make payments on the student loan will continue for a significant portion of the repayment period.  For example, a bankruptcy court would likely deem this element satisfied if a debtor can show some that there is no foreseeable chance that he can obtain a higher paying job in the future.  In analyzing this condition, a bankruptcy court would also take into consideration a debtor's medical condition or other disability that would prevent him from improving his financial condition.

Under the final condition of the Brunner test, a debtor must show that he made good faith efforts to repay the loan.  Under this portion of the analysis, courts routinely analyze the efforts made by the debtor to find a higher paying job, minimize expenses, and generally repay the loan.

Additionally, it is important to note that certain jurisdictions will allow a partial discharge of student loan debt.  In other words, a court may allow a debtor to discharge a certain percentage of his student loan debt; however, all elements of the Brunner test must still be satisfied.

Lastly, the proper procedure to determine whether student loan debt may be discharged is to file an adversary proceeding complaint against the lender.  The timing may vary depending upon whether the debtor is in Chapter 7 or Chapter 13, but in most jurisdictions the action may be filed at any time, either during the case or even after it is closed.   For Chapter 13 cases, certain jurisdictions will require that it be filed after the completion of the Chapter 13 plan. 

The analysis for undue hardship under Section 523(8) is fact specific and determined on a case by case basis.  Overall, under the current provisions of the United States Bankruptcy Code and applicable case law, it is likely that most debtors will not meet the undue hardship standard and will not be eligible to discharge their student loan indebtedness.   

[1] Brunner v. New York State Higher Education Services Corp., 831 F. 2d 395 (2d Cir. 1987).  But see In re Long, 322 F. 3d 549 (8th Cir. 2003) (applying more general "totality of the circumstances" test).

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