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ELIMINATING STUDENT LOAN DEBT IN BANKRUPTCY

Imagine Life without Student Loan Payment Obligations

Student loan debt can be massive, burdensome and overwhelming. Some former students have accumulated more than $310,000 of student loan debt and simply do not have the ability to repay these massive debts. Consequently, many Americans consider filing bankruptcy to eliminate their student loan debt.

Before filing a bankruptcy case, the student loan debtor should weigh the pros and cons of both the bankruptcy and non-bankruptcy options. You are strongly urged to talk with a licensed bankruptcy attorney to explain the options so you can make a fully informed decision. The non-bankruptcy option could save the student loan debtor significant money over the life of the student loan. Similarly, it may be possible to defer the student loan payments or to renegotiate more favorable student loan terms. On the other hand, the bankruptcy option could save the student loan debtor significant money if the debtor could convince the court that the failure to discharge the student loan would cause an "undue hardship" upon debtor and debtor’s dependents.

Student Loan Topics

  1. Recent Court Cases
  2. US Bankruptcy Code
  3. 3-Prong Test Regarding Dischargeability
  4. Legislation Proposed in Congress
  5. Non-Bankruptcy Alternatives

Recent Court Cases

Below are some interesting legal cases involving Americans’ attempts to eliminate student loan debt via bankruptcy. The cases offered on this website are removed and replaced periodically with newer cases. So I urge you to check back to this website periodically for the latest developments. However, prior cases are transferred from this webpage to my student loan blog for you to retrieve. You are encouraged to view my student loan blog to discover more information about eliminating student loan debts. Visit Student Loan Blog or contact me to talk to an experienced bankruptcy attorney.

  1. In re Walker v. Sallie Mae Servicing, 406 B.R. 840 (Bankr. D. Minn. 2009). Debtor discharged over $310,000 of student loan debt that she incurred while earning a bachelor’s degree at the University of Illinois, a medical degree at University of Illinois College of Medicine, and a master’s degree at Governors State University. Debtor was healthy and able to work, but stayed home to rear five children. Debtor’s husband held a full-time job as a policeman and a part-time job as a security officer. Debtor’s approximate household income was $67,000 annually. In addition, within about 18 months of filing the adversary proceeding to discharge the student loan debt, debtor’s spouse purchased a $40,000 new Chevrolet Suburban truck by incurring a vehicle loan with a monthly payment obligation of $850. Plus, debtor’s spouse signed a $50,000 second mortgage to build a 22-foot deck off their home with a monthly payment obligation of $372.

    Nevertheless, the bankruptcy court rejected the objections to discharge argued by the student loan creditors, finding that debtor had provided sufficient evidence that the repayment of the student loan debt would have been an “undue hardship” on debtor and debtor’s dependents. The Walker Court applied the 8th Circuit’s “totality-of-the-circumstances” test. The court made note that the health of debtor’s twin approximately 9-year old sons was a major factor in its decision. The twins suffered with a form of child autism and were receiving intensive therapy offered by the state government for children with autism.

    Interestingly, the court allowed the discharge finding that the debtor had overcome debtor’s burden of proving “undue hardship” without calling an expert witnesses for an opinion as to the sons’ status and prognosis from the perspective of medicine/psychology or education. Nevertheless, the $310,000 student loan debt was discharged.

  2. In re Booth, 410 B.R. 672 (Bankr. E.D. Wash 2009). A chapter 7 bankruptcy debtor brought an adversary complaint against a student loan creditor seeking discharge of the student loan debt pursuant to Section 523(a)(8) of the Bankruptcy Code alleging that an “undue hardship” would result if the debtor had to repay the student loan debt. Prior to filing bankruptcy, the debtor had participated in a student loan deferral payment program. As a result of the program and debtor’s deteriorating financial position, the student loan creditor established a zero dollar per month short-term repayment plan with the balance to be paid much later. Nevertheless, debtor filed for bankruptcy and sought a complete discharge of all the student loan debt.

    The student loan creditor opposed the complete discharge of the student loan debt. In fact, the creditor filed a motion for summary judgment seeking an order finding the student loan debtor NOT eligible for a bankruptcy discharge AS A MATTER OF LAW because the deferral payment program had granted debtor a zero dollar per month short-term repayment plan. In short, the student loan creditor believed that the debtor could not establish “undue hardship” as a matter of law since debtor had agreed to a zero dollar short-term repayment plan and therefore no hardship existed, much less “undue” hardship.

    The Court rejected the student loan creditor’s argument and denied the motion for summary judgment. The court noted the difference in relief granted by both options: (a) the bankruptcy discharge offered permanent relief by eliminating the student loan debt forever, whereas (b) the deferral payment program only offered short-term relief with the balance coming due later. Next, the court focused on the factual review given by both options: (a) the bankruptcy court would review the facts of each case on a case-by-case basis to determine if the repayment of the student loan debt would result in an undue hardship upon the debtor, whereas, (b) the deferral payment program gave no individual review, instead relying upon a formula to determine loan payments.

    The conclusion is that the student loan debtor was allowed to go forward with the bankruptcy case and will be offered an opportunity to prove that the payment of the student loan debt would be an undue hardship on the debtor and debtor’s dependents.

  3. In re Knecht, 410 B.R. 650 (Bankr. D. Montana 2009). A bankruptcy debtor filed chapter 13 bankruptcy and proposed a repayment plan that would cause the student loan creditor to be the only unsecured creditor to receive any money. Specifically, the debtor sought confirmation of the repayment plan which proposed to pay more than $36,000 to the student loan creditor while paying nothing to the other unsecured creditors. The trustee objected asserting that the proposed plan unreasonably “discriminated” among unsecured creditors.

    The bankruptcy court sustained the trustee’s objection and denied confirmation, holding that the student loan debtor had failed to satisfy the burden of proving that the repayment plan’s separate classification of student loan debt did not unfairly discriminate against the other unsecured creditors.

    The court believed that a student loan creditor cannot create a chapter 13 plan that allows a student loan debtor to repay student loans “out of the hide” of other unsecured creditors. Instead, the other unsecured creditors must be paid their pro rata share. For example, let’s assume a debtor owes both $36,000 in student loan debt and another $36,000 in credit card debt. Now, if that debtor would file a plan calling for unsecured creditors to receive $36,000, then the student loan creditor would only be receiving $18,000 while the credit card creditors would also be receiving the other $18,000. Clearly this result is not as beneficial to a debtor because the $18,000 paid to the credit card creditor would be wasted since any unpaid credit card debt would be discharged---whether $18,000 is still owed or the full $36,000 is still owed; moreover, this result is not as beneficial because the $18,000 of unpaid student loan debt would survive the bankruptcy and have to be repaid--- absent a separate adversary complaint proving undue hardship.

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US Bankruptcy Code: Excepting Student Loans From Discharge

Section 727(a) of the US Bankruptcy Code provides individuals filing Chapter 7 bankruptcy a bankruptcy "discharge." In general, the discharge eliminates the debtor’s obligation to pay all debts that arose before the date the bankruptcy case is filed. However, not all debts are discharged. Similarly, Section 1328 of the Bankruptcy Code provides a discharge to individuals filing Chapter 13 bankruptcy. The discharge is generally granted to debtors who complete all payments under the confirmed repayment plan. The court grants each debtor a discharge of all debts provided for by the plan. Like Section 727(a), Section 1328 also provides some exceptions to this general discharge.

Section 523 of the Code identifies certain debts that are “excepted” from the general discharge, meaning that debtors would be still obligated to pay these excepted debts even though these same debtors were granted a general discharge by the court. Student loans are one of those excepted debts identified in Section 523. Section 523 states that a discharge entered under Section 727 or 1328 does NOT discharge an individual debtor from any debt relating to student loans. But subsection 523(a)(8) opens the door to the possible exception to the “excepted” student loan debt.

Section 523(a)(8) states that student loan debt is excepted from discharge “unless excepting such debt from discharge under this paragraph would impose an “undue hardship on the debtor and the debtor’s dependents,” for (A) (i) an educational benefit overpayment or loan made, insured, or guaranteed by a government unit, or made under any program funded in whole or in part by a governmental unit or nonprofit institution; or (ii) an obligation to repay funds received as an educational benefit, scholarship, or stipend; or (B) Any other educational loan that is 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.

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3-Prong Test: Law Relating to the Discharge of Student Loans

While government guaranteed student loans generally may not be discharged or eliminated in bankruptcy, Section 523(a)(8) permits the discharge of such loans when failure to do so would &impose undue hardship on the debtor and the debtor’s dependents." Therefore, after the 2005 amendments to the Bankruptcy Code, the only ground on which a student loan will be discharged is when the court finds that repayment of the debt would work an "undue hardship" on the debtor and debtor’s dependents.

But, the question that must be answered is: What constitutes an "undue hardship" under the Bankruptcy Code? Unfortunately, the Bankruptcy Code does not define "undue hardship." Consequently, that question must be answered by the bankruptcy courts on a case-by-case basis with special focus on the specific facts of each case. Most courts follow the three-part test set forth by the US Court of Appeals for the 2nd Circuit in Brunner v. New York State Higher Education Services Corp., 831 F.2d 395 (2nd Cir. 1987). The Court of Appeals for the 7th Circuit also adopted the Brunner three-part test in In re Roberson, 999 F.2d 1132 (7th Cir. 1993). Other courts have adopted a less rigid standard considering the "totality of the circumstances," perhaps as a reaction to the abolishment of the prior statute permitting discharge of student loans which were more than seven years old. Procedurally, a debtor is permitted to discharge student loans after filing a bankruptcy case and filing a related adversary proceeding.

In all circumstances, a bankruptcy debtor must file an adversary proceeding/lawsuit in the bankruptcy court to obtain a judgment of dischargeability as to the student loan debt. Absent an adversary filing, the student loan debt would not be discharged. That means the debtor must take a proactive step and file the adversary. Only by taking this proactive step would the debtor have the opportunity to present facts that prove that the student loan debt should be discharged because the lack of discharge would cause an "undue hardship." Absent an adversary proceeding, the student loan debt would be deemed nondischargeable.

An adversary proceeding is akin to a regular lawsuit. A "complaint" is filed and served upon the creditor. The legal basis for the complaint must be identified with specificity. Court pleadings will be required and court hearings will be held. Evidence must be gathered, indexed, and be presented at trial. A skilled bankruptcy attorney would be a vital necessity to maximize a debtor’s best opportunity to eliminate or discharge the student loan debts.

At the adversary proceeding trial, the student loan debtor would have to make a three-part showing demonstrating that the payment of the student loan debt would be an undue burden upon the debtor and the debtor’s dependents before the student loan debt should be discharged. The three-part test requires a showing---

  1. That the debtor cannot maintain, based on current income and expenses, a "minimal" standard of living for the debtor and the debtor’s 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 has made good faith efforts to repay the loans.

See Brunner v. New York State Higher Education Services Corp., 831 F.2d 395 (2nd Cir. 1987); In re Roberson, 999 F.2d 1132 (7th Cir. 1993).

The first prong of the test requires an examination of the debtor’s current financial condition to see if payment of the loans would cause the debtor’s standard of living to fall below that minimally necessary. Bankruptcy courts have routinely applied this requirement as the bare minimum to assert a claim of "undue hardship" warranting discharge of student loans. In light of the heightened standard for dischargeability of student loans, an examination into the debtor’s ability to maintain a minimal standard of living comports with common sense. The Roberson court believed this test should serve as the starting point for the Section 523(a)(8) inquiry since information regarding the debtor’s current financial situation generally will be concrete and readily obtainable; only if the debtor meets this test should a court examine the other two prongs of the Brunner test. See In re Roberson, 999 F.2d 1132 (7th Cir. 1993).

The second prong of the test focuses on what the Brunner court believed was the clear congressional intent exhibited in Section 523(a)(8) to make the discharge of student loans more difficult than that of other nonexcepted debt. But, predicting future income is problematic. Nevertheless, the Brunner court believed that requiring evidence not only of current inability to pay but also of additional circumstances, strongly suggestive of continuing inability to repay over an extended period of time, more reliable guarantees that the hardship present is "undue."

The Seventh Circuit’s Roberson court agreed with the Brunner court, stating that the second prong of the Brunner test properly recognized the potential continuing benefit of an education, and imputed to the meaning of "undue hardship" a requirement that the debtor show a dire financial condition is likely to exist for a significant portion of the repayment period. The court further noted that the proponents of Section 523(a)(8)’s higher standard for dischargeability recognized that education loans are different from most loans because they are made without business considerations, without security, without cosigners, and rely for repayment solely on the debtor’s future increased income resulting from the education. In this sense, the Seventh Circuit believed the loan is viewed as a mortgage on the debtor’s future.

The Roberson court accepted the notion that the dischargeability of student loans should be based upon the certainty of hopelessness, not simply a present inability to fulfill financial commitment. The Seventh Circuit recognized that upon graduation, the student borrower’s outstanding student loans often will dwarf the debtor’s assets; even though in the long run a government financed education may generate substantial return, if steady employment is not immediately forthcoming bankruptcy provides an attractive means by which the student may eliminate frustrating and burdensome student loan payments. "Requiring evidence not only of current inability to pay but also of additional circumstances, strongly suggestive of continuing inability to repay over an extended period of time, more reliable guarantees that the hardship presented is 'undue.'" See Robertson quoting Brunner v. New York State Higher Education Services Corp., 831 F.2d 395 (2nd Cir. 1987).

Upon the debtor’s satisfaction of the first two prongs of the dischargeability test, the court should examine the third prong---whether the debtor has made a good faith effort to repay the student loan. With the receipt of a government-guaranteed education, the student assumes an obligation to make a good faith effort to repay those loans, as measured by the student’s efforts to obtain employment, maximize income, and minimize expenses. The Seventh Circuit declined to consider the "value" of the education in making a decision to discharge the student loan because it would turn the government into an insurer of educational value. According to the Roberson court, Congress’ decision to increase the availability of higher education through student loans does not necessarily equate to a decision to insure the future success of each student taking advantage of that opportunity. The government guarantees repayment of the loan to the private lender so that those who, because of their current wealth and future earning potential would not be eligible to receive any financing or only financing at a higher rate of interest, may nonetheless receive an education.

Finally, the Seventh Circuit stated "the government is not twisting the arms of potential students. The decision of whether or not to borrow for a college education lies with the individual; absent an expression to the contrary, the government does not guarantee the student’s future financial success. If the leveraged investment of an education does not generate the return the borrower anticipated, the student, not the taxpayers, must accept the consequences of the decision to borrow."

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Proposed Legislation: Discharging Private Student Loans

The U.S. Congress held a hearing on September 23, 2009 to consider amending the Bankruptcy Code to make it easier for debtors to discharge student loan debt. The U.S. House Judiciary Committee’s Subcommittee on Commercial and Administrative Law Bankruptcy Code conducted the first hearing since 1976 that was held specifically on the issue of student loan discharges.

Witnesses at the Congressional hearing told the subcommittee that Section 523(a)(8) needed to be rolled back to its pre-2005 version, which did not provide a discharge exception for private student loans. Subcommittee chair Steve Cohen, D-Tenn., agreed that private student loans should not receive the same protection under the Bankruptcy Code as federal student loans and promised to introduce legislation to remedy the problem. The Congressman said he was concerned about "the great increase in the number of private student loans issued over the past decade, especially to students of modest means. Unlike federal student loans, private loans lack important consumer protections, leaving financially distressed borrowers with little option but to seek bankruptcy relief."

The president of the Institute for College Access and Success, Lauren Asher, testified before Congress that private student loans are a risky way to pay for a college education. She stated that private student loans "are not financial aid any more than a credit card is when used to pay to pay for textbooks or tuition." Asher also stated that "private loans typically have variable interest rates that are higher for those who can least afford them. In 2008, interest rates for private loans were as high as 18 percent, based in part on the borrower’s credit score. These variable rates are rarely capped and can change as often as once a month. Fees vary widely between lenders and even between borrowers with the same lender. Promissory notes usually give the loan holder broad authority to increase borrower costs, such as raising interest rates in response to late payments." Although there is little difference between paying for college with a credit card or a private student loan, the 2005 amendments to the Bankruptcy Code made private student loans nondischargeable under Section 523(a)(8). House Judiciary Committee chair John Conyers of Michigan questioned why people can discharge debts for luxury items such as yachts and vacation homes, while people trying to get ahead in life can’t discharge educational loans. The National Association of Consumer Bankruptcy Attorneys ("NACBA"), of which attorney Schaller is a member, had a witness testify on its behalf at the subcommittee hearing in September 2009. Attorney Brett Weiss testified that student loans were originally excepted from discharge to prevent debtors from abusing the system even though there was no evidence that they were abusing it then or are abusing it now. A bad situation was made worse when private student loans were included within Section 523(a)(8)’s discharge exception.

NACBA’s representative stated: "to make matters even worse, the current undue hardship system is random, arbitrary and unfair. Under current law, most federal and private student loans can only be discharged if the debtor can show that payment will impose an undue hardship on the debtor and the debtor’s dependents. The student must seek the hardship determination in court through a separate proceeding. While the current system may deter some student borrowers who can afford to pay their loans it more often snares those who are truly financially distressed and desperately need relief."

NACBA’s representative further stated "the arbitrary system hits lower-income borrowers particularly hard. Even if they have access to free or low cost legal assistance, they still must find resources to pay for depositions and in some cases even expert witness testimony. Even with strong testimony, it is nearly impossible to predict outcomes since so much rides on which jurisdiction the borrower happens to live in and which judge the debtor draws." NACBA’s representative concluded that it was time to allow debtors to discharge student loans in the same manner as other unsecured debt.

Seattle University School of Law professor Rafael Pardo had another suggestion. The professor suggested that the repayment of student loans should be treated like reaffirmed consumer debt, which would bring certainty to the standard while simultaneously harmonizing the Bankruptcy Code. Section 524 of the Bankruptcy Code states that a presumption of undue hardship arises in the context of reaffirmation agreements if the debtor’s disposable income is insufficient to make the payments specified in the agreement. The debtor may rebut the presumption only by identifying an additional income source that will enable the debtor to make the scheduled payments. The professor further testified that "one witnesses in the reaffirmation context the formulation of undue hardship as a function of presuming that a debtor will have a future inability to repay a debt based on the debtor’s current inability to repay. Were Congress to write a similar presumption into the Bankruptcy Code’s undue hardship discharge provision, it would relieve debtors from the unreasonable burden that current doctrine has imposed upon them---namely, the requirement to forecast with certainty a future inability to repay that will persist over a significant period of time, a period that can potentially span decades given the long repayment periods for certain student loans. Instead, student-loan creditors would bear the burden of rebutting the presumption of the debtor’s inability to repay. This legislative change would strike a more appropriate balance in a litigation process that unjustifiably favors creditors." Source: Consumer Bankruptcy News, 10/22/09.

Keep watching this website for the latest in the legislative updates. The source of information for this legislative update section is an article written by the Consumer Bankruptcy News publication.

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Non-Bankruptcy Alternatives to Discharging Student Loans

Please Contact Us for to learn about non-bankruptcy alternatives to eliminating student loan debt. Some people gravitate towards a non-bankruptcy alternative because they would like to avoid filing bankruptcy if at all possible. Both the bankruptcy and the non-bankruptcy alternatives address the same fundamental problem: the student loan debtor cannot afford to repay the student loans.

The Schaller Law Firm is developing a proprietary program called "The Private Trustee" that assists student loan debtors in eliminating their student loan debts. This program is designed to maximize the following benefits:

  1. Save the student loan debtor significant money;
  2. Defer the student loan payment;
  3. Modify the terms of the student loan agreement;
  4. Reduce or eliminate the costs, late fees, and attorney fees assessed by the student loan note holder; and
  5. More.

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