Since 1841, albeit with a few periodic lapses[1], some means of bankruptcy has been available for the “honest but unfortunate debtor.”[2] Inherent with such a privilege comes certain exceptions, including specific types of debt that cannot be eliminated or “discharged” in bankruptcy. These exceptions are identified in section 523 of the current Bankruptcy Code and are to be “narrowly construed against the creditor so as to fulfill bankruptcy’s goal of giving the debtor a fresh start.”[3] There you will find some fairly obvious terms befitting this category, such as debt incurred through “fraud,” “defalcation,” “willful and malicious injury,” “embezzlement,” “larceny,” and “false representations.” Also nestled among this lineup of usual suspects is student loans. Unlike its brethren, the dastardliness of student loans is not so self-evident. They are not innately incurred in bad faith or intentionally at the expense of an innocent third party. Earlier this year, the Federal Reserve Chairman even wondered aloud why student loans are included among these non-dischargeable debts.
In truth, student loans have only recently been nondischargeable in bankruptcy. For years debtors could freely discharge these loans alongside their credit cards and medical bills. However, by the late 1970s, Congress became concerned with the potential for young people to immediately and fraudulently discharge these obligations upon graduation.[4] This fear was based primarily on the growing volume of accessible government funding. Recent legislation at the time, such as the National Defense Education Act (1958), Higher Education Act (1965), and Basic Educational Opportunity Act (1972), established a variety of government loans and assistance to make college more accessible for all students.[5] These loans were unsecured and handed out to young adults with little in the way of income or assets to ensure repayment. The only item of value “pledged” for the privilege of a college education was the borrower’s future earning power. In the eyes of some, it would be fraudulent for a recent graduate to use a discharge to deny the government its right to the only “collateral” offered – his future earnings after bankruptcy. Congress viewed dischargeability limits in bankruptcy as a quid pro quo to a student’s easy access to government-funded student loans; graduates should not be able to throw off their cap and gown and throw out their student loans in one fell swoop.
Through the Bankruptcy Reform Act of 1978, Congress added student loans to Section 523 and prohibited their discharge unless the borrower could affirmatively show an “undue hardship.” This initial exclusion, however, was limited to guard only against the concern expressed. The debt was only nondischargeable for the first five years of repayment. By year six, a student could freely include his student loans in bankruptcy. The legislative history includes the following, “The Committee notes that in most circumstances, a student may leave school with several thousand dollars in student loans and no assets, thereby making the student technically eligible to declare bankruptcy. The amendment, by waiting five years, would offer a more realistic view on the student’s ability to repay a student loan.”[6] In addition, the loan had to be made or guaranteed directly by the government or university. Private loans designated for education were still fully dischargeable.
Through multiple amendments over the following decades, the student loan exception in bankruptcy broadened significantly. In 1990 Congress extended the period of non-dischargeability from the first five years to the first seven years of repayment. In 1998, it did away entirely with a time limitation; but for some type of “undue hardship,” student loans owed to a governmental entity were nondischargeable no matter how old. This change was obviously significant and differed from the Code’s typical approach to government-owed debt. For example, contrasted with student loans, the Bankruptcy Code still generally allows the discharge of income taxes following their second year of repayment.[7] Similarly, fines, penalties, and forfeitures payable to a governmental unit are generally dischargeable after three years.[8]
Finally, in 2015 Congress clarified the statute to eliminate any doubt it applied to both public and private student loans.[9] This swept in an enormous amount of debt previously dischargeable. For example, private student loan debt in 2014-2015 was $7.8 billion.[10]
Even with all these door-closing amendments, Congress still left ajar a small opening to eliminate student loans if the borrower can prove repayment “would impose an undue hardship on the debtor and the debtor’s dependents.” [11] Notwithstanding the fact these loans are presumptively nondischargeable and the burden (and cost of litigation) rests on the debtor, at least there remains an avenue of relief. If courts were to liberally interpret “undue hardship,” bankruptcy could still be a viable option. It is not a stretch to think that many of these borrowers, whose financial problems forced them into bankruptcy already, would qualify.
Unfortunately, courts have not taken a liberal view. Just the opposite, they have narrowed the definition of “undue hardship” to make it nearly impossible for a debtor to meet his burden to discharge student loans. Most courts have followed the Second Circuit’s undue hardship test as articulated in Brunner v New York State Higher Educ. Serv. Corp., 831 F.2d 395, 396 (2d Cir. 1987). Under Brunner, a debtor is required to demonstrate all three of the following prongs to prove an undue hardship:
- 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;
- 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
- that the debtor has made good faith efforts to repay the loans.
Bound by Brunner, even sympathetic judges have found little wiggle room for student loan debtors. Many have interpreted the second prong to necessitate “that a certainty of hopelessness exists that the debtor will not be able to repay the student loans.”[12] There must be a showing of circumstances that are “beyond the reasonable control of the debtor that would prevent future employment and the ability to repay the debt.”[13] The fact the debtor may currently be unemployed and penniless does not carry the day. Only rare circumstances will normally satisfy this requirement, such as long-term illness, disability or a lack of useable job skills that would prevent future employment and repayment. Is the debtor healthy? Does she have useable job skills? If so, it will be extremely difficult to prove her current unemployment and financial situation will persist in the future to meet the second prong of Brunner. As a result, few debtors now even attempt to discharge student loans in bankruptcy.
While the first and third branches of the U.S. government were busy cementing the exclusion of student loans in bankruptcy, the debt itself changed dramatically. As any parent knows, tuition has skyrocketed in the last four decades. On average, tuition for a four-year private college in 1980 was $3,617.[14] For the 2017–2018 school year at a private college, the average tuition is $34,740.[15] As a specific example, undergraduate tuition (not including room and board) at the University of Pennsylvania has increased from $4,825 in 1978 to $55,584 today, a 1,052% increase.[16] UPenn’s tuition hike falls in line with a 2012 Bloomberg report that claimed college tuition and fees have risen at 1,120% since 1978, four times faster than the consumer price index.[17] This cost might be manageable if a graduate’s income level rose equally alongside, but it has not. According to the U.S. Census Bureau, in 1980, the median household income in the United States was $16,671, and in 2016 it grew to $55,322 – a relatively nominal increase of roughly 230% that barely passes the rate of inflation.[18]
With costs drastically exceeding income, the volume of student borrowing has soared. Student debt now totals roughly $1.45 trillion, up significantly from around $500 billion owed in 2007.[19] Student loans have now passed the total amount of auto loan and credit card debt owed in America.[20] The average student loan debt for the graduating class of 2016 was $37,172 – an increase of 6% from 2015.[21] This eye-popping escalation applies to both the volume and dollar amount. For example, students in 1990-1991 borrowed $24 billion, compared to students in 2012-13 who borrowed $110 billion.[22] Borrowers with more than $20,000 in student loans represented only 20% of all borrowers in 2002.[23] In 2017, that number increased to 40%.[24] There are currently 44.2 million Americans with student loan debt, with an average monthly payment of $351 for those between 20-30 years of age.[25]
Another recent development is a shift in age demographics. Borrowers between the ages of 45 and 74 now owe more on student loans than younger graduates.[26] Borrowers under age 35, on average, owe $32,900, compared to 45-54-year-olds who owe $37,000 and even 65-74-year-old borrowers who owe $35,400.[27] The shift certainly demonstrates longer-term or straggling student loan repayment, which is ironic when juxtaposed to the mere five-year window of repayment that Congress deemed non-dischargeable under the 1978 Bankruptcy Reform Act. In addition, the increase in older borrowers reflects a trend of “Parent PLUS loans,” parents and grandparents attempting to assist a child or grandchild.[28]
Not only is the debt large, but it is growing in default. One in every ten student borrowers is currently behind in repayment – the highest delinquency rate of any type of borrower, including home mortgages, auto loans, and credit cards.[29] Unfortunately, the future appears graver as a recent study concluded that 40 percent may default on their student loans by 2023.[30]
The ramifications of this debt are significant. Studies have suggested student loan payments are delaying this generation’s decision to get married and start a family.[31] In addition, it may be holding young people back from starting up a business, saving for retirement, and buying a home. [32] “When students use up their debt capacity on student loans, they can’t commit it elsewhere.”[33] This affects not just individual lives but the economy as a whole. In 2014, then Federal Reserve Chairman Janet Yellen appeared on Capitol Hill to warn of the dangers student loan debt may have on the economy, including how this delay in buying first homes is hurting the housing market. Washington, it appears, had finally taken notice.
So with rubber firmly hitting the road, where does this leave the dischargeability of student loans in bankruptcy? It is patently obvious that these types of student loans were not the ones facing Congress when it passed the Bankruptcy Reform Act in 1978 or even the Second Circuit when it decided Brunner in 1987. As a great man once said, “laws” and “institutions must advance…to keep pace with the times.”[34] For decades, the Bankruptcy Code has refused to budge, apparently turning a blind eye to what has become a burgeoning student loan crisis. However, on this 40th anniversary of the 1978 version of the Bankruptcy Code that declared this debt nondischargeable, perhaps we are beginning to witness a push to reverse course in light of the economic dynamics in play.
In late February 2018, the current Federal Reserve Chairman, Jerome Powell, echoed his predecessor’s warning of how student loan debt was impacting the economy, stating, “You do stand to see longer-term negative effects on people who can’t pay off their student loans…it hurts their credit rating, it impacts the entire half of their economic life.” Going one step further from Janet Yellen, Powell openly questioned why student loans cannot be discharged in bankruptcy, stating, “I’d be at a loss to explain why that should be the case.”[35]
In that same month, the Department of Education issued a “Request for Information on Evaluating Undue Hardship Claims in Adversary Actions Seeking Student Loan Discharge in Bankruptcy Proceedings.”[36] As its title states, through this request, the Department is seeking information into how it and the courts should interpret “undue hardship” going forward. While it cannot amend the Bankruptcy Code, the Department can revise its internal regulations regarding when and if it should defend against a borrower’s request to discharge his student loans in bankruptcy.[37] The Department of Education can also offer guidance to courts in terms of their interpretation of “undue hardship” to perhaps veer away from Brunner’s heightened standard.
Finally, John Delaney (D –Md) and John Katco (R-NY) have recently sponsored a bi-partisan bill (H.R. 2366) that would actually amend the Bankruptcy Code to once again make student loans dischargeable in bankruptcy.[38] That bill remains within the House of Representatives.
It is far too early to declare an about-face from the decades of congressional and legislative actions that have excluded student loans from bankruptcy discharge. However, momentum may finally appear to be on the borrower’s side. It would be quite remarkable to see, within 40 years, both the creation and elimination of one of the most ironclad exceptions to bankruptcy discharge. At the very least, perhaps we witness a broadening of the term “undue hardship” or a rollback to a specific time period of nondischargeability to offer much-needed relief to a far greater number of borrowers going forward.
[1] While Article 1, Section 8 of the Constitution specifically empowered Congress to establish “uniform laws on the subject of bankruptcies throughout the United States,” Congress did not do so until 1800, when it passed a short-lived Bankruptcy Act that allowed for involuntary petitions. However, it wasn’t until 1841 that the first modern Bankruptcy Code allowing for voluntary petitions was enacted following the economic “Panic of 1837.” Ironically, the first student loans in America were offered by Harvard University around 1841 as well. This version of the Bankruptcy Code later lapsed and was replaced in 1867, again in 1898, and finally in 1978, bringing us our current Bankruptcy Code.
[2] Grogan v. Garner, 498 U.S. 279 (1991).
[3] Bank. Of Am. v. Jarczyk, 268 B.R. 17, 21 (W.D.N.Y. 2001).
[4] See State v. Wilkes, 41 N.Y. 2d 655 (1977) (“The number of student loan bankruptcies has increased from a cumulative total of 2,146 for an aggregate of $2.4 million from the beginning of the student loan program through fiscal 1972, to an accumulated total of 8,969 for an aggregate of $11.3 million by February 1975”).
[5] While an oversimplification, these acts encapsulate two prominent themes of the era: a sputnik race of arms and intelligence with the Soviets and a Great Society open for all.
[6] In re Garcia, 1 B.R. 253 (Bankr. S.D. Fla. 1979) (quoting H.R.Rep.No.1232, 94th Cong., 2d Sess., 13-14 (1976).
[7] See 11 U.S.C. § 523(a)(1)(B)(ii).
[8] See 11 U.S.C. § 523(a)(7).
[9] In addition to the changes to the Bankruptcy Code, in 2001, the Department of Education began offsetting up to 15% from a borrower’s Social Security and retirement benefits (typically exempt assets) to repay defaulted federal educational loans.
[10] See A Look at the Shocking Student Loan Debt Statistics for 2018: https://studentloanhero.com/student-loan-debt-statistics/
[11] 11 U.S.C. § 523(a)(8).
[12] Davis v. Educational Credit Management Corp., 373 B.R. 241, 250 (W.D.N.Y. 2007) (also broadly defining “current income” under prong one of Brunner to be the total household income (not just the debtor’s income), including the non-debtor spouse, live-in companion, life partner, and contributing co-habitants). But see, In re King, 368 B.R. 358 (Bankr. D. Vt. 2007) (discrediting the “hopelessness” standard).
[13] Wells v. Sallie Mae, 380 B.R. 652, 661 (Bankr. N.D.N.Y. 2007). See also Jackson v. The Education Resources Institute, 2007 Bankr. LEXIS 2713, *13 (Bankr. S.D.N.Y. 2007).
[14] See Cost of College almost encourages dropping out: https://fa16tmblog1.wordpress.com/2016/12/02/cost-of-college-almost-encourages-dropping-out/
[15] See CollegeData: https://www.collegedata.com/cs/content/content_payarticle_tmpl.jhtml?articleId=10064
[16] Compare Tuition and mandated fees, Room and Board and other educational costs at Penn since 1900: 1970-1979, Upenn.edu: http://www.archives.upenn.edu/histy/features/tuition/1970.html, with Paying for a Penn Education, Cost of Attendance Academic Year 2018-2019, Upenn.edu: http://sfs.upenn.edu/paying/cost-of-attendance.htm
[17] See Cost of College Degree in U.S. Soars 12 Fold: Chart of the Day, Bloomberg (August 15, 2012): https://www.bloomberg.com/news/articles/2012-08-15/cost-of-college-degree-in-u-s-soars-12-fold-chart-of-the-day (also noting as a comparison that during that same time period, medical expenses rose 601% and food prices 244%). See also, Will Tuition Ever Stop Increasing, USA Today (Nov. 8, 2014): https://www.usatoday.com/story/money/personalfinance/2014/11/08/credit-dotcom-tuition/18417721/
[18] See Median Household Income in the United States: https://www.davemanuel.com/median-household-income.php; and https://www.census.gov/search-results.html?q=median+income&page=1&stateGeo=none&searchtype=web&cssp=SERP See also, Student Debt’s Grip on the Economy, The New York Times (May 20, 2017): https://www.nytimes.com/2017/05/20/opinion/sunday/student-debts-economy-loans.html
[19] See You may soon be able to declare bankruptcy on your student loans- here’s how, CNBC.com (March 22, 2018): https://www.cnbc.com/2018/03/22/you-may-soon-be-able-to-declare-bankruptcy-on-your-student-loans.html
[20] Why the Student Loan Crisis Is Even Worse Than People Think, Time (Jan. 11, 2016): http://time.com/money/4168510/why-student-loan-crisis-is-worse-than-people-think/
[21] See A Look at the Shocking Student Loan Debt Statistics for 2018, Student Loan Hero (May 1, 2008): https://studentloanhero.com/student-loan-debt-statistics/
[22] See The Growth in Student Debt, Pew Research Center (August 2014): http://www.pewsocialtrends.org/2014/10/07/the-growth-in-student-debt/
[23] See CFPB Data Point: Student Loan Repayment, Consumer Financial Protection Bureau (August 2017): https://s3.amazonaws.com/files.consumerfinance.gov/f/documents/201708_cfpb_data-point_student-loan-repayment.pdf
[24] See id.
[25] A Look at the Shocking Student Loan Debt Statistics for 2018, Student Loan Hero (May 1, 2018): https://studentloanhero.com/student-loan-debt-statistics/
[26] See This Generation Has a Huge and Growing Student Debt Burden. It’s Not Who You Think, Time (April 27, 2018): http://time.com/money/5256805/student-debt-boomers-millennials/
[27] See id.
[28] See id (noting these federal Parent PLUS loans have “roughly quadrupled over the period between the 1989-90 and 2011-2012 school years…”).
[29] See Student Debt’s Grip on the Economy, The New York Times (May 20, 2017): https://www.nytimes.com/2017/05/20/opinion/sunday/student-debts-economy-loans.html
[30] See The looming student loan default crisis is worse than we thought. Brookings Institute (Jan. 10, 2018): https://www.brookings.edu/research/the-looming-student-loan-default-crisis-is-worse-than-we-thought/
[31] See LIFE DELAYED: The Impact of Student Debt on the Daily Lives of Young Americans, American Student Assistance (2015): http://www.asa.org/wp-content/uploads/2017/06/life_delayed_whitepaper_2015.pdf
[32] See The Ripple Effect of Student Loans, New York Times (May 24, 2014): https://www.nytimes.com/2014/05/25/business/the-ripple-effects-of-rising-student-debt.html
[33] Id.
[34] Thomas Jefferson, July 12, 1816 (“I am not an advocate for frequent changes in laws and Constitutions. But laws and institutions must go hand in hand with the progress of the human mind. As that becomes more developed, more enlightened, as new discoveries are made, new truths discovered and manners and opinions change, with the change of circumstances, institutions must advance also to keep pace with the times. We might as well require a man to wear still the coat which fitted him when a boy as civilized society to remain ever under the regimen of their barbarous ancestors.”).
[35] See Student debt could hold back economic growth, should be discharged in bankruptcy, Fed chief says., CNBC (March 1, 2018): https://www.cnbc.com/2018/03/01/student-loan-problems-could-hold-back-economic-growth-fed-chief-says.html
[36] See Office of the Federal Register (February 21, 2018): https://www.federalregister.gov/documents/2018/02/21/2018-03537/request-for-information-on-evaluating-undue-hardship-claims-in-adversary-actions-seeking-student
[37] See e.g., 34 C.F.R. § 674.49(c)(3) and (c)(5) (these regulations currently hold that upon a borrower’s request for determination of dischargeability “the institution must determine, on the basis of reasonable available information, whether repayment…would impose an undue hardship” and if so, and the costs to oppose discharge do not exceed 1/3 of the total amount owed on the loan, the institution muse “oppose the borrower’s request for a determination of dischargeability.”).
[38] See https://www.congress.gov/bill/115th-congress/house-bill/2366
Article written by: Devin L. Palmer, Esq.
