Student Loans in Bankruptcy: A New Opportunity
There is a widely held belief that student loans are not able to be discharged in individual bankruptcy cases. For many years, that belief was substantially correct. Changes in the process that took effect in 2022, however, have made it so that federal student loan debt, which is the vast majority of student loan debt (about 93% of all student loan debt), is more than likely to be eligible for discharge in bankruptcy. Doing so will require extra effort on the part of your bankruptcy attorney, the involvement of both the Department of Justice and the Department of Education, and some additional cost, but for most who owe student loan debt it is well worth it.
Prior to the 1998 adoption of the current Bankruptcy Code, student loan debt was generally able to be discharged in bankruptcy. Initially, it was treated like any other debt and discharged in the ordinary course of bankruptcy. Later, a five-year rule was put into effect where the student loan debt had to have been in repayment for at least five years before they could be discharged, but still no special action had to occur in the bankruptcy case.
The 1998 adoption of the Bankruptcy Code enacted Section 523(a)(8). Section 523 in general references debts that can or are not discharged in an ordinary bankruptcy case. Section 523(a)(8) is a section added specifically for student loans. The language of the section of the statute says that student loans are not discharged in the ordinary course of a bankruptcy case. If a debtor in bankruptcy wants to have their student loans discharged, they have to file a separate action within the bankruptcy called an adversary proceeding against the lender, usually the United State Department of Education. An adversary proceeding is basically a mini-lawsuit within the bankruptcy. Since it is the debtor in bankruptcy that is seeking the relief, they have to meet the burden of proving that having the student loan debt survive the bankruptcy would case and “undue hardship” on the borrower/debtor.
The phrase “undue hardship” when referring to student loan debt already had an established definition within the bankruptcy courts. There was an existing case, Brunner vs. NY State Higher Education, that defined the test for meeting the undue hardship standard. The short version is that the debtor must meet three elements:
- They must prove that at the time of their filing they do not have the current ability to make payments on their student loans while maintaining a minimal standard of living.
- They must prove that in the future, their situation is not likely to improve to the point where they will be able to maintain payments on their student loans while maintaining a minimal standard of living.
- They must prove that in the past, they have made some good faith efforts to handle their student loan debt.
The analysis using these factors, now commonly known as “The Brunner Test”, was adopted by most of the jurisdictions across the country. A few jurisdictions adopted a slightly weaker standard based on the decision in a case called In re Long and referred to as the “Totality of Circumstances Test”, but that standard is only slightly less challenging than that of Brunner.
With the strength of the 1998 adoption of the Bankruptcy Code’s Section 523(a)(8) and the decision in Brunner, student loan lenders were fighting from a position of extreme strength whenever a debtor in bankruptcy tried get to their student loans discharged. For federal student loans, which are loans either made or guaranteed by the U.S. Department (DOE) of Education, adversary proceedings are defended by U.S. Department of Justice (DOJ) attorneys. The DOJ attorneys would fight these cases tooth and nail.
- They would pick apart a debtor’s budget, questioning every borderline expense and budget decision in an effort to depict the debtor as frivolously spending rather than paying back their student loans.
- They would argue that if the debtor’s finances were really that bad, the Higher Education Act provides for a series of Income Driven Repayment Plans available that would allow for the debtors to make small or no payments on their student loans until their finances improve. How can a zero dollar payment be an undue hardship?
- No matter what the debtor’s history was regarding making efforts to address their student loan debt, it was never enough to be in good faith in the eyes of the government.
For this reason, since the adoption of the Bankruptcy Code, less than .01% of student loan debt involved in bankruptcy cases was discharged according to a 2020 Duke University study. Courts went as far as to say that one had to prove a “certainty of hopelessness” if they wanted to have any chance at discharging their student loan debt. From 1998 – 2022, it was a truly terrible time to file for bankruptcy protection if you had student loan debt.
This all changed on November 17, 2022, when the Department of Justice, in collaboration with the Department of Education, issued their new Departmental Guidance Regarding Student Loans in Bankruptcy (the Guidance). This single piece of guidance, adopted under the Biden Administration and continued and approved by the Trump Administration, completely changes the bankruptcy landscape. Note that the Guidance only applies to federally issued or guaranteed student loans, but since these comprise about 93% of all student loan debt, odds are that your loans are federal loans. Your attorney can tell you for certain.
Basically, the DOJ and DOE recognized that the current system of handling student loan debt in bankruptcy was in conflict with the concept of giving the honest but unfortunate debtor a true fresh start. They also recognized that Congress was unlikely to change the Bankruptcy Code and that the courts were unlikely to weaken the current tests under Brunner or Long. So what they did, which should be recognized for a bit of brilliance, is develop the Guidance so that they, as the defendant in the majority of student loan discharge adversaries, could readily stipulate (agree) that the student loans would be an undue hardship on the debtor. Almost all courts, upon receiving these stipulations, have entered consent judgments discharging the student loan debt.
The first huge step that the Guidance took was to put a set of objective standards to apply to the three prongs of the Brunner test. If the debtor meets these standards, the DOJ and DOE will stipulate to discharge.
- For the first prong, the “current ability to pay” prong, the DOJ and DOE took two major actions. First, they standardized the comparison of income and expenses, using existing IRS standards supplemented by additional actual expenses that the debtor is or should be incurring. As this is similar to the methodology of bankruptcy’s Means Test, it made it much easier for debtors to prove that they do not have enough disposable income to pay their student loan debt. Second, they eliminated the argument of the debtor having the ability to enter into an Income Driven Repayment Plan by stating clearly that any disposable income is to be compared to the Standard Payment. The Standard Payment generally refers to the monthly payment it would require in order to pay the full balance of the outstanding loans with interest over a ten year period. If you have $60,000 in debt at average interest rates, the Standard Payment would be about $750 per month. It is a lot easier to prove that you cannot afford $750 per month versus $0 per month.
- For the second prong, the “future inability to pay” prong, the DOJ and DOE adopted a set of factors that, when true, raise a presumption that this prong is met. These include if the debtor is over 65 years old, if the loans have been in repayment for over ten years (COVID forebearances are included in the ten year period) and others. Even if the debtor does not have any of these factors, they can still prove the second prong by a variety of other factors, they are simply not strong enough to raise a presumption in favor of the debtor.
- For the third prong, the “good faith efforts to address the student loans” prong, the DOJ and DOE again list a variety of factors that can meet this prong successfully. Making payments on the loans, entering into forebearances and deferments, seeking enrollment in an Income Driven Repayment Plan and contacting the loan servicer for assistance all count. Perhaps most importantly, one factor is seeking professional advice to address your student loans. This includes your bankruptcy attorney, so it is rare that this prong is not met.
In order commence the process, an adversary proceeding is still required. You cannot file an adversary proceeding until after the underlying bankruptcy has been filed. If your bankruptcy case has been filed and has already been discharged, so long as it was pending on November 17, 2022 you are able to reopen the case and file the adversary proceeding. The adversary complaint, which is the document that advises the court of the relief you seek, in this case a discharge of the student loan debt, and the basis for that relief, must be served appropriately on the DOJ and DOE.
In other adversary cases, and historically true in student loan discharge adversaries, the parties would immediately go into “litigation mode”. Discovery would sought, depositions held, documents produced and interrogatories (legal questions about a case) answered. Once discovery was complete, the case would head to trial, it would be litigated and usually, the debtor would lose and the student loans would survive the bankruptcy.
Under the Guidance, however, this entire process changes as well. The DOJ has developed a document referred to as the Attestation. The Attestation is a 15 page form that you as the debtor must complete and provide to the DOJ attorney (known as the Assistant U.S. Attorney, or AUSA for short). This form provides the AUSA with the details of your financial circumstances and exactly how you meet the three prongs of the Brunner test. This Attestation, signed under oath by you, is then delivered to the AUSA along with proof of your income and any other supporting documents that you and your attorney believe will help prove your situation.
The AUSA will then review the Attestation, the supporting documents you and your attorney provided and the underlying bankruptcy case. During this review, the litigation process normally associated with an adversary proceeding is suspended. The DOE will also provide the AUSA with some documents, collectively called their “litigation package”. This is comprised of the DOE’s records, both their own and from their loan servicers, with the details of your student loan history. The AUSA will take all of this information under consideration, then make a recommendation as to what to do regarding the potential discharge of the student loans. They have three real options. They can recommend a full discharge, a partial discharge or determine that the borrower/debtor is not entitled to any stipulation of discharge.
The recommendation of the AUSA is then reviewed by the DOE, as they are ultimately the client and the Guidance says that they must work collaboratively to make these decisions. The DOE, at least so far, has substantially supported the recommendation of the AUSAs around the country. They then advise the AUSA of their position and the AUSA will contact your attorney with the decision. If a full or partial discharge is to be stipulated to, the AUSA will prepare a legal document, usually but not always a Consent Judgment, that is filed with the court to dismiss the adversary and discharge the agreed upon amount of student loan debt.
While complete data from across the country is difficult to track by any party other than the DOJ, and they have not released updated figures recently, indications are that adversary proceedings filed pursuant to the Guidance are extraordinarily successful. Approximately 70% of all adversary proceedings filed pursuant to the Guidance have resulted in a complete and total discharge of the student loan debt. Another 15% have resulted in a partial discharge of the debt, where some of the debt is eliminated while a balance (but not the entire balance, and that is the important part) survives the bankruptcy and remains due. From this, many believe that the remaining 15% of adversary proceedings are denied, but that is absolutely not the case for two primary reasons. First, after the COVID pandemic, there were several efforts made by the federal government to forgive student loan debt. Many of the early adversary proceedings under the Guidance were dismissed because the borrower received forgiveness under a different federal program and no longer needed the discharge. Second, many of the early cases were filed by pro se debtors representing themselves. Quite of few of these cases were dismissed, usually for failure to prosecute the cases properly. These two factors effectively mask that the success rate of these cases that are prosecuted properly is much higher than 85% percent.
The results of these cases are life changing. One consent judgment has been entered in cases discharging over $500,000 in student loan debts. There have been dozens eliminating over $100,00 in student loan debt. We can only imagine the feeling that these debtors had when their attorney advised them that their student loan debt has been discharged along with their other debt.
If you have student loan debt and are filing for bankruptcy, make sure you speak to an experienced bankruptcy attorney who will prosecute an adversary proceeding on your behalf. They at least should have an attorney on speed dial that they can refer your case to. The success rates are too high to be ignored and the impact it will have on your post-bankruptcy life cannot be overstated.
