As many of you may know, it is extremely difficult to discharge student loan debt in bankruptcy.
Bankruptcy exists as an ultimate safety net for consumers. The underlying premise and philosophy of bankruptcy is that sometimes bad things happen, people make mistakes, or consumers get in way over their head – sometimes with the best of intentions and through no fault of their own – and everyone deserves a fresh start and a second chance. But in today’s world, student loan borrowers are effectively locked out of this concept of a fresh start. Most student loan borrowers are unable to get their loans discharged through bankruptcy, and those that want to try must go through an entirely separate and grueling adversarial litigation proceeding, with low chances of success.
It wasn’t always like this. Decades ago, federal law allowed borrowers to include student loans in bankruptcy. To protect against fraud, there was simply a “waiting period:” borrowers couldn’t take out student loans, graduate from school, and then walk right into a bankruptcy court to discharge them. They had to be in repayment for years before their loans could be eligible for bankruptcy. But then, if they really could not repay their student loans, they could discharge them through bankruptcy.
Over the course of the 1990s and 2000s, however, Congress gradually whittled away bankruptcy protections for student loans – first for federal student loans in 1998 by eliminating discharge even after waiting periods, and then for private student loans in 2005. Congress also passed legislation requiring that student borrowers prove in court that an “undue hardship” prevents them from paying off their student loans in order for a bankruptcy discharge to be granted.
This “undue hardship” standard has become nearly impossible for borrowers to prove, because judges, relaying on a case called Brunner, must not only conclude that the borrower’s circumstances prevent them from repayment the student loan, but also that the borrower’s circumstances will persist into the indefinite future. In other words, judges must act like fortune-tellers. Can’t repay your loans because you don’t have a job? Well, you could get a good job in the future (theoretically), so no bankruptcy discharge for you. This is why many of the successful recent student loan bankruptcy discharge cases have involved borrowers who are older or have profound disabilities.
This may be starting to change, however. As reported in an analysis by the New York Times, judges are starting to buck the precedent. These judges point out that Brunner – the case that the “undue hardship” standard is based upon – was decided in the late 1980’s. This was during a time when federal student loans could be discharged in bankruptcy (you just had to go through a waiting period), and private student loans barely existed and could be discharged in bankruptcy without any waiting period. Furthermore, this was also before the astronomical rise in higher education costs and student borrowing that we have seen since the Brunner case was decided. Total outstanding student loan debt was nowhere near the $1.3 trillion that it is today. And the standard set by Brunner just does not make sense in this context.
So some judges have started to stray from the strict Brunner analysis, arguing in written, precedent-setting decisions that the standard currently in use by bankruptcy courts is too narrow, too restrictive, and does not reflect the current student debt environment. These judges are granting some student loan borrowers a discharge of their student loans in bankruptcy on this basis.
To be clear, these are a few judges in a few jurisdictions. Judicial precedent can take a very long time to get a foothold when it starts from the bottom-up (in individual bankruptcy courts) as opposed to the top-down (in the form of a Supreme Court decision or an act of Congress). This is not a rapid sea-change in the interpretation of the bankruptcy code in favor of student loan borrowers, but a few brave judges trying to adapt a very out-of-date precedent to the current environment.
Notwithstanding this incremental pace, I see these bankruptcy decisions as a sign of real movement in the bankruptcy sphere, and part of a larger, growing recognition in key decision-making and policy-making circles that our higher education financing system is broken. Congressmen and even the Obama administration have put forth proposals to relax the rules regarding the discharge of student loans in bankruptcy for the same reasons put forth by these “rebellious” bankruptcy judges in their decisions. I think – and hope – that these proposals, buttressed by well-reasoned decisions from a growing number of bankruptcy judges, will result in real student loan reform.