personal finance

Discharge Student Loans In Bankruptcy? Courts Disagree — But Reform Could Be Coming

Recent bankruptcy decisions on discharging student loan debt have led to confusing and conflicting outcomes for borrowers. But efforts to reform the bankruptcy code to more easily allow student loans to be discharged in bankruptcy continue.

To discharge student loans in bankruptcy, most borrowers must show that they have an “undue hardship,” which is a difficult standard to meet and is not well-defined in statute. Bankruptcy courts have created legal “tests,” which vary by jurisdiction, to help judges determine whether a borrower meets the undue hardship standard.

But to prove undue hardship, borrowers must initiate an “adversary proceeding,” which is essentially a lawsuit against their student loan loan lenders brought within the bankruptcy case. The adversary proceeding can be a long and invasive process for borrowers, and it can be costly to retain an attorney to assist. Student loan lenders often have significantly more resources than borrowers, which can provide an advantage. Consequently, many student loan borrowers are not able to prove undue hardship, and many others decline to pursue the avenue at all.

Some borrowers have tried to get around the undue hardship standard. Earlier this month, the U.S. Court of Appeals for the Second Circuit ruled that a student loan borrower could discharge his private student loans in bankruptcy, following an adversary proceeding. Rather than proving undue hardship however, the borrower was able to prove that the private student loans at issue did not constitute an “educational benefit” within the meaning of the Bankruptcy code. The Court rejected the student loan holder’s argument that the Bankruptcy Code’s prohibition of discharging “obligation[s] to repay funds received as an educational benefit” encompasses nearly all private student loans. “If Congress had intended to except all educational loans from discharge [under this provision], it would not have done so in such stilted terms,” the appellate panel wrote in its decision. The Second Circuit’s ruling aligns with similar decisions in a handful of other jurisdictions, but the holding is narrow and applies only to certain private student loans. The vast majority of outstanding student loan debt is federal, or federally-backed.

In another recent development, the U.S. Supreme Court refused to hear a case on appeal that denied a bankruptcy discharge to a different private student loan borrower. That borrower filed an adversary proceeding not to show that she met the undue hardship standard, but to show that the private student loans were not “qualified education loans” within the meaning of the bankruptcy code (making similar arguments as in the Second Circuit case) due to questions and disputes about the exact cost of attendance, her status as a student, and her other applicable financial aid. However, the bankruptcy court rejected her arguments, and a federal district court and the federal Sixth Circuit Court of Appeals affirmed. The Sixth Circuit concluded that the plain language of the loan application and promissory notes clearly showed that these were student loans and, thus, were not dischargeable in bankruptcy, absent a showing of undue hardship. The Supreme Court’s refusal to take up the case effectively left the undue hardship standard intact.

The above cases show that while it is not impossible to discharge student loan debt in bankruptcy, it remains quite difficult for many borrowers. This is particularly true for federal student loan borrowers, who cannot necessarily use the same legal arguments utilized in the Second Circuit case to get around the undue hardship standard. These borrowers often also face crushing opposition from the Department of Education in adversary proceedings.

One solution would be for Congress to amend the bankruptcy code to altogether remove the undue hardship requirements for discharges of student loan debt. Earlier this year, Senate Democrats released the Medical Bankruptcy Fairness Act of 2021, which would allow borrowers to discharge their student loans through bankruptcy without having to prove undue hardship. The bill would simply amend the bankruptcy code and take out the section that treats student loan debt differently from other dischargeable consumer debts. Polling show that student loan bankruptcy reform is popular; a recent poll by Data For Progress indicated that 61% of respondents favored amending the bankruptcy code to treat student loan debt the same as other forms of consumer debt in bankruptcy.

This week, Senate Judiciary Committee Chairman Dick Durbin (D-Illinois) announced that the committee will hold a hearing on August 3 to address student loans and bankruptcy reform. Advocates for student loan bankruptcy reform praised the move.

“We’re grateful for Senator Durbin and the committee’s commitment to examine how Congress and the Department of Education can take meaningful steps to ensure that student loan borrowers facing bankruptcy are able to get a second chance and move on with their lives,” said Student Defense President Aaron Ament. 

Further Reading

Biden Administration Will Make It Easier For Student Loan Borrowers To Get A Mortgage

Biden Administration Announces Major Revamp Of Income Based Repayment, Student Loan Forgiveness Programs

Student Loan Mess Looms: Borrowers, Do These 6 Things By September

The Chances That Biden Extends The Student Loan Payment Pause Just Went Up — A Lot


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