On February 21, 2018, the U.S. Department of Education (the “Department”) published a Request for Information (“Notice”) seeking input on whether the Department should modify current restrictive standards that often prevent bankrupt student loan borrowers from getting their debt discharged. Affected parties such as lenders, servicers, colleges, and consumer groups should consider filing comments on this question, which has been the subject of vigorous debate for decades.
The question of whether bankrupt borrowers should be able to escape their student loan indebtedness pits the need to maintain fiscal integrity in the federal and private student loan programs and to keep the programs widely accessible against the debt-relief objectives underlying the U.S. bankruptcy system. Comments in response to the Notice are due by May 22, 2018.
The U.S. Bankruptcy Code currently provides for the discharge of student loans in bankruptcy only in circumstances where the debt would impose an “undue hardship” on the borrower and his or her dependents. See 11 U.S.C. § 523(a)(8). Several legislative proposals to modify the undue hardship requirement have been introduced in recent years but none have become law.
While one might expect that families in bankruptcy would be able to readily show undue hardship, the legal standard constructed by the federal courts instead imposes burdens of proof that many bankrupt borrowers are unable to meet.
Just recently, the Chairman of the Federal Reserve questioned whether there is a good rationale for barring the discharge of student loan debt in bankruptcy. In a March 1, 2018, appearance before the Senate Banking Committee, Chairman Jerome Powell was asked whether student debt creates “a drag on the economy.” His response observed that “alone among all kinds of debt we don’t allow student loan debt to be discharged in bankruptcy,” and he went on to say that “I’d be at a loss to explain why that should be the case.” Whether Chairman Powell’s observation is a harbinger of pending Department action to relax the standards remains to be seen, but the Notice clearly indicates that the issue is being reexamined.
The legal impediments that make it difficult for bankrupt families to get relief from their student loan debt are deeply entrenched in our judicial system. Because Congress used the words “undue hardship” in the statute without defining them, it was left to the federal courts to articulate the applicable standard. The courts have articulated two separate pathways for proving undue hardship. Under the first standard, the debtor must establish 1) an inability to maintain a minimal standard of living if forced to repay the loans; 2) that the state of affairs is likely to persist throughout the life of the loans; and 3) that good faith efforts were made to repay the loans. Brunner v. New York State Higher Educ. Services Corp., 831 F.2d 395 (2d Cir. 1987). Under a separate pathway, the court examines the “totality of circumstances” affecting borrower hardship, including the debtor’s past, present, and future financial resources, living expenses, and other relevant facts. Long v. Educ. Credit Mgmt. Corp., 322 F.3d 549 (8th Cir. 2003). As is often the case where federal courts adopt varying legal standards, which pathway applies to a particular court case is a function of geography. However, the Brunner test is used in the majority of federal courts.
Under either legal formulation, the burden is on the debtor to come forward with evidence establishing undue hardship under multiple criteria and with regard to past, present, and future circumstances. Debtors often lack the resources needed to martial the required evidence. Moreover, even for borrowers facing extreme financial hardship, uncertainty about whether their debt will ever be discharged can be a deterrent that keeps them from pursuing relief in court. These impediments have prompted calls for a rebalancing of the tension between the priorities of protecting the federal and private student loan programs and of recognizing undue hardship that warrants relief for bankrupt borrowers.
In July 2015, the Department attempted to clarify the undue hardship process by publishing a Dear Colleague Letter for use by guarantors and educational institutions when evaluating whether to object to undue hardship claims. The guidance sought to refine the undue hardship analysis by listing eleven factors, some quite complex, while cautioning that the list was “by no means an exhaustive list of factors that are appropriate for consideration” and that the list was not “a determination as to how much, if an, discovery is needed to conduct the analysis required.” As one might expect, this complicated and uncertain formulation did not result in any substantial expansion of the bankruptcy discharge pathway.
This year’s Notice appears to be a tacit acknowledgement that the July 2015 guidance failed to clarify or alleviate the confusion and uncertainty faced by bankrupt borrowers, and that the question needs to be revisited. The Notice has triggered a substantial response. With still two months to go before the May 22 comments deadline, the Notice had already triggered more than 250 written comments. While the vast majority of those comments are from consumers seeking relaxation of the undue hardship standard, that perspective is not exclusively the domain of consumer advocates. One major student loan servicing company has weighed in with consumers, stating publicly that it favors “[b]ankruptcy reform that allows federal and private student loans to be discharged after a good faith effort to repay.” Given the interests and equities that are being reexamined by the Department, stakeholders should consider joining in this public discourse by filing comments in response to the Notice.
Stan Freeman is the founder of the Powers Education Practice Group and focuses full time on the representation of colleges, universities, and other education companies and concerns on regulatory and transactional matters. Stan can be reached at 202-872-6757 or at stan.freeman@powerslaw.com.