Student Loans In Bankruptcy

Here is a brief outline of a recent presentation that I gave to the American Bankruptcy Law Forum:

When Can Student Loans Be Discharged in Bankruptcy

The Special Restriction on Dischargeability Applies to Most Student Loans

• Chapter 7 eliminates most of a debtor’s unsecured debts with certain statutory exceptions.
• 11 U.S.C. 523(a)(8)
  • Unless excepting such debt from discharge under this paragraph would impose an undue hardship on the debtor and the debtor’s dependents, for—
  • • an educational benefit overpayment or loan made, insured, or guaranteed by a governmental unit, or made under any program funded in whole or in part by a governmental unit or nonprofit institution; or
    • an obligation to repay funds received as an educational benefit, scholarship, or stipend; or
  • Any other educational loan that is a qualified education loan, as defined in section 221(d)(1) of the Internal Revenue Code of 1986, incurred by a debtor who is an individual;
• So, what is covered by 11 U.S.C 523(a)(8)
• Stafford Loans, supplemental student loans, Federal Direct loans, Perkins loans, loans made by state agencies and nonprofit organizations. See TI Fed. Credit Union v. DelBonis, 72 F.3d 921; In re Roberts, 149 B.R. 547; In re Reis, 274 B.R. 46.
• Educational benefit overpayments (Pell grant overpayments), and obligations to repay funds received as educational benefits, scholarships, or stipends. See In re Burks, 244 F.3d 1245; U.S. Dep’t of Health & Human Servs; V. Smith, 807 F.2d 122; In re Coole, 202 B.R. 518.
• Most loans by private for-profit lenders. See 11 U.S.C. 523(a)(8); 26 U.S.C. 221(d)(1).
• 22 U.S.C. 221
• (d) Definitions
• For purposes of this section—
  • (1) Qualified education loan
    The term “qualified education loan” means any indebtedness incurred by the taxpayer solely to pay qualified higher education expenses—
    • which are incurred on behalf of the taxpayer, the taxpayer’s spouse, or any dependent of the taxpayer as of the time the indebtedness was incurred,
    • which are paid or incurred within a reasonable period of time before or after the indebtedness is incurred, and
    • which are attributable to education furnished during a period during which the recipient was an eligible student.

Private Student Loans Not Dischargeable if:

• Student loans which the taxpayer may a deduction for interest paid on the student loan.
• These educational expenses must be incurred on behalf of the taxpayer, the taxpayer’s spouse, or any dependent of the taxpayer.
• To qualify for the tax deduction the indebtedness must be “incurred by the taxpayer solely to pay qualified educational expenses.
  • Mixed use loans are not excepted from discharge.
    • Loans that cover “cost of attendance”.” See 11 U.S.C. 221(d)(2).
  • Room, board, books, supplies, computer
    • (2) Qualified higher education expenses
      The term “qualified higher education expenses” means the cost of attendance (as defined in section 472 of the Higher Education Act of 1965, 20 U.S.C. 1087ll, as in effect on the day before the date of the enactment of the Taxpayer Relief Act of 1997) at an eligible educational institution, reduced by the sum of—
      • the amount excluded from gross income under section 127, 135, 529, or 530 by reason of such expenses, and
      • the amount of any scholarship, allowance, or payment described in section 25A(g)(2).
    • For purposes of the preceding sentence, the term “eligible educational institution” has the same meaning given such term by section 25A (f)(2), except that such term shall also include an institution conducting an internship or residency program leading to a degree or certificate awarded by an institution of higher education, a hospital, or a health care facility which offers postgraduate training.
  • Essentially “cost of attendance” is left up to the institution.
    • Loans used at an Eligible education institution.
  • If Institution is not an eligible education institution loans are dischargeable in bankruptcy.
    • Eligible institutions are defined as institutions that are eligible to participate in Title IV programs.

Some Education Debts Should be Dischargeable

• Employer pay off of loans for employee education are dischargeable. See In re Segal, 57 F.3d 342; In re Hawkins, 317 B.R. 104.
• When the creditor fails to establish the existence of a “loan” involving a transfer of funds and a formal agreement specifying repayment terms. See In re Chambers, 348 F.3d 650.

Refinanced Student Loans in Bankruptcy

• 22 U.S.C. 221(d)(1) defines a “qualified education loan” as including “indebtedness used to refinance indebtedness which qualifies as a qualified education loan.”
• Refinanced loans may be dischargeable if refinanced loan is a “mixed use” loan. See 26 C.F.R. 1.221-1.

Burden of Proof and the Student Loan Dischargeability Exception

• Debtor to file an adversarial action to determine dischargeability.
• Burden of proof falls upon the creditor regardless of who files
• Preponderance of the evidence
• Evidence narrowly construed against the creditor

Parents and Other Co-Signers

• Arguments for the discharge of debt for co-signers
• The debts were “educational loans” because the co-obligors did not use the loan proceeds for their own educational benefit.
• Granting the discharge furthers the “fresh start” goal of bankruptcy.
• The legislative history of the discharge exception focused on students about to embark on high paying careers, not their parents
  • Court rejected all arguments for discharge. See In re Pelkowski, 990 F.2d 737.

Determining Undue Hardship as a Basis for Discharge

A student loan may be discharged if payment of the debt “will impose an undue hardship on the debtor and the debtor’s dependents.” 11 U.S.C. 523(a)(8)(B).

• Brunner Test – 3 prong test to show hardship
• (1) Showing that the debtor cnnot maintain, based on current income and expenses, a “minimal” standard of living for the debtor and the debtor’s dependents if forced to repay the student loans
• (2) 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
• (3) The debtor has made good faith efforts to repay the loans.

Brunner “Undue Hardship” Test

• The first prong: the debtor’s current income and expenses
• courts often reiterate that the Bruner quote minimal standard of living quote does not require the debtor to live in poverty. See In re Hornsby, 144 F.3d 433.
  • It may be helpful to present evidence that the debtor’s actual living expenses are below certain national standards for allowable living expenses. See in re Brown, 378 B.R. 623.
  • The basic purpose of this prong of the test is to ensure that, after borrowers have provided for their basic needs, they do not allocate discretionary income to the detriment of student loan creditors.
  • The first Bruner prong looks at whether the debtor can repay the loan and provide a minimum standard of living not only for the debtor but also for the debtor’s dependence.
    • The second prong: additional circumstances indicate current hardship likely to continue
  • Under this prong the court evaluates quote additional circumstances quote that make more likely than not the debtor’s current state of affairs will continue for the remainder of the loans repayment term.
  • Our court has held that a debtor must show that circumstances indicate a certainty of hopelessness, not merely a present inability to fulfill financial commitment. See In re Douglas a Wallace Junior, 443 B.R. 781.
    • Requires debtors to prove a negative
    • It suggests a burden of proof must stricter than the preponderance of evidence standard.
      • The third Bruner prong – good faith
  • The third prong of the Bruner test requires that the borrower show good faith attempting to repay the loan
  • Under the standard the court will assess whether the debtor willfully or negligently cause the default.
  • The core may also consider whether the debtor fell into default due to conditions that were reasonably beyond his control.
  • In order to satisfy the good-faith test, it is not essential that the debtor have actually made any payments. See In re Mosley, 494F.3d 1320.
    • Other hardship factors
  • a student’s undue hardship argument may be stronger when the student loan arose from a proprietary school that closed down or defrauded the student.