Navigating the Issue of Student Loan Discharge in Consumer Bankruptcy
With over $19 billion of student loan debt owed by Kentucky residents—on average each of the 600,000 Kentucky student loan debtors owes nearly $31,000—it is necessary to understand the mechanisms through which student loan debt can be discharged in bankruptcy and what the path forward looks like in light of pending federal legislation.
By Brian Fields, Student Fellow at Legal Aid Society. First published in the March 2022 issue of the Louisville Bar Briefs.
Amidst the ongoing debate surrounding federal student loan forgiveness, countless individuals across the country continue to feel the burden of student loan debt. According to a nationwide survey conducted by the Student Debt Crisis Center, approximately 44% of fully-employed student loan borrowers said they cannot afford their monthly student loan payments or are in loan default, with the economic outlook only worsening for these borrowers when the current moratorium on federal student loan payments expires on May 1st. With this and federal action on debt forgiveness up in the air, many individuals facing the hardship of student loan debt compounded by other economic difficulties will inevitably have to navigate the issue of student loan discharge in consumer bankruptcy. This article will discuss the current legal issues surrounding student loan discharge, some of the roadblocks to student loan discharge in consumer bankruptcy, and the racial justice elements of student loan reform.
Legal Aid Society represents individuals and families whose incomes are at or below 200 percent of the poverty guidelines in Jefferson County and 14 surrounding counties in Kentucky. Legal Aid provides counsel and advice on bankruptcy issues to eligible clients and also files Chapter 7 bankruptcy petitions for those who need them. Many of our clients’ economic hardships are compounded by student loan debt. With over $19 billion of student loan debt owed by Kentucky residents—on average each of the 600,000 Kentucky student loan debtors owes nearly $31,000—it is necessary to understand the mechanisms through which student loan debt can be discharged in bankruptcy and what the path forward looks like in light of pending federal legislation.
The Brunner Test
The ability to discharge student loans in bankruptcy is laid out in 11 U.S. Code § 523(a)(8), which states that a bankruptcy discharge “does not discharge an individual debtor from any debt…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.” The test for “undue hardship” is outlined in various federal circuits by the 1987 test established the Second Circuit case Brunner v. New York State Higher Education Services. This decision created a three-pronged showing required for the court to find that undue hardship existed: 1): that the debtor cannot maintain, based on current income and expenses, a minimal standard of living for themselves and dependents if forced to repay the loans 2) that 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) that the debtor has made good faith efforts to repay the loan.
The implication of this has been that a very limited number of debtors can successfully prove circumstances that satisfy these criteria. Only the most egregious circumstances permit discharge in jurisdictions using the Brunner test; long-term permanent disability, lack of job skills, or necessity of supporting several dependents as a full-time caretaker are several often-cited issues that may satisfy the criteria. Notably, these circumstances alone are not enough to successfully petition discharge. Debtors must still show good faith attempts to repay and the inability to maintain a minimal standard of living, with some courts requiring that debtors prove a “certainty of hopelessness” in ever being able to repay the loan. The effect is that many debtors, whose economic circumstances are serious enough to file bankruptcy, still don’t meet the current minimum threshold needed to discharge the student loans. These student loans, commonly in the six figures, will continue to burden them after other debts have successfully been discharged in bankruptcy.
Pending Federal Legislation
Although the Brunner test has created a stringent framework through which few individuals meet the necessary criteria to discharge student loans in bankruptcy, bipartisan legislation has been introduced to simplify the discharge process for student loans during bankruptcy. Senate Bill 5259 (Cornyn, R-TX, Durbin, D-IL), Fostering Responsible Education Starts With Helping Students Through Accountability, Relief, and Taxpayer Protection Through Bankruptcy Act of 2021 (the “FRESH START Act”) would allow for the easier discharge of student loans in bankruptcy. The bill would allow for the discharge of federal student loans for all individuals ten years after the first payment is due while still allowing the undue hardship standard established under Brunner both for private loans and for federal student loans that are short of that ten-year timeframe. The legislation would also increase accountability in higher education by requiring that institutions with more than one-third of their students receiving federal loans to partially reimburse the government if a student’s loan is later discharged through bankruptcy. This provision would incentive minimizing the number of students taking out loans, and hopefully encourage institutions to assist students in ensuring they avoid default. Most importantly, it would create an avenue for students who have no realistic path forward to pay back their student loan debt by using bankruptcy as a tool to discharge their debt.
Moving forward with federal legislation to allow for the discharge of student loans will provide relief to countless Americans suffering under the weight of student loan debt but who otherwise cannot satisfy the requirements of the Brunner test to prove undue hardship. Many individuals with high amounts of loans, who will likely never repay them but exist above the “minimal standard of living” presented in the Brunner test, would be able to take the step to discharge them through bankruptcy. The second prong of the Brunner test, which requires that additional circumstances exist indicating that this situation is likely to persist, has proven consistently difficult to satisfy, and allowing for discharge in bankruptcy would be a victory for individuals who may experience intermittent hardship that falls short of the standard that it is “likely to persist.” Determining which additional circumstances satisfy this portion of the test is fact-intensive and case-specific, resulting in variations in what hardships may satisfy the test among different courts. If the FRESH START Act were to pass, individuals would have at least one avenue of relief after ten years, regardless of the circumstances that have rendered them unable to pay. The result would be broader student debt relief, allowing for those who utilize bankruptcy and have struggled with long-term payments to have a better path forward without the weight of student loans.
Racial Justice and Student Loan Policy
Another reason that legislators are considering student loan bankruptcy reform is the student loan debt crisis’s disproportionate impact on minority communities. The looming burden of student loans exacerbates pre-existing racial wealth gaps. In 2013, 42 percent of Black families had student loans, compared to 28 percent of white families. Coupled with existing pay disparities among race and gender lines, creating a more robust legal tool to address student loan debt would benefit those who have historically faced disadvantages in education and the workforce. A recent study by think-tank The Century Foundation found that:
Black adults are almost twice as likely to have student debt as white adults.
The proportion of Black households taking on educational debt doubled between 2001 and 2013 and increased from 6 percent of total household debt burden for Black households to 20 percent, while the percent of debt coming from student debt in white households only grew from 4 percent to 8 percent
A recent study by the Brookings Institute found that Black B.A. graduates “default at five times the rate of white B.A. graduates (21 versus 4 percent)” even after adjusting for differences in degree attainment, college GPA, post-college employment, and institution type. Notably, Black B.A. holders are “more likely to default than white dropouts.”
A recent report further broke down the study by gender and found that in the 12 years after starting college, the median Black female borrower’s student loan balances grew by 13 percent. At the same point, the median white borrower owed only 60–65 percent of their original loan.
These data show that there is a clear disproportionate effect of student loan debt on borrowers of color. The current student debt crisis exacerbates underlying existing racial injustices that impact the economic well-being of minorities such as the racial wealth gap, racial pay disparities, and often unequal access to educational resources. While allowing for student loan discharge in bankruptcy won’t solve these issues, the current proposals in Congress would provide some tools to begin to alleviate this disparate racial impact in higher education by helping to reduce the burdens created by the student loan crisis.
Conclusion
While much of the current student loan debate focuses on federal student loan forgiveness, other mechanisms for relief such as bankruptcy can serve as critical tools for combating our student debt crisis. While the current legal framework allows for discharge in only limited cases, current proposals in Congress would allow for broader relief to address our national student debt. Allowing for easier discharge of student loans in bankruptcy would help relieve those weighed down by this burden while reducing the disproportionate impact that student loan debt has on low-income and minority borrowers.
As the legal profession continues to navigate the complex landscape of student loan debt issues, the Legal Aid Society will continue to advocate for vulnerable members of our community to ensure they receive much-needed legal assistance to help them achieve economic stability. With the federal student loan moratorium slated to end May 1st, the work of student loan debt assistance and broader economic relief will only become more vital. If you have a low-income client who needs assistance with a bankruptcy or consumer debt matter – or if you would like to volunteer to take on a bankruptcy case pro bono – please contact the Legal Aid Society at 502 584-1254.