The Bankruptcy Code’s (and the Courts’) Treatment of Student Loans Is the Gift to Lenders That Keeps on Giving

Discharging Student Loan Debt in California BankruptcyIn 1976, Congress amended the Bankruptcy Code to make government backed student loans nondischargeable in bankruptcy unless the debtor could prove that being forced to repay her student loans would impose an “undue hardship.” This exceptional treatment of student loan debt ran counter to the general principle of bankruptcy law to favor a fresh start for the debtor and constituted special, preferential treatment for student loan lenders. In fact, this change was a solution in search of a problem, as the congressional record from the time shows that Congress was relying on just a few anecdotes of perceived abuse by students who had never attempted to repay their loans and ignored the empirical evidence then supplied by the General Accounting Office that less than one percent of student loans had previously been discharged in bankruptcy.

In 2005, when Congress passed the sweeping pro-creditor changes to bankruptcy law contained in the BAPCPA, Congress made even private student loans nondischargeable without a showing of “undue hardship.” This subversion of the Bankruptcy Code’s favoring of discharge of prebankruptcy debts was nothing but a shameless giveaway to the private student loan industry, according student loan lenders special treatment not given to any other type of creditors. Moreover, because “undue hardship” was never defined by Congress, the bankruptcy courts were left to create their own judicial test for what constitutes “undue hardship” sufficient to discharge student loans.

Debtors filing bankruptcy in California who seek to discharge student loans must prove “undue hardship” by proving all three prongs of the “Brunner Test” as the Ninth Circuit adopted the Brunner test in 1998 in the case In re Pena.  This means that the bankruptcy debtor must file an adversary proceeding in his bankruptcy case and litigate whether his student loans should be discharged. The burden of proof is on the bankruptcy debtor, and he must prove by a preponderance of the evidence three separate prongs contained in the Brunner Test, namely: “(1) that the debtor cannot maintain, based on current income and expenses, a ‘minimal’ standard of living for herself and her 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 loans.” In re Brunner, 831 F.2d at 396.

By giving student loan lenders such special treatment, Congress and the bankruptcy courts have denied tens of thousands, perhaps hundreds of thousands of honest debtors the fresh start free of debt that bankruptcy is intended to provide. It is impossible to know how many debtors might have obtained a discharge of their student loans because I believe the vast majority of bankruptcy debtors with student loans simply cannot afford to litigate the issue of whether their student loans might be discharged. Most consumer bankruptcy attorneys in California are solo attorneys or very small firms that cannot afford to litigate these cases pro bono, and their clients, especially the ones who might just win a discharge of their student loans simply choose not to fight this costly fight.

Apart from the barrier to discharge imposed on student loan debtors created by the necessity of costly bankruptcy litigation, the other problem with student loans in bankruptcy is that the Brunner Test is as clear as mud. Reading the Ninth Circuit cases interpreting and applying the Brunner test (e.g., inter alia, In re Pena, In re Nys) the bankruptcy attorney cannot help but conclude that the bankruptcy court’s application of this test is an exercise in subjective speculation by the judge about each debtor’s present and future circumstances.  The student loan debtor’s chances of proving “undue hardship” and thereby obtaining a discharge of his student loans in bankruptcy are nothing but a very expensive gamble.

Today, Americans are saddled with over $1 Trillion in student loan debt. The rise of for-profit colleges and their aggressive peddling on television and elsewhere have encouraged millions of Americans to take out large student loans while graduating them with dubious skills and slim chances of earning enough to pay off their student loans. Private student loan lenders are largely unregulated, charge high interest, and are unsympathetic to borrowers who need lower interest and consolidation options. In this bankruptcy attorney’s view, the treatment by the Bankruptcy Code and by the courts of student loans represents an ongoing giveaway to student loan lenders, and coupled with the impending crisis over the sheer amount of student loan debt in this country and the rise of unscrupulous for-profit schools, represent a coming “perfect storm” for our ever shrinking middle class.

For a free consultation with experienced consumer bankruptcy lawyers in San Jose, California, contact us. We’ll be happy to review your entire financial situation and give you our honest opinion about whether filing bankruptcy might help.

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