Tag Archives: Student Loans

Why Is It So Difficult To Discharge Student Loans In Bankruptcy?

By Ryan C. Wood

Our media and politicians love to discuss and complain about student loan debt.  Student loan debt should be no different, better or worse, than home mortgages.  Home mortgages and student loans both allow someone to obtain something expensive now and pay for it later over a long period of time to make it affordable.  For homes it allows people who otherwise could not purchase a home purchase a home.  Student loans likewise allow someone to obtain an expensive education now that they cannot afford.  As long as the home appreciates in value the home loan is a good deal and there is a return on the investment.  Student loans are also supposed create a return on investment.  The problem is student loans are approved with no real analysis of the likelihood of the borrower paying them back.  What is the potential return on investment?  At the moment for student loans it does not matter.  Why scrutinize the borrower’s chances of paying the student loans back if the loan is federally subsidized and almost impossible to get rid of?  Why scrutinize the institution the borrower is attending.  

Brief Summary of the Problem Discharging Student Loans

Fake news and social media warps the truth. The truth is the Bankruptcy Code permits debtors showing undue hardship to discharge student loan debt when filing for bankruptcy. The problems is showing an undue hardship is dreadfully different depending upon what circuit you live in given the circuits are divided on how to determine whether undue hardship exists. The First Circuit and Eighth Circuit use the totality of the circumstances test. Many circuits, like the Ninth Circuit, use a three-part test developed by the Second Circuit in Brunner v. New York State Higher Education Services Corp., 831 F.2d 395, 396 (2d Cir. 1987). Then there is the application of the three-part Brunner test by circuits that apply Brunner. Application and results vary widely. According to many bankruptcy lawyers the Fifth Circuit is needlessly harsh in its application of the Brunner test rendering it virtually impossible to satisfy. This is why the Bankruptcy Code’s language providing for the discharge of student loan debt is fake news for most bankruptcy filers even though

Money Matters Given You Have to Sue the Student Loan Company to Prove Undue Hardship and Discharge Student Loans

Money matters when speaking about attempting to discharge student loans when filing for bankruptcy. A typical Chapter 7 Bankruptcy filer in the State of California is living paycheck to paycheck and has less than $10,000 in assets, not including their car or retirement account. How can a bankruptcy attorney get paid for suing the bankruptcy filers student loan company? With no guarantee of success and a client with almost no ability to pay their attorney to litigate whether their student loans are an undue hardship what happens? Lawsuits or adversary proceedings to try and discharge student loans are rare on this basis alone. In California we have Civil Code Section 1717 awarding attorneys fees and expenses to the prevailing party. What about if you lose and the student loan company is awarded their fees/expenses for the litigation? That is going to be anywhere from $15,000 – $60,000 added to whatever student loans must paid back post-discharge. The cost benefit analysis almost always on balance results in not suing the student loan company.

Income Based Repayment (IBR) and The Supreme Court of the United States

There is an appeal before the Supreme Court of the United States from the United States Court of Appeals of the Fifth Circuit; Thelma G. McCoy, Petitioner, vs. United States, Case No. 20-886. The facts of this include income based repayment and the three prong Brunner Test. Ms. McCoy’s student loan payments were set at $0.00 at the time she filed for bankruptcy and sued here student loan company due to being enrolled in an income based repayment plan. If she did not obtain a higher paying job she would not have to make a higher student loan payment in the future. Begs the question how can student loans be an undue hardship if the monthly payment is limited to $0.00 each month? If your income increases you may have to pay more than $0.00 each month. What is also missing in the fake news and social media is a discussion or analysis about all the programs in real world for those having problems paying back student loans. Depending upon the IBR program, after 25 years in the IBR program and making the required payments, the remaining principal and interest are cancelled. See Code of Federal Regulations; 34 C.F.R. 685.221(f)(2).

People Interpreting The Law Is Always The Problem

The U.S. Constitution from day one provided we are all entitled to equal protection under the law and due process.  How has that worked out?  It comes down to human interpretation.  It is almost always human interpretation of the law that is problem and not the law itself.  The argument begins at the macro level [President, Vice President, Senator, Congressman, Supreme Court] when the real issue is the interpretation of the law at the micro level [Gov. Employee, Administrative Judge, Attorney, Corporation].  Who are the one or two human beings that will make the interpretation of the law you are addressing at your level?  It is not the Supreme Court of the United States.  Not the President of the United States or any part of your elected Congress.  You need to be concerned about the decision making person that was never appointed by the President of the United States or ever elected to office.  This person was hired to do a job and their interpretation and opinion is the most important at your micro level. 

Brief History of Student Loans and Discharge When Filing Bankruptcy

The last major change to student loans and the ability to discharge student loans when filing bankruptcy was 2005.  The BAPCPA Bankruptcy A Protection Consumer Protection Act.

Section 523(a)(8) of the Bankruptcy Code provides:

(a)A discharge under section 727, 1141, 1192 [1] 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt—

(8) unless excepting such debt from discharge under this paragraph would impose an undue hardship on the debtor and the debtor’s dependents, for—

(A) (i)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 (ii)an obligation to repay funds received as an educational benefit, scholarship, or stipend; or

(B) 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;

Debt Not Excepted From Discharge Under § 523(a)(8)(A)(ii) Because it was Not an Obligation For “Funds Received”

Prior to the Bankruptcy Consumer Protection Act of 2005, the language of Section 523(a)(8) was different. The words “funds changing hands” or “funds received” are now a separate category delinked from the phrases “educational benefit or loan.”

Except from discharge means not dischargeable or not discharged. Debts excepted from discharge and types of debts that would normally be discharge but for specific law providing certain types of debts are not discharged or excepted from discharge. Student loans are general unsecured debts and generally unsecured debts are dischargeable.

Section 523(a)(8) excepts from discharge four types of student debt: (1) 523(a)(i) an educational benefit overpayment or loan made, insured, or guaranteed by a governmental unit; or (2) made under any program fund in whole or in part by a governmental unit or nonprofit institution, or (3) an obligation to repay funds received as an educational benefit, scholarship, or stipend; or (4) 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 that is an individual. Meridian concedes it is not a governmental unit and the credit is not a qualified education loan as defined by section 221(d)(1) of the Internal Revenue Code. So that leaves number (3) above. Christoff received two tuition credits totaling $11,000 and she signed a promissory note with interest of 9%. She agreed to repay the tuition credits upon graduation at $350 per month. Christoff did not receive any funds and did not complete the program and graduate.

In 2013, Christoff filed for bankruptcy protection under Chapter 7 and Meridian filed an adversary proceeding lawsuit to determine if the tuition credits are excepted from discharge under Section 523(a)(8). This case addresses the language of Section 523(a)(8)(A)(ii) which provides “an obligation to repay funds received as an educational benefit, scholarship or stipend” is excepted from discharge. Meridian argued that Christoff received a loan in the form of a tuition credit and received an education. Christoff’s bankruptcy attorney argued that she never received any funds from Meridian and Meridian did not receive any funds from a third-party financing source. Judge Montali focuses on the language “funds received” in Section 523(a)(8)(A)(ii). The Court analyzed a number of cases from other circuits and the Ninth Circuit regarding Section 523(a)(8). Again, the main distinction between the various cases and decisions is whether the debtor/student actually “received funds.”

In the Christoff case in the Northern District of California, Judge Montali ruled that because the debtor’s obligations arose from funds not received by the debtor or Meridian from any other source, the underlying debt is not covered by Section 523(a)(8)(ii) and eligible for discharge. On June 26, 2014, Meridian College appealed Judge Montali’s ruling to the Bankruptcy Appellate Panel, Case No. NC14-1336.

Hawkins v. Franchise Tax Bd. of Cal., 769 F.3d 662, 666 (9th Cir. 2014) The plain language of this prong of the statute (Section 523(a)(8)) requires that a debtor receive actual funds in order to obtain a nondischargeable educational benefit.” Cazenovia Coll. v. Renshaw (In re Renshaw), 229 B.R. 552, 555 n.5 (2d Cir. BAP 1999), aff’d, 222 F.3d 82 (2d Cir. 2000)) Again, no funds were received so Section 528(a)(8)(A)(ii) did not except from discharge the tuition credits Ms. Christoff received.


3rd Prong of Brunner Test: Good Faith Effort to Repay the Student Loans


The main issue in the case was the 3rd prong of the Bruner Test, good faith effort to repay the loans. Whether someone has made a good faith effort to repay the student loans is more complicated and involves more issues that just making a monthly payment. A thorough conversation with your bankruptcy attorney should be had regarding these issues. Good faith can be measured by student loan holder’s efforts to obtain employment, the type of employment, the level of pay of the employment. The good faith prong also involves the student loan holder expenses. Did they minimize their expenses? Are their expenses for certain things too high given their income? The good faith prong also evaluates whether the student loan holder took advantage of payment plan options of the student loan company.

It was found that Hedlund was maximizing his employment income with his current employment in Klamath Falls. Heldund had also applied to two higher paying jobs. The Court noted that Hedlund had attempted to take the bar exam unsuccessfully three times. Not that passing the bar would have increased his income. Next the Court reviewed Hedlund’s expenses and found that his clothing, recreation and miscellaneous budgets including childcare and haircuts could be reduced.

Again, the District Court reviewed the original trial case de novo and found that Hedlund had not used his best efforts to maximize his income or minimize his expenses. The District Court notably criticized Hedlund for choosing to live as a single-income family, “a lifestyle that few today an afford.” Hedlund v. Educ. Res. Inst. Inc, 468 B.R. 901, 916 (D. Or. 2012). In the end the District Court should have reviewed the good faith prong of the test for clear error. The Ninth Circuit Court of Appeals found there was not clear error in the original bankruptcy court’s judgment to partially discharge Hedlund’s student loans.

Tuition Credits are Not a Student Loan and Dischargeable When Filing Bankruptcy

By Ryan C. Wood

You have probably heard over and over that student loans are not dischargeable in bankruptcy unless you can prove that repaying the student loans constitutes an undue hardship for you. That is still the case. 11 U.S.C. 523(8) excepts from discharge (A)(i) an education 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 (ii) an obligation to repay funds received as an education benefit, scholarship, or stipend; or (B) any other educational loan that is a qualified education loan, as defined in §221(d)(1) of the Internal Revenue Code of 1986, incurred by a debtor who is an individual. This means if your student loans fall into any of the above categories the debt is not dischargeable in your bankruptcy case and you will still owe the funds after your case is closed unless you can prove undue hardship by filing an adversary proceeding.

Although the statute above may seem daunting there may be hope. In a recent case, In re: Christoff, Bankruptcy Case No. 13-10808DM, Northern District of California (2014), the court held that the debts held by Ms. Christoff were never received by her and therefore are not excepted from discharge by 11 U.S.C. §523(a)(8) and were discharged in her Chapter 7 bankruptcy case. In this case, Ms. Christoff attended the Institute of Imaginal Studies dba Meridian University (“Meridian”). She was awarded $6,000 in financial aid to pay for some of her tuition. She signed a promissory note. She did not actually receive any funds from Meridian though. Instead, what she received was a tuition credit. The terms of the note required her to pay back the funds at $350 per month after she finishes her coursework or she withdraws from Meridian along with 9% interest to be compounded monthly. She received another $5,000 in tuition credit the following year after signing a promissory note with the same terms. She withdrew from Meridian after completing all her coursework and clinical hours but before she completed her dissertation. She filed for Chapter 7 bankruptcy protection in August 2013 and Meridian filed an adversary proceeding to determine that the amount owed to Meridian was nondischargeable under 11 U.S.C. §523(a)(8) as a student loan.

The court in this case thoroughly examined student loan cases throughout the Ninth Circuit and other circuits. What is important to bankruptcy lawyers is what differentiates this current case with all other student loan cases is the fact that Ms. Christoff never received the funds from Meridian nor did Meridian receive funds from any other source. Ms. Christoff received a “credit” towards her education to be paid back at a later time. Both parties agreed that Meridian was not a governmental unit so they did not fit into §523(8)(A)(i). They also agreed that Meridian did not fit into §523(8)(B). Therefore the only avenue to except the debt from discharge is §523(8)(A)(ii). The entire case hinged on whether the funds were received as an education benefit, scholarship or stipend. The court determined that since there were no funds received in Ms. Christoff’s case, the debt did not fit into §523(8)(A)(ii) either and therefore the debt was dischargeable in her bankruptcy case.

What is interesting to note in this case as well is the fact that the court looked to one case, In re Oliver, 499 B.R. 617 (Bankr. S.D. Ind. 2013) where a university withheld a student’s transcript because she did not pay the tuition or related fees. The Oliver court indicated that to be excepted from discharge, the debt must still be a loan. Therefore if you did not borrow money to pay the tuition (i.e: you pay for it yourself without borrowing money from a governmental entity, private student loan company, from the school itself, or from any other third party) the debt does not fit into any of the above exceptions to discharge and is therefore dischargeable in a bankruptcy. This court completely agreed with the Oliver court in their analysis and conclusion. Meridian’s bankruptcy attorney appealed this case on the same day the decision came out so we may or may not have the same result later on. We will follow continue to monitor this case and will report on the outcome of the appeal.

Legislation May Allow Private Student Loans to be Discharged in Bankruptcy

By Ryan C. Wood

Student loans are currently non-dischargeable in bankruptcy. What this means is that even if you file for bankruptcy you will still have to pay for your student loans after receiving a discharge in the bankruptcy case. They do not get wiped out along with all your other discharged unsecured debts. This rule applies to both federal subsidized and private student loans. See 11 U.S.C. §523(a)(8).

One form of limited relief from this strict rule is what is called the Brunner Test adopted by some of the circuit courts. This test was taken from Brunner v. New York State Higher Education Services, 831 F.2d 395 (2nd Circuit, 1987). The Brunner Test states that student loans will be dischargeable if (1) you cannot maintain, based on your current income and expenses, a minimal standard of living if you are forced to repay the student loans, (2) these circumstances are likely to continue for a significant portion of the repayment period for the student loans, and (3) you have made good faith efforts to repay the loans. The courts have taken a very strict approach when determining whether the student loans are discharged. This three prong Brunner Test is very hard to pass for most people. It is very frustrating as a bankruptcy lawyer to not be able to provide complete relief for people who really need it. That is includes the burden of educational loan debt they cannot afford.

On February 6, 2013, Tennessee Democratic Representative Steve Cohen introduced H.R. 532 in the House of Representatives. There are currently 29 other Democratic cosponsors for the bill. The bill is called the Private Student Loan Bankruptcy Fairness Act of 2013. This bill will essentially render private student loans dischargeable with all the other unsecured debts such as credit card debt, medical bills, personal loans, and payday loans. There is no need to prove undue hardship. This bill says nothing about the federal student loans though, so they will still be non-dischargeable in bankruptcy even if this bill passes. H.R. 532 will undo the changes that the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005 brought. Prior to BAPCPA, private student loans were dischargeable in bankruptcy along with all other general unsecured debts. Only federally subsidized student loans were non-dischargeable at that time.

The Private Student Loan Bankruptcy Fairness Act of 2013 could provide needed debt relief for people with huge student loan debts. Student loan debts are currently out of control and are a burden for many recent graduates that have a lot of debt and cannot find a job. H.R. 532 has currently been referred to the Subcommittee on Regulatory Reform, Commercial and Antitrust Law. If the bill makes it past the committee it will be presented for a vote in the House of Representatives. The House has more Republicans than Democrats so we would need some of these Republicans to vote for the bill in order to pass. If you support this bill I would highly recommend you contact your representatives to vote for the bill. Public pressure goes a long way.

If the Private Student Loan Bankruptcy Fairness Act of 2013 becomes the law of the land and you have a lot of private student loans to discharge, you should immediately contact an experienced bankruptcy attorney to help you discharge those student loans in your area.