Treatment Of Student Loans In Bankrupty
Prior to 2005, private student loans were treated as unsecured debt and essentially discharged at the close of the bankruptcy while the federal student loans required a showing of undue hardship to qualify for discharge. However, in 2005, Congress changed the characterization of private student loans to mirror that of the federal student loans. Accordingly, the discharge of any student loan debt (with a few unique exceptions) is now contingent upon a showing by the debtor that the repayment of the loan(s) will cause an undue hardship to you and your dependents. What this means for debtors is the days of discharging private student loans by simply listing them as unsecured creditors are over. Now, absent certain exceptions, you must meet the undue hardship standard as set out by the Bankruptcy Code.
The Standard Of “Undue Hardship”
Undue hardship has long been the standard for proving the dischargeability of federal student loans. Now that it applies to both private and federal loans, its effect is more sweeping. The Bankruptcy Code specifically lists undue hardship as the standard.
- 523(a)(8) of the Code states: “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;
(A)(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.”
This exception for undue hardship applies to all federal and private student loans. Proving that you meet this criteria for undue hardship is a very difficult task. Historically, many federal courts have applied a three-pronged analysis to determine if there is indeed an undue hardship. The analysis came out of Brunner v. New York State Higher Educ. Servs. Corp., 831 F. 2d 395 (2d Cir. 1987).
The Brunner Test
The Brunner test requires the debtor to show that 1) the debtor cannot maintain, based on current income and expenses, a “minimal” standard of living for the debtor and the debtor’s dependents if compelled to repay the student loans; 2) additional circumstances exist in such a way that they are likely to continue, without improvement, 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.
With regard to the first condition, the bankruptcy court reviews your complete financial status to determine if you could sustain a minimal standard of living if required to repay your student loans. Secondly, the courts analyze your current situation and determine what improvements, if any, you may experience over the life of the repayment period. Finally, to determine the third prong of the Brunner analysis, the courts will look into your payment history over the life of the student loans, whether you have attempted to lessen your expenses, and whether you have attempted to obtain better or additional employment.
Ultimately, meeting the Brunner test has been described as showing a “certainty of hopelessness.” Keep in mind though that even if you cannot meet the standard to get all of your student loan debt discharged, some courts will allow a partial judgment for discharge of your student loans. In general, you should go into your bankruptcy prepared to have the student loan debt survive discharge as meeting the Brunner test of showing undue hardship is extremely difficult.
So, while private student loans used to be dischargeable like any other unsecured loan, they’re now subject to the same tough standards as federal student loans.
Exceptions To The Undue Hardship Standard
While you generally have to meet the undue hardship standard to have your private student loans discharged, there are certain exceptions. These exceptions turn around the idea that you were sold an education that would never have offered you any benefits.
If the private student loans were not for an eligible educational institution or the loans were not for a qualified higher education expense you may be able to discharge them. For example, if you have private student loan debt used for an unaccredited school, you may be able to discharge this private loan in a Chapter 7 bankruptcy. If the school is unaccredited, it doesn’t qualify for the same rules that govern loans for accredited schools. Similarly, you may be able to discharge a loan if the school falsely certified that you were qualified for it. The school that certifies the loan is responsible for ensuring that you meet the requirements for certification. If it fails to do so and you’re falsely certified for the loan, you may be entitled to a discharge in bankruptcy. For example, if you were granted a loan for a program that requires a clean criminal background when you had multiple felony convictions, you never could have benefited from the education and the loan may be discharged.
The Automatic Stay
When you file a bankruptcy, you get a legal protection called the “automatic stay.” The automatic stay forces all creditors to stop all collection efforts. Even if your debt is not going to be discharged, the automatic stay will stop collection for the duration of the bankruptcy. That means the government can’t start or continue garnishing your wages, nor can it withhold your transcripts for unpaid tuition and fees. The automatic stay won’t prevent a student loan creditor from conditioning the availability of future loans on the satisfaction of those loans due prior to the filing of the bankruptcy. The creditor also has the option of filing a motion to lift the automatic stay during the bankruptcy. If the court grants the motion, the creditor can proceed as they could prior to the bankruptcy filing.
How to Get Your Discharge
If you are involved in an active bankruptcy and seek to discharge your student loans, then according to Rule 7001(6) of the Federal Rules of Bankruptcy, you or your attorney if you have one, should file an adversary proceeding against the creditor of the student loan. Whether you are in a Chapter 7 or Chapter 13 bankruptcy could affect the time within which you should file this action. Most jurisdictions will allow you to file the adversary proceeding during bankruptcy or even after your bankruptcy closes.
Working with an experienced California bankruptcy attorney can make the difference between a lifetime of student loan debt and a complete discharge. Bankruptcy rules are complicated and small errors can have big consequences. Contact one of our experienced attorneys today for a free consultation to learn how we can help you manage your student loan debt. For some people, bankruptcy will be the best option. For others, student loan consolidation or rehabilitation may be the right choice. For still others, adjusting the student loan repayment plan is all it takes to make the load manageable. If you’re already in default on your student loans, we can help you manage that, too. We understand how tough it is to deal with student debt – lawyers have to get through a lot of years of school. We’re standing by to help you get out from under the burden of student debt and start your life with a clean financial slate.
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