DISCHARGE STUDENT LOANS IN BANKRUPTCY – IS IT POSSIBLE?
There are many types of debts a Bankruptcy will discharge. Generally speaking, subject to exceptions, unsecured debts are dischargeable while secured debts are not. As a reminder, secured debt is the type of debt that is secured with collateral. A car, home or refrigerator you bought at Best Buy are all secured debt. They can be physically taken away from you. Unsecured debt on the other hand is secured only by your signature – in other words, no collateral. Credit cards, pay day loans, medical and dental bills are typical unsecured debts.
With that in mind, it would seem that student loans should be viewed as unsecured, and thus fall into the dischargeable unsecured loan category. Well, in law there are always exceptions, and unfortunately for many students looking to escape a loan often times larger than a home mortgage — student loans are one of them. To understand why student loans are viewed differently we need to travel back in time.
THE BACK STORY
On November 8th, 1965, Lyndon Johnson signed the Higher Education Act of 1965 which in part established the Guaranteed Student Loan Program (hereafter Program). A large component of the Program was designed to enable college students to have easy access to low interest rate loans. Under the Program, educational loans from various types of lenders such as banks, credit unions and educational institutions were insured by the United States Department of Education or by state agencies or nonprofit organizations and reinsured by the Department of Education. If the student borrower failed to make repayments because of death, disability or discharge in bankruptcy, the lender was entitled to repayment from the federal government.
These loans – now fully backed by the Department of Education – were originally entitled to full discharge in bankruptcy. As you can imagine, the temptation was too great for many student debtors to resist and soon there was a perceived rise in recent graduates filing for bankruptcy. Since a new graduate usually had little, if any non-exempt property that would be distributed to creditors, a bankruptcy was a relatively painless and inexpensive way to avoid repayment of their educational debt. The end result was free college tuition. Aside from contravening general public policy, these bankruptcies began to call into question the solvency of the Guaranteed Student Loan Program and its future viability.
The Bankruptcy Reform Act of 1978 was a direct response to these abuses, adding a provision which severely restricted the dischargeability of student loans. That provision, section 523(a)(8)currently provides that an educational loan is not dischargeable in bankruptcy “unless excepting such debt from discharge … would impose an undue hardship on the debtor and the debtor’s dependents.” To complicate matters, the Bankruptcy Code does not define “undue hardship” nor did Congress explain how to apply the new provision to determine when a hardship qualifies as “undue.” What is clear is that undue hardship is not a mere inconvenience, loss in standard of living, or temporary inability to pay, such as unemployment.
There are currently two tests that various courts of appeals have applied when determining what constitutes an undue hardship under section 528(a)(8). The first and most widely adopted is the three-part test in Brunner v. New York State Higher Education Services Corp., 831 F.2d 395,396 (2d Cir. 1987). It has currently been adopted by the 2nd, 3rd, 5th, 6th, 7th, 9th, 10th and 11th circuit courts. What this means is that if you live in Kansas – a 10th circuit state – the judge will be required to apply the Brunner test if you are looking to discharge your student loan debts.
The three-part Brunner test requires the debtor to prove:
(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. 831 F.2d 395, at 396
The other undue hardship test, adopted solely by the Eighth Circuit is called the “totality of the circumstances.” See Andrews v. S.D. Student Loan Assistance Corp. (In re Andrews), 661 F.2d 702, 704 (8th Cir.1981). I may discuss it in the future, but since it is out of step with most of the country I am only mentioning it now.
HOW DOES THIS APPLY TO YOUR SITUATION?
Everyone’s situation is unique and will need to be evaluated by an attorney. Generally speaking, if you are permanently disabled you may wish to file an adversarial hearing to determine the dischargeability of your student loans. At the adversarial hearing you will be asked to provide evidence of the nature of your disability and your ability to pay it in the future. There is a presumption that you can pay, so the evidence will have to overcome this presumption. If you pass the Brunner test, the judge has discretion to dismiss your student loans in bankruptcy.
THERE ARE ALTERNATIVES
Aside from filing an adversarial hearing in bankruptcy, you may be able to get your student loans dismissed based on permanent and total disability. A new, less restrictive discharge standard just went into effect on July 1st, 2010. To quote directly “As of July 1, 2010, this discharge requires certification from a doctor that you are unable to work and earn money because of an illness or injury that is expected to result in death, last for a continuous period of not less than 60 months or can be expected to last for a continuous period of not less than 60 months (5 years). This is more restrictive than many other federal disability programs, but as of July 1, 2010, it is less restrictive than the prior standard. In addition, veterans who have been determined by the Secretary of Veterans Affairs to be unemployable due to a service-connected condition qualify for this discharge without having to provide additional documentation from a doctor. The Department has released a letter with more information for veterans applying for this discharge.”
All federal loan borrowers are eligible for this discharge. For more information, including a downloadable self-help packet, I strongly recommend going here.
To schedule your free initial consultation with a committed and dependable lawyer, call 800-768-8036. We are open Monday through Friday from 9 to 5, as well as evenings and weekends.
Chris W. Steffens, Attorney at Law
The Law Offices Of Garrett & Coons
840 Connecticut St., Ste D
Lawrence, KS 66044
Phone: (800) 768-8036
Fax: (785) 856-8727
515 S. Kansas Ave, Ste 403
Topeka, KS 66603
Phone: (800) 768-8036
Fax: (785) 856-8727
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