Student Loans Tougher to Discharge: “Undue Hardship” Examined
Posted By Steven J. Richardson on June 16, 2006
People with student loans have more to worry about with the implementation of BAPCPA. Originally, guaranteed student loans (those loans that were government-made, insured or guaranteed, and loans made by nonprofit institutions) were non-dischargeable in bankruptcy if they were less than seven (7) years old, unless the debtor could prove “undue hardship.” This later changed to eliminate the seven year time period. Now, with BAPCPA, this is expanded to include “any other educational loan that is a qualified education loan, as defined in §221(d)(1) of the Internal Revenue Code . . . incurred by a debtor who is an individual.” Bankruptcy Code, §523 (a)(8)(B). The Internal Revenue Code defines a “qualified education loan” as,
“any indebtedness incurred by the taxpayer solely to pay qualified higher education expenses—
(A) which are incurred on behalf of the taxpayer, the taxpayer’s spouse, or any dependent of the taxpayer as of the time the indebtedness was incurred,
(B) which are paid or incurred within a reasonable period of time before or after the indebtedness is incurred, and
(C) which are attributable to education furnished during a period during which the recipient was an eligible student.
Such term includes indebtedness used to refinance indebtedness which qualifies as a qualified education loan. The term “qualified education loan” shall not include any indebtedness owed to a person who is related (within the meaning of section 267(b) or 707(b)(1)) to the taxpayer or to any person by reason of a loan under any qualified employer plan (as defined in section 72(p)(4)) or under any contract referred to in section 72(p)(5).”
This effectively broadens the scope of non-dischargeability to include virtually all student loans. With many people graduating from school with degrees and no job, this can create a real problem. Adding to that is the fact that the Bankruptcy Code, even with the changes under BAPCPA, does not define the term “undue hardship.”
Bankruptcy courts across the country, however, have ruled on what that term means. In the landmark case of Brunner v. New York State Higher Education Services Corp., 831 F.2d 395 (2nd Cir. 1987), a three-prong test was devised to see whether a debtor owing student loans was truly suffering “undue hardship.” A debtor seeking to discharge said loan obligation must prove that:
- he or she cannot maintain, based on current income and expenses, a “minimal” standard of living for him/herself and his/her dependents if forced to repay the loans;
- additional circumstances exist indicating that the state of affairs is likely to persist for a significant portion of the repayment period of the student loans; and
- he or she has made good-faith efforts to repay the loan.
Although many people are able to meet the first prong of the test, the other two are the ones that present problems for debtors trying to discharge student loans. On the second prong of the test, courts have held that underemployed debtors do not meet this test because that situation may well not last for a “significant portion of the repayment period” if they get a better job. In one case, the debtor was a pastor of a small church making less than $10,000 a year. However, he held a bachelor’s and master’s degree, and had previously worked as a salesman and audio engineer at a much higher income. The court stated that the debtor’s “choice to work as a pastor of a small start-up church cannot excuse his failure to supplement his income so that he can meet knowingly and voluntarily incurred financial obligations. By education and experience, he qualifies for higher paying work and is obligated to seek work that would allow debt repayment before he can claim undue hardship.”
In another case the debtor was over 40, was the single parent of a seven-year-old, and was self-employed as a decorative painter. However, she had an associate’s degree in tourism as well as a real estate license, and in the past, she had had higher paying jobs (e.g. restaurant manager of the Queen Mary in Long Branch, CA). The court ruled against her dischargeability action, noting that having a low paying job “does not in itself provide undue hardship, especially where the debtor is satisfied with the job, has not actively sought higher-paying employment, and has earned a larger income in previous jobs.”
As to the third prong of the test, there must be some good-faith effort to repay the loan. The courts look to see if the debtor has applied for the Income Contingent Repayment Plan offered by Direct Loans. In addition, the court has denied relief where the debtor had made minimal (in one case, only $4,093.52 on an overall loan balance of $84,604.65), or no, payments, or the student loan was a significant portion of the overall debt (in one case 98%).
Therefore, it is clear that any debtor in bankruptcy seeking to discharge a student loan must do more than show current, dire financial straits. He or she must seek to be employed to the maximum of their potential, and address payment in some significant way. With all three prongs addressed, that debtor should be in a good position before the court to convince them of undue hardship.
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