On February 21, the United States Department of Education, led by Secretary Elisabeth Dee DeVos, issued a memorandum indicating it was considering stepping into the debate over the standard used to determine whether a student loan can be discharged under the Bankruptcy Code.  The request for public comment appears aimed in part at revisiting allowing the discharge of debts when they create “undue hardship” for the debtor.

Public Input Requested by Department of Education

In the memorandum, the DOE asked for public input on:

  • who typically requests elimination of student loan debt in Chapter 7 (liquidation) proceedings;
  • factors to be considered in evaluating “undue hardship” claims asserted by student loan borrowers in bankruptcy;
  • the weight to be given to the undue hardship factors;
  • whether the existence of two tests to evaluate undue hardship claims results in inequities among borrowers seeking discharge; and
  • how all of these considerations (and possibly others) should weigh into whether loan holders should discharge debts for undue hardship.

The “Brunner Test” for Undue Hardship

Since 1978, § 523(a)(8) of the Bankruptcy Code has exempted any student loan debt from discharge unless its repayment would “impose an undue hardship on the debtor and the debtor’s dependents.”

This standard is applied using a test adopted by the U.S. Court of Appeals for the Second Circuit in 1987, in Brunner v. New York State Higher Education Services Corp.  Under Brunner, once a creditor establishes the existence of an educational debt, a debtor can only prove an “undue hardship” by demonstrating:  (1) an inability to maintain, based on current income and expenses, a “minimal” standard of living for themselves and their dependents if forced to repay the loans; (2) additional circumstances indicating that this state of affairs is likely to persist for a significant portion of the relevant loans’ repayment period; and (3) their good faith efforts to repay the loans. If a debtor fails to establish all of the factors under the test, the court will deny a request for discharge due to undue hardship under § 523(a)(8).

Arguments on Changing the Brunner Test

Critics of the Brunner test assert that it was developed during a radically different era.

In 1987, under the Bankruptcy Code, the relevant time period for examining whether a debtor had made good faith efforts to repay a student loan was limited to seven years, and the number and kinds of student loan debts covered by § 523(a)(8) were relatively few. In 1998, Congress removed the seven-year look-back time limit, and in 2005 redefined “educational debt” to include many more private student loans.

In light of these changes over the years, critics say continued use of the Brunner test is unduly harsh, essentially requiring proof of unending poverty and barring discharge of numerous types of private loans that were not in the court’s mind when Brunner was decided. On the other hand, opponents of a change to the standard say that Congress could easily incorporate a less harsh and rigid definition of “undue hardship,” but no such change has ever been made.

Likely Responses to Any Change in Discharge Standards

If the comments elicited by this memorandum prompt the Trump Administration to support a revision of § 523(a)(8)’s “undue hardship” test, borrowers who meet the new standard (which is likely to be less onerous than the Brunner test) will rejoice.

At the same time, basic theories of economics suggest that a change to the discharge standard may result in an increase in interest rates for student loans and heightened standards for issuance of such loans, as lenders respond to an increase in uncollectable debt. Lenders also will need to prepare to fend off new challenges in the country’s 94 bankruptcy courts, with little jurisprudence for guidance in determining how any new standard should be applied.

Interested parties may submit comments through the Department of Education’s website.