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August 11, 2014

Alex Moretsky

September 23, 2014

Since I last wrote about this topic, there has been some slow but steady progress in expanding discharges for student loans. As a general rule, student loans are not dischargeable in Chapter 7 or Chapter 13 unless they pose an undue hardship. Commonly referred to as the Brunner Test, the case from which the name is derived, you must show that repayment would create a hardship upon you, your family and/or your dependents. The three criterion for meeting this test are as follows:

  1. Based upon your current income you cannot maintain a minimal standard of living;
  2. Your financial situation is unlikely to improve during the repayment period; and
  3. You have made a good-faith effort to repay the loans.

While action by Congress to offer relief to borrowers has been ineffectual two recent bankruptcy cases offer hope that the judiciary might, in incremental steps, be opening a door for debtors to discharge their student loans.

The Eight Circuit Court rejected the Brunner Test when it ruled its application diminished the Court’s inherent discretion contained in the law. Instead the court provided a more lenient path, analyzing the whole circumstances of the debtor including his past, present and likely future financial situation; reasonable living expenses; and all other relevant facts. Later, the First Circuit Bankruptcy Appeals Panel (BAP) weighed in on that Brunner decision holding that “Brunner takes the [undue hardship] test too far” since it forces debtors to show “extraordinary circumstances” that the Bankruptcy Code does not require. These two decisions chose judicial discretion over Brunner’s rigid requirements noting Brunner lacks a textual foundation in the Bankruptcy Code.

In April 2013, the Seventh Circuit and Ninth Circuit BAP handed down two more decisions that chart a trend away from Brunner. They found the language of Brunner “judicial gloss” and cautioned against any interpretation that supersedes the statute. They further stated that failure to negotiate or accept an alternative payment plan is not the sole reason for finding good faith.

Student borrowing has changed since Brunner was decided in 1987. Students today must borrow heavily to finance their futures due to the astronomical costs of modern education. These changes have made the application of the Brunner standard overly harsh, impractical and “a relic of times long gone.” The moribund reliance on Brunner is ebbing and with it a more conciliatory attitude towards student loan debt and its discharge is developing.

While we wait for the declining reliance on the Brunner standard to take hold there are other avenues that could assist you in getting student loans discharged. Jason Iuliano, in a published study found that 40% of borrowers who attempted to discharge their loans in bankruptcy got some or all of the student debt discharged. Debtors have successfully argued that private student loans were used to attend a school not eligible for these federal student aid programs and the loans did not fall under the definition of education loans and therefore should be discharged. For this reason alone, debtors should consider trying to reduce or eliminate their student debts.

There are defenses to the re-payment of student loans, particularly if you attended a trade/vocational school including the following:

  1. Breach of contract
  2. Unfair/deceptive business practices
  3. Fraud
  4. Did not benefit from education
  5. Institution was a fraudulent school
  6. Alcoholism or mental impairment, SSD, health issues/expenses

Student loans, by definition in the bankruptcy code, require that the loans be used for cost of attendance expenses. Those expenses include tuition, fees and indirect costs related to enrollment. Some borrowers have argued a portion of student loans were used for non-eligible expenses and should be dischargeable. This is a risky argument as the promissory note signed by the borrower contains statements requiring that funds be used for educational purposes. By borrowing you agree to use funds appropriately.

Finally, cancellation of the student loan is available outside of bankruptcy in cases where the borrower has a total and permanent disability or:

  1. Has died
  2. School has closed
  3. School falsely certified borrower’s eligibility
  4. School has failed to refund tuition after withdrawal