POINT: Should Congress Abrogate Brunner’s Criteria for Determining “Undue Hardship” Under § 523(a)(8)?
Since the 1980s, Brunner has provided a useful standard for evaluating requests to discharge student loans based on undue hardship. The criteria identified in that decision allow courts to balance the objectives of maintaining availability of student loan funding for many who could not otherwise afford higher education with providing avenues of relief for students under an overwhelming burden of debt. Although most districts have adopted the Brunner test, modern bankruptcy courts are examining whether a partial discharge of student loans is an effective compromise. Therefore, the question must be asked: Is it time for Congress to abrogate Brunner’s criteria for determining “undue hardship” under 11 U.S.C. § 523(a)(8)?
Anatomy of Student Lending
A brief review of how student loan debt arises in the first place may provide a better understanding of why Congress originally decided to treat student loans differently from other unsecured debt by excepting them from discharge in bankruptcy unless a successful adversary proceeding is filed. In general, student loans (particularly government-subsidized student loans) are granted without a review of a student borrower’s credit score. In exchange for lower “underwriting” eligibility standards, federal student loan lenders get the added security of higher barriers to discharge of student loan debt. Eligibility is based on demonstrated financial need, United States citizenship (or eligible non-citizenship), valid Social Security number (subject to limited exceptions), registration with Selective Service (for males between the ages of 18 and 25), and satisfactory academic progress in college or career school.
Federally guaranteed student loan programs, as outlined in the laws establishing them, were intended to (1) “ensure a sufficient supply of well-trained, competent professional and technical personnel; and (2) to allow every person the fullest possible educational opportunity by making loans available to those who could not otherwise obtain a loan because of their age and lack of collateral or borrowing history.”
While federal loans provide a source of funds without respect for credit-worthiness, private student loans are generally credit-based, and the lender’s assessment of creditworthiness influences the interest rate and other terms. Despite their use of credit evaluation criteria, under the most recent amendments to the Code, private student loans also enjoy the protections of heightened standards for dischargeability.
Bankruptcy Law and Student Debt
From enactment of the Bankruptcy Act of 1898 until 1976, debt classified as what we now call “student loans” was treated and subject to discharge in the same fashion as any other unsecured loan. In 1976, Section 523(a)(8) was enacted as part of the Education Amendments of 1976 to exempt student loans from a bankruptcy discharge during the first five years, absent a showing of undue hardship, based on reports that students took out loans to fund their education and then sought to discharge their liability for repayment shortly after graduation so that they could begin their careers debt-free.
More specifically, the 1973 Report of the Commission on the Bankruptcy Laws of the United States pointed out that while an increase in bankruptcy filings was a “natural if not inevitable result” of increased availability of consumer credit, “the easy availability of discharge from educational loans threaten[ed] the survival of existing educational loan programs.” The threat of making loans that would never be repaid, in light of the original goal of making educational funding available to people who might otherwise be unable to afford an education, prompted action to protect the programs.
As a result, the Bankruptcy Commission recommended adding a provision to the Bankruptcy Act (now the Bankruptcy Code) providing that individuals seeking to discharge educational debt would be required to establish undue hardship, unless the loan had been in default for at least five years. That recommendation led to the enactment of Section 523(a)(8), which initially provided for a five-year delay before student debt could be discharged.
11 U.S.C. § 523(a)(8) provided that student loans were not subject to discharge in a bankruptcy case unless the debtor proved that excepting the debt from discharge would impose an undue hardship to the debtor and his dependents. Although the statute has been amended several times, the term “undue hardship” has remained a constant element. Cases interpreting “undue hardship” in all versions of Section 523(a)(8), most notably, Brunner, have developed a means of determining whether a debtor has established undue hardship sufficient to warrant discharge of the debtor’s student loans.
Under Brunner, a debtor must establish:
(1) that the debtor cannot maintain, based on current income and expenses, a “minimal” standard of living for [himself] and [his] 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.
The 2nd Circuit Court of Appeals upheld the lower court’s ruling adopting the standard set forth above; however, examination of the lower court’s opinion sheds important light on the rationale behind the standard, as well as the reasons for maintaining it until or unless Congress decides to amend the statute.
In his opinion at the lower court, Judge Charles S. Haight, Jr., of the U.S. District Court for the Southern District of New York, pointed out that something more than immediate inability to repay was needed to support discharging educational loans in bankruptcy just as the borrower was embarking on a career. Factors that might support a finding of “undue hardship” included illness, lack of usable job skills, existence of a large number of dependents, or a combination of these circumstances.
Recognizing that such requirements would present a very high hurdle to overcome, Judge Haight noted:
“The effect of these requirements is to make student loans a very difficult burden to shake without actually paying them off. While this result may seem draconian, it plainly serves the purposes of the guaranteed student loan program. When making such loans, the government (as guarantor) is unable to behave like ordinary commercial lenders, who may, after investigating their borrowers’ financial status and prospects, choose to deny as well as grant credit and may adjust the interest rate which they charge according to their judgment as to the likelihood of repayment. The government has no such luxury. It offers loans at a fixed rate of interest, and it does so almost without regard for credit-worthiness. Indeed, because it bases its loan decisions in part on student need, it arguably offers loans selectively to the worst credit risks.”
Judge Haight’s opinion acknowledged that the standard articulated a basis for determining whether a student may obtain a discharge of student loans in bankruptcy before the five-year period ends, although the appellate decision overlooked that point in affirming it. Brunner thus was decided at a time when, although intentionally difficult, discharging a student loan was at least possible, albeit time-dependent.
After the Brunner decision, Congress extended the delay period from 5 to 7 years. By 2005, the time periods had been eliminated altogether; by 2012, discharge protections had been extended to private loans. Elimination of any time-dependent default period has yielded a potentially unintended result of making student loan debt virtually non-dischargeable. All versions of the statute retained the escape clause of “undue hardship,” but interpretation of what is intended by the phrase “undue hardship” has been left to the courts, because Congress has, as yet, failed to provide any statutory guidance of what “undue hardship” means.
There is no question that the standard for “undue hardship” elucidated in Brunner was intended to be rigorous and fact-dependent – “undue hardship” as determined by the facts of a particular case – to meet the Congressional objectives of protecting the availability of student loan funding for as many as possible. However, Brunner did not hold that student loans may never be discharged. It merely required the party seeking to discharge a debt that Congress has said requires a showing of undue hardship to actually “show” the undue hardship.
Most circuits have adopted the test used in the Brunner decision, requiring that a debtor seeking to discharge student loan debt must satisfy all three elements before any discharge can be granted at all. As of this writing, the First and Eighth Circuits use a “totality of the circumstances” test to determine whether discharging student loan debt is warranted, while the remaining circuits have adopted Brunner. Despite their differences, both tests require a bankruptcy court to evaluate a debtor’s financial condition and determine whether conditions might improve sufficiently to allow the debtor to repay the loans.
The rationale for adherence to the Brunner elements derives from the Code’s purposes of providing both an opportunity for the “honest but unfortunate” debtor to obtain a fresh start and equal treatment for similarly situated creditors.
Were it to specify what criteria may be considered in evaluating undue hardship, the Legislature also could address other issues that affect how student loans are treated in bankruptcy and elsewhere. For example, there are existing administrative remedies available under various federal student loan programs which are not available in the private student loan sector. Currently, federal student loans may be consolidated; private loans cannot be included in such consolidation programs. Even with consolidation, however, repayment periods may extend to 20-30 years.
The current administration has already begun the process of evaluating the availability of discharge of student loans in bankruptcy. As of February 2018, the Department of Education has requested comment on “factors to be considered in evaluating undue hardship claims asserted by student loan borrowers in adversary proceedings filed in bankruptcy cases, the weight to be given such factors, whether the existence of two tests for evaluation of undue hardship claims results in inequities among borrowers seeking undue hardship discharge, and how all of these, and potentially additional, considerations should weigh into whether an undue hardship claim should be conceded by the loan holder.”
In addition, the Tax Cuts and Jobs Act of 2017 excluded discharged student loan balances from taxable income arising from the death or total permanent disability of a borrower. Student loan interest is still deductible (up to $2,500), and the administration is reviewing federal student loan repayment programs with an eye toward creating a single income-driven repayment program that would cap monthly installments at 12.5% of discretionary income and limit the repayment period to 15 years (instead of 20-25 years). These changes would be limited to undergraduate student loans; graduate loans would share the same higher percentage of discretionary income, and the repayment period would be extended to 30 years, instead of the current period of 20 years.
While there are additional bills pending that address discharge of private student loans in bankruptcy, as well as other options for relief, the fact that Congress is taking action on these legislative issues suggests that Brunner and its progeny have done the job of identifying issues that need legislative solutions and appropriately placed the responsibility for resolution onto Congressional shoulders.