Getting Out From Under: Student Loans and Bankruptcy, Explained

President Joe Biden’s decision to forgive some federal student loan debt highlights the struggle that many borrowers endure to pay off the cost of higher education.

Biden’s move to forgive $10,000 for borrowers under certain income thresholds, and $20,000 of debt held by Pell Grant recipients, makes only a small dent in the debt that some current and former students hold. Some borrowers may be tempted to turn to bankruptcy in hopes of eliminating that debt.

Unlike many other forms of debt, it’s extremely difficult—and in some jurisdictions, practically impossible—to get rid of student loan obligations with a bankruptcy filing. Consumer advocates, practitioners, and academics have long been pushing for a simpler path to provide that relief.

1. Can student loans be discharged in bankruptcy?

Under bankruptcy law, student loan debt is one of several categories of debt, along with recent taxes, domestic support obligations, and debts resulting from fraud or willfully harmful conduct, that usually can’t be discharged.

Large lenders pushed for the student loan exception amid worries that students would borrow money to get professional degrees and then file bankruptcy before establishing a career and accumulating assets, despite a lack of evidence of such abuse.

2. Are exceptions possible?

Bankruptcy judges can discharge educational loans if not doing so “would impose an undue hardship on the debtor and the debtor’s dependents.” But over time it’s proved extremely difficult to prove undue hardship.

Establishing hardship under a US Court of Appeals for the Second Circuit test used by most courts requires a showing that the debtor can’t maintain even a minimal standard of living if student loans are repaid; that that state of affairs is likely to persist; and that a borrower has made a good-faith effort to repay the loans.

3. What have courts said?

The Second Circuit established its undue hardship test in a 1987 decision, Brunner v. New York State Higher Educ. Services Corp, Before that, it was easier for debtors to successfully sue to get their debts discharged.

Since Brunner, some courts have tried to loosen the reins for obtaining student debt relief, with mixed results. A bankruptcy judge in the Southern District of New York in 2021 wrote an opinion discharging student loan debt on a showing of hardship, but not relying on the Brunner test to make that determination. That decisionwas overturned on appeal.

Some courts have tightened the hardship standard. The Fifth Circuit has said that a debtor’s hardship must result in a “total incapacity” to pay the debt now and in the future.

4. Are changes coming?

Attorneys, professors, and consumer advocates have sought to make more comprehensive relief from student loans obtainable through bankruptcy.

The US Education Department is weighing policy changes. In March, Secretary of Education Miguel Cardona tweeted that the department is working on changing policies for student loan discharge in bankruptcy, and asking the Justice Department to pause cases where a borrower is seeking a student loan discharge.

The Education Department is often the defendant in lawsuits seeking a student loan discharge. It can influence how “undue hardship” should be interpreted and to what extent the government would oppose an action to discharge a student loan.

In 2019 a commission formed by the American Bankruptcy Institute issued a comprehensive report suggesting possible ways to address student loan debt, including a return to making the loans dischargeable after seven years. The commission also recommended relaxing the definition of “undue hardship.”

Rep. Glenn Grothman (R-Wisc.) introduced a bill (HR 4563) in July 2021 that would remove student loans from the list of nondischargeable debts.

The following month, Senate Judiciary Committee Chairman Richard Durbin (D-Ill.) introduced a measure (S. 2598) with bipartisan support that would make student loans dischargeable in bankruptcy after ten years from when the first payment was due.

To Learn More:

—From Bloomberg Law:

Student Loan Borrower’s Elimination of $221,000 Debt Overturned

Bankruptcy Group Seeks to Ease Student Loan Burden (1)

Sympathetic Judge Won’t Wipe Out Jobless Woman’s Student Debt

—From Bloomberg News:

Biden Unveils Bid to Free Students From ‘Unsustainable Debt’ (1)