Until 1976, student loan debt could, like most forms of financial obligation, be discharged in bankruptcy proceedings. At that point, student loan programs were not yet two decades old and student loan debt had not yet reached the stratospheric proportions that defined it in the 21st century.
That year, largely baseless claims that student debtors were abusing the bankruptcy system led to the first restrictions on bankruptcy discharge of student loan debt. These restrictions were tightened even further in the ensuing decades. Little progress has been made in reversing them despite concern that they have unfairly biased the system against indebted college graduates.
While other forms of debt relief do exist, notably deferment and income-driven repayment followed by forgiveness after a set period, critics of bankruptcy restrictions charge that these options are insufficient. Some bankruptcy judges have begun offering partial student loan discharge under the vague provisions that allow for it under current bankruptcy law.
Bankruptcy proceedings, as traumatic as they are, are meant to provide citizens with a clean financial slate. By freeing them from crushing debt, the discharge of debt through bankruptcy allows people to begin their lives anew. Most types of debt can be discharged in bankruptcy, with a few exceptions. Notably, some types of tax debt, debt incurred by criminal activity, and spousal and child support debt are exempted from discharge.
The precedents for bankruptcy discharge are literally biblical. The Book of Deuteronomy mandates the so-called seven-year rule:
“At the end of every seven years you shall grant a release. And this is the manner of the release: every creditor shall release what he has lent to his neighbor or his brother, because the Lord’s release has been proclaimed.”
Biblical mandates that reference debt forgiveness are also found in Exodus, Leviticus, the Book of John, and the Book of Matthew. Most non-Abrahamic religions also urge this practice. These religious prescriptions have manifested in legal systems worldwide.
Hysteria over Bankruptcy Abuse
Beginning in the 1970s, journalists and legislators began raising concerns about the possibility that student debtors might abuse the bankruptcy system as a means of wriggling out from under their loan debt following graduation. Of particular concern to these critics was the notion that medical and law students graduating with significant debt might attempt to discharge it despite the earning potential that would allow them to pay it down with relative ease. No evidence of actual abuse was ever presented.
The Congressional Commission on the Bankruptcy Laws of the United States, formed in 1970, issued its findings in a 1973 report. This report contained recommendations that were intended to assuage those concerns, notably suggesting that student loan debt be barred from discharge for five years following the commencement of repayment and that a standard of undue hardship be established.
Three years later, Congress commissioned a study on the subject by the Government Accountability Office. It found that a relatively high percentage (18%) of educational loans were in default, but also that less than 1% were discharged in bankruptcy.
Despite these negligible findings, the Education Amendments of 1976 (page 61) adopted the Bankruptcy Commission’s recommendation, stipulating that student loans could not be discharged in bankruptcy until five years after commencement of the repayment period, barring any undue hardship.
Support for the amendments was strong.
Supporter Rep. John Erlenborn of Illinois asserted that, “… if, shortly after graduation and before having an opportunity to get assets to repay the debt, [student debtors] seek to discharge that obligation, I say that is tantamount to fraud.”
However, others found the new restrictions too draconian.
Rep. James O’Hara of Michigan claimed that the regulation “… treats educational loans precisely as the law now treats loans incurred by fraud, felony, and alimony-dodging. No other legitimately contracted consumer loan … is subjected to the assumption of criminality which this provision applies to every educational loan.”
Further Legislative Changes
In 1978, the exception to bankruptcy discharge of student loans was moved from the Higher Education Act to the U.S. Bankruptcy Code at 11 USC 523(a)(8) with the passage of the Bankruptcy Reform Act. While the bill written in the House of Representatives had proposed reversing the 1976 reforms, the Senate version prevailed. An amendment the next year clarified that the five year limit applied to loans backed “… in whole or in part by a governmental unit or a nonprofit institution of higher education.”
In 1984, the Bankruptcy Amendments and Federal Judgeship Act of 1984 further tightened the rules on bankruptcy discharge by dropping “of higher education” from the wording of the legislation. This broadened the restrictions on discharge to include private loans backed by non-profit institutions as well as government loans.
The Crime Control Act of 1990 extended the period before which bankruptcy proceedings could commence to seven years after repayment began.
In 1991, the six-year statute of limitations on collection of defaulted loans, which had been established in 1985, was completely eliminated by the Higher Education Technical Amendments.
Further legislation was even less generous toward student debtors. By 1998, the seven-year period after which student loan debt could potentially be eliminated through bankruptcy proceedings was also eliminated with the passage of another set of Higher Education Amendments. Thus, the nebulously defined “undue hardship” was the only remaining provision under which student debt could be discharged in bankruptcy.
Seven years later, in 2005, all qualified education loans, including most private loans, were excepted from discharge with the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act. Private student loans no longer needed to be associated with a nonprofit institution to be excepted from bankruptcy discharge.
Critics have claimed that the lack of recourse to bankruptcy has all but ensured that lenders will continue to extend credit to student borrowers with abandon. Under the current legislation, lenders have little motivation to assess the creditworthiness of the people to whom they lend.
They are almost completely secure in the knowledge that their borrowers will remain on the hook for the amount borrowed, and, in the case of private lenders, the exorbitant interest fees that will accrue. Thus, they feel no need to underwrite the loans. Research has demonstrated that there was no change in the availability of private student loans before and after passage of the 2005 legislation.
Further, some have contended that the increasing availability of student loans has enabled institutions to continue to raise tuition rates. This controversial linkage of the two phenomena is known as the Bennett hypothesis, after former Education Secretary William J. Bennett, who first advanced the idea in a 1987 New York Times op-ed.
Legislators have attempted, with little success, to roll back these regulations starting as early as 1977, a year after the first bankruptcy restrictions were instituted on student loan debt.
Recent attempts include:
- The Student Borrower Bill of Rights Act , introduced by Democratic senator for New York Hillary Clinton in 2006. The bill, which never came to a vote, would have reinstituted the seven year rule stricken by the Higher Education Amendment of 1998.
- The Fairness for Struggling Students Act, first introduced in 2010 by Senator Dick Durbin of Illinois and proposed again several times. It was intended to allow students to again seek bankruptcy relief for private student loans. Despite public support, it has stagnated.
- President Barack Obama’s 2015 Student Aid Bill of Rights urged investigation of the issue. It appears to have had little effect.
- The Discharge Student Loans in Bankruptcy Act of 2019, introduced by Republican representative for New York John Katko. Previously introduced in 2017, it sought to drop the undue hardship requirement, restoring bankruptcy protections to student loans.
The relatively few cases of student debt that have made it to bankruptcy court have rested on the “undue hardship” clause that has survived the increasing restrictions on discharge. Findings of undue hardship require adversarial proceedings.
The standard established by this case, popularly known as the Brunner test, mandates that a student loan may be discharged if the debtor is unable to pay on the loan and that the circumstances that have led to that financial hardship are likely to persist. It further stipulates that the claimant must have made good faith efforts to repay the loan.
The Brunner test applies in all circuits but the 1st and 8th circuits. The 8th circuit uses a similar but more flexible test called the Totality of Circumstances test established six years earlier in Andrews v. South Dakota Student Loan Assistance Corp (1981).
The Brunner test has, in practice, proven extremely difficult to meet. One bankruptcy court judge referred to the Brunner test as requiring “a certainty of hopelessness, not simply a present inability to fulfill the financial commitment” (Bankruptcy Judge Burton R. Lifland, In re Briscoe v. Bank of New York and New York State Higher Education Services Corp, 16 B.R. 128 Bankr. S.D.N.Y. 1981).
An increasing number of bankruptcy judges are speaking out on what they view as the unfair standard they are expected to uphold in their decisions. Some have discharged portions of student loan debt but have found it impossible to absolve it entirely, thus in their view defeating the purpose of the “clean slate” that bankruptcy proceedings are supposed to provide.
Further complicating bankruptcy proceedings for student loan debtors is the fact that they must retain legal representation, usually at significant cost.
In one significant case, which reached the Supreme Court, a student debtor had discharged the interest on his loans in Arizona district court while still agreeing to pay on the principal. His lender was not notified of the decision and then began garnishing his tax returns to recoup the interest. Though the district court later reversed the initial decision, the court of appeals upheld it. When the case went to the Supreme Court in 2009, the initial decision was again upheld (United Aid Funds, Inc. v. Espinosa).
The case was characterized by procedural errors, notably that the undue hardship findings had occurred outside of an adversarial proceeding as technically required. As such, it did not establish a useful precedent for future discharge cases.
Other Forms of Student Debt Relief
The alternatives to bankruptcy discharge have mostly occurred in the form of income-driven repayment plans, of which there are currently four.
The option was first offered in 1993 following the passage of the Higher Education Amendments of 1992. The income-contingent repayment (ICR) plan laid out in this legislation applies to federal direct loans and mandates loan payments amounting to 20% of discretionary income. Loans are forgiven following 25 years of payment on this plan.
The College Cost Reduction and Access Act of 2007 established an income-based repayment (IBR) plan for both federal direct loan and Federal Family Education Loans (FFEL). Under this plan, borrowers are required to put 15% of their discretionary income toward loan payments. After 25 years under this plan, the loans are forgiven.
The income-based repayment plan laid out in the Health Care and Education Reconciliation Act of 2010 reduced the amount of discretionary income to 10% and shortened the repayment period to 20 years for new borrowers as of July 2014.
This repayment plan was rolled out two years early, in 2012, as the Pay As You Earn (PAYE) repayment plan. The U.S. Department of Education used its regulatory authority to modify the regulations for the income-contingent repayment plan to implement the new version of income-based repayment. It was available only to borrowers who first took out a federal loan on or after October 1, 2007 and who received loan funds on or after October 1, 2011. It requires that 10% of discretionary income be put toward loan payments and offers a 20 year repayment period, after which the remaining balance is forgiven.
The Revised Pay as You Earn (REPAYE) repayment plan launched in 2015 is available to all borrowers of federal direct loans. Again, this repayment plan was implemented by modifying the regulations for the income-contingent repayment plan. It requires payments amounting to 10% of discretionary income over a period of up to 20 years for undergraduate borrowers and up to 25 years for graduate borrowers, after which the remaining balance is forgiven.
Unlike IBR and PAYE, REPAYE has a marriage penalty and no cap on the monthly loan payments. Under IBR and PAYE, loan payments from married borrowers are based on just the borrower’s income for borrowers who file federal income tax returns as married filing separately. REPAYE bases the monthly payments on joint income, regardless of tax filing status. IBR and PAYE also limit the monthly payments to no more than required under standard 10-year repayment, while REPAYE allows monthly payments to increase without limit as income increases.
Student borrowers going into certain professions may be eligible for Public Service Loan Forgiveness (PSLF), under which the remaining debt for some types of federal loans will be forgiven after 10 years of payments if the borrower works in a public service position.
Deferment and forbearance options are also available to select borrowers, such as those enrolled in certain educational programs, volunteering in the Peace Corps or AmeriCorps, or performing active military service. There is also a disability discharge for borrowers who are totally and permanently disabled.
Though helpful to some, these options do not approach the level of relief offered by bankruptcy discharge.
The U.S. Department of Education often raises the availability of income-driven repayment and disability discharges as a defense to bankruptcy discharge. Bankruptcy discharge is thus usually limited to the following situations:
- Borrowers who have a disabled dependent with high ongoing cost of care
- Private student loans that do not offer a disability discharge or income-driven repayment
- Student loans that do not satisfy the requirements for a qualified education loan, such as bar study loans, residency and relocation loans, and loans at unaccredited colleges
- Disabled borrowers who are ineligible for a total and permanent disability discharge due to income above the poverty line, yet still have insufficient income to repay the student loan debt
- An excessive amount of debt prevents the borrower from obtaining affordable payments even if the borrower maximizes income and minimizes expenses
- Borrowers are not eligible for income-driven repayment on Federal Parent PLUS loans
While advocates continue to push for reversal of the legislation that has eliminated bankruptcy discharge for most borrowers, the prospects of that happening any time soon appear to be dim. The best hope for overwhelmed student debtors appears to rest with jurists who liberally interpret the undue hardship standard and the few lawyers who represent student loan bankruptcy cases pro bono.
For the most part, though, overwhelmed student debtors have little hope of relief in the near term.