Discharging Student Loans in Bankruptcy – a Legal Background

The burden of student loan debt has become a formidable challenge for countless individuals striving to secure an education and build a better future. For some, the weight of these financial obligations becomes unbearable, leading them to explore the possibility of discharging student loans through bankruptcy. 

Section 523(a)(8) of the Bankruptcy Code:

Underlying any attempt to discharge student loans in bankruptcy is Section 523(a)(8) of the bankruptcy code, which stipulates that student loans are generally not dischargeable unless the debtor can prove "undue hardship." Unfortunately, the bankruptcy code does not provide a definition of “undue hardship”.  

Undue Hardship and the Brunner Test:

Since the bankruptcy code does not define “undue hardship,” courts have had to try to provide some guidance.  The most commonly used test to assess "undue hardship" is the Brunner Test, named after the 1987 case Brunner v. New York State Higher Education Services Corp. This test, employed in many jurisdictions, requires debtors to demonstrate three key elements to qualify for discharge:

1. Present Inability to Pay:  The debtor must prove that maintaining a minimal standard of living for themselves and their dependents while repaying the loan is not feasible.
2. Future Inability to Pay:  The debtor’s financial hardship is likely to persist over a significant portion of the loan repayment period so that they will not be able to repay the loans.
3. Good Faith Effort to Repay: The debtor must show a good faith effort to repay the loans by making payments in the past or making a reasonable attempt to negotiate a favorable repayment plan with the lender.

Totality of Circumstances Test:

In addition to the Brunner Test, some jurisdictions use the Totality of Circumstances test. This test looks to: (1) the debtor's past, present, and reasonably reliable future financial resources; (2) a calculation of the debtor's and their dependents' reasonably necessary living expenses; and (3) any other relevant facts and circumstances surrounding each particular bankruptcy case.  This broader approach provides more flexibility for debtors to present a comprehensive picture of their financial situation and argue for the discharge of their student loans.

The Adversary Proceeding

In order to initiate any “undue hardship” review, however, the debtor must first file bankruptcy.  After the bankruptcy has been filed and while it is pending, the debtor must then file an adversary complaint against the Department of Education.  The adversary complaint is essentially a mini litigation within the bankruptcy which is tracked as a separate legal action with its own discovery and trial.  

Traditionally, the cost of this adversary proceeding has been extremely high – in both time and out-of-pocket costs.  In particular, these adversary proceedings opened the door to extensive and intrusive discovery requests.  So much so that according to a 2020 Duke Law Journal study, of the 250,000 bankruptcy cases involving student loans filed annually, fewer than 300 debtors (less than .1%) received a discharge of student loans.

A New Beginning

While virtually everyone in the bankruptcy community recognized the challenges of an “undue hardship” proceeding, very little could be done.  On November 17, 2022, that all changed.  The Department of Justice in conjunction with the Department of Education issued written Guidance which provides objective standards by which DOJ and DOE would determine “undue hardship”.  So, while “undue hardship” is still the standard and Section 523(a)(8) and Brunner/Totality of the Circumstance test still the underlying law, the new Guidance offers debtors a streamlined and cost-effective path towards actually achieving forgiveness.  In fact, as of September 2023, 70% of cases brought before DOJ/DOE under the new Guidance received a discharge.  That’s a far cry over the .1% before the Guidance.