Everyone knows that you cannot bankrupt student loans. Search the web with the
keywords “bankruptcy” and “student loans” and you get either many listings for
lending institutions trying to get you to take out another loan, or you see articles
telling you that it is virtually impossible to bankrupt your student loans except
under the condition of “undue hardship” and then they fail to tell you anything
how to go about proving the condition. How frustrating!
Below is a summary of the salient points given in Bankrupt Your Student Loans and
Other Discharge Strategies by Chuck Stewart, Ph.D. (ISBN 0-9764154-5-3). Here is
an author who has been through the process, successfully bankrupting $54,000 in
student loans, and has written a clear, step-by-step, instruction manual to help
other honest debtors in their efforts to have their student loans discharged through
bankruptcy or Compromise or Write-Off.
The bankruptcy courts originally treated student loans the same as any other
unsecured debt. Student loans could be listed in a Chapter 7 filing and fully
discharged. However, in 1976 Congress modified the Higher Education Act of 1965
and required student loans to be nondischargeable unless: (a) the debt first became
due more than 5 years before the date of filing of the bankruptcy, or, (b) failure to
discharge the debt would cause “undue hardship” to the debtor or to dependents of
the debtor. In 1990, Congress extended the 5 year rule to 7 years and eventually
eliminated the time limit altogether in 1998. Thus, the only option debtors
currently have for bankrupting their student loans under 11 U.S.C.A. Bankruptcy
Reform Act (1998) 523(a)(8) is to prove repaying their student loans would cause
an “undue hardship.”
“Undue Hardship” Analysis
Unfortunately, Congress failed to define the term “undue hardship.” A review of the
discussion and debate by the legislature regarding the education amendment is
unrevealing as to the meaning of undue hardship. Thus, it has been left up to the
courts to determine its meaning. Aggressive defense by Department of Education
attorneys has influenced the court to a decidedly rigid interpretation. In general, for
a debtor to qualify for an undue hardship discharge of student loan debt, the debtor
must be living at, or below, the Federal Poverty Guideline and have no hope for
increased future income substantial enough to make payments on the loans.
Over the past quarter-century, courts have developed many tests to determine the
existence of undue hardship. The leading test used in most court is the Brunner
Test. Other tests include the Bryant Poverty Test, Totality of the Circumstances
Test, and the Johnson Test. A review of these tests locate some common
characteristics used by courts to determine undue hardship. These include:
Characteristic A. An evaluation of the debtor’s current living condition and the
impact that has on the ability to repay the loan while maintaining a “minimal living”
standard.
Characteristic B. The debtor’s future prospects for repaying the loan.
Characteristic C. Evaluate whether or not the debtor demonstrated good faith during
loan repayment.
There are two steps involved to demonstrate Characteristic A
1. Every court reviews the debtor’s current living condition and evaluates it against
the Federal Poverty Guidelines. Debtors with incomes above poverty will be
scrutinized by the courts to assure all expenses are “minimized.” Expenditures will
be compared to an “idealized” debtor of similar situation but at the official poverty
level.
2. Once the court is satisfied the debtor has minimized living expenses, the court
evaluates whether repaying the student loans will push the debtor down to or below
the poverty level.
Characteristic B is impossible to predict. Courts have recognized the folly in trying
to predict future income, but it has not stopped them from including it in their
analysis. Courts have considered many factors that may affect future earnings
including personal limitations such as: (1) medical limitations, (2) support of
dependents (and their medical conditions, if applicable), and (3) lack of useable job
skills. Courts have also considered some external factors such as age
discrimination (for debtors over age 50), having been labeled a whistleblower, and
other social and cultural factors that affect the ability to obtain gainful employment.
Congress was most concerned with debtors who seemingly “defrauded” the
government by bankrupting their student loans soon after graduation. To reinforce
that concern, courts want debtors to demonstrate “good faith” attempts at repaying
student loans. Characteristic C, Good Faith, means that the debtor must show that
he or she made payments on student loans whenever his or her income was above
the poverty level, or, when there was insufficient income, he or she obtain
deferments or forbearances to keep the loan in good standing.
Income Contingency Repayment (ICR) Plan
Even if a debtor clearly demonstrates that the undue hardship analysis applies to his
or her case, the Income Contingency Repayment (ICR) Plan may unravel the case.
The ICR allows student loan repayment to increase or decrease according to the
income of the debtor. As such, if the debtor’s income is below the Federal Poverty
Guideline, then the payment drops to zero. The plan lasts for 25 years and any
outstanding debt is discharge. However, the loan discharged amount is treated as
income by the IRS and income taxes will be due.
It is often stated by Department of Education attorneys that ICR makes it impossible
for debtors to discharge their student loans in bankruptcy. They contend that
anyone can make “zero dollar” payments, thus negating the undue hardship
exception of 523(a)(8). In many cases this is true. But for some debtors the ICR is
inappropriate. For example, imagine being 65 year or older living on SSI or on a
fixed income and then a large tax liability descends upon you for debt discharged at
the end of an ICR plan. That would place an undue hardship upon you. In fact, the
ICR is really inappropriate for anyone over the age of 40 because of the tax liability
at the end of the repayment period.
Regardless, debtors planning an adversary proceeding must prepare a robust
response to the Income Contingency Repayment Plan.
Filing the Bankruptcy and Adversary Proceeding
Student loans are listed in the Chapter 7 bankruptcy as one of the outstanding
debts held by the debtor. The debtor must then file an Adversary Proceeding in
conjunction with the Chapter 7 bankruptcy case within 60 days of the meeting with
the creditors. The adversary proceeding is against the Department of Education (or
other guarantee lender) and asks the court to determine if the “undue hardship”
clause applies. If the court decides 523(a)(8) applies to the case, then the student
loans are discharged through the Chapter 7 bankruptcy.
There is research to show that debtors who file their own Chapter 7 bankruptcy and
adversary proceeding prevail more often than if an attorney is used. Most attorneys
will not touch an adversary proceeding on student loans, and those that do, want at
least $5,000 up front with additional high hourly fees. You know your situation
best and it is suggested that you try to do this yourself. Even if you retain an
attorney, you will have to perform most of the financial research needed to prove
undue hardship. If you do file your own case, you may want to retain an attorney
or paralegal to help with some of the steps, forms, or language.
Here is where strategy comes into play. You really do not want to go to trial. In a
majority of cases, the debtor loses. In Bankrupt Your Student Loans and Other
Discharge Strategies, a chapter is devoted to an analysis of court cases. Often
courts give irrational responses and rule against debtors with clear cases of
hardship. Most courts analyze the debtor at the Federal Poverty Level whereas a
minority of courts performs the same analysis at a middle class income level.
Because Congress failed to clearly define “undue hardship,” the courts have ruled all
over the place; and there is no consistency even between courts using the same
test.
The better tactic is to settle out of court with the Department of Education or
renegotiate the loan and stipulate that to the court. For example, you could
convince the Department of Education to accept 10 cents on the dollar as banks
often do with bad debt. Say a $60,000 loan is reduced to $6,000 paid over 5 years
(i.e., $50/month) with the remaining $54,000 discharged through the Chapter 7
bankruptcy. By discharging the debt through bankruptcy, there is no income
reported to the IRS with no resulting income tax. You and the Department of
Education create a Stipulation to the new repayment plan and submits it to the court
for approval without trial.
Debtors need to prepare like they are going to trial. Each of the Characteristics and
ICR discussed above must be addressed in full. It is not difficult work, just detailed
and tedious. It is advisable to create worksheets to systematically organize financial
details and write, in your own words, responses to each item. Research will be
needed to obtain current financial guidelines for the Federal Poverty Level and
typical expenditures for similarly situated debtors reported by the IRS. This
research helps to establish that you have not been negligent in your spending.
Bankrupt Your Student Loans and Other Discharge Strategies has created a
systematic approach to proving “undue hardship” with the use of worksheets,
sample forms, and extensive Appendix. By gathering all these materials together,
you will be able to aggressively negotiate with the Department of Education before
the trial. Hopefully, you will succeed and avoid a judge making the final decision.
It is impossible to write in general terms about how the adversary proceeding will
proceed. Each court is different and each case is different. However, like with other
civil complaints, there are usually the following steps:
• Filing the Complaint with Proof of Service
• Status Hearing
• Mediation
• Pre-Trial Hearing
• Trial
It is before the Mediation that you present your case to the Department of
Education. This is your opportunity to try and renegotiate your loan: including
having it completely discharged. More often than not, the attorney for the
Department of Education will play hardball citing the ICR as the reason you cannot
prevail with the undue hardship argument. You continue to negotiate with the
Department of Education after the Mediation and address those questions that came
up during the Mediation. In many cases, they will accept the offer if it is reasonable
rather than risk losing at Trial.
Even in situations where debtors do not file bankruptcy, there is the opportunity to
have student loans discharged through the little known processes of Compromise
or Write-Off. Instead of filing suit and having the case decided at trial, the debtor
negotiates directly with the Department of Education to discharge the loan. Why
would they do this? It costs money to keep dead loans in the system. Also, there
are government directives allowing the Department to discharge loans through
Compromise or Write-Off. Regardless if a bankruptcy or Compromise or Write-Off
is planned, the process of proving “undue hardship” remains the same.
The above article was a brief summary of Bankrupt Your Student Loans and Other
Discharge Strategies by Chuck Stewart, Ph.D. (ISBN 0-9764154-5-3). It is the only
book to give step-by-step instructions for filing and arguing an adversary
proceeding to discharge student loans through bankruptcy. It is written in plain
English, with a minimum of legalese, and can be purchased directly from
www.StewartEducationServices.com or from Amazon.com.
Chuck Stewart, Ph.D.
