Consumer advocates are calling on the U.S. Supreme Court to provide a uniform, nationwide standard for what debtors must prove to eliminate student loan debt in bankruptcy.
Wiping out student loan debt through bankruptcy is exceedingly difficult. The bankruptcy code requires proof of “undue hardship” to shed student loan debt, a term that’s generated widely disparate interpretations from federal appeals courts.
Now, groups like the Center for Responsible Lending and the National Consumer Bankruptcy Rights Center are rallying around a case from the U.S. Court of Appeals for the Fifth Circuit that the justices are being asked to consider.
Bankruptcy law is supposed to be uniform, yet courts’ interpretations of the undue hardship standard is anything but. The Supreme Court could change that, if Congress doesn’t act first.
“This widely varying application of the Bankruptcy Code undermines its uniformity and undercuts the Code’s promise of relief to the honest, but unfortunate debtor,” the National Consumer Bankruptcy Rights Center and the National Association of Consumer Bankruptcy Attorneys said in a joint brief asking the Supreme Court to take up the case.
The variance among appellate courts means eliminating student debt in bankruptcy now depends less on debtors’ circumstances than where they live.
One nine-year study released in 2016 found that 54% of Chapter 7 debtors in the First Circuit were able to prove undue hardship, compared with just 24% in the Third Circuit.
“You have wildly different outcomes,” said Tara Twomey, executive director of the National Consumer Bankruptcy Rights Center.
Some courts require a debtor to prove “intolerable difficulties” or a “total incapacity” to ever repay the loans. Others seek “a certainty of hopelessness.”
A minority of the appellate courts take a more lenient approach, simply looking at the “totality of the circumstances.”
Outstanding student debt now totals about $1.7 trillion and millions of borrowers are in default. A more uniform and realistic standard could help ease the staggering burden debtors now face, their advocates say.
Most circuits determine what constitutes undue hardship using a three-prong test from a 1987 Second Circuit decision, Brunner v. New York State Higher Education Services Corp. Over time, courts in different parts of the country have added their own criteria.
Under the Brunner test, undue hardship requires a debtor to prove 1) repaying the loan would make a “minimal” standard of living impossible; 2) the inability to pay is likely to persist; and 3) a good faith effort had been made to repay the loan.
The Fifth Circuit case that’s appealed to the Supreme Court comes from Thelma McCoy of Galveston, Texas, who was 59 when she filed for bankruptcy and sued to eliminate more than $345,000 in student loan debt.
McCoy said her Ph.D. in social work took longer than expected when a head-on collision with a drunk driver put her in a wheelchair for two years. After a divorce, a freak spa accident also left her with severe facial burns that made it difficult to find work, she said.
By the time she filed for bankruptcy, she was earning less than $10,000 per year and facing $2,200 in monthly student loan payments.
The bankruptcy court denied her request to eliminate the debt, saying she failed to prove “that her inability to repay will persist.”
McCoy says the the Fifth Circuit’s interpretation of “undue hardship” in Section 523(a)(8) of the bankruptcy code unfairly prevents borrowers from getting a fresh start.
“There is some growing frustration in the lower courts, at least, about the impact of the Brunner test on people who are really struggling,” said Susan L. DeJarnatt, a professor at Temple University Beasley School of Law.
When the Second Circuit decided Brunner, the law only required debtors to prove undue hardship if they wanted to discharge student loans earlier than five years after repayment was due. Congress later extended the waiting period to seven years, then eliminated it entirely in 1998.
With that waiting period now gone from the law, debtors have to prove that they will face undue hardship forever, DeJarnatt said.
Over time, some courts added their own criteria to Brunner, while others have rejected the test entirely. Every circuit puts its own “gloss” on the Brunner test, and “once the circuit adopts the gloss, then all the lower courts are bound,” Twomey said.
In Maine, for example, the bankruptcy court applied a “totality of the circumstances” standard to allow a 64-year-old mental health counselor with progressive hearing loss to eliminate $107,000 in student loan debt.
Last year, a Navy veteran who filed for Chapter 7 in the U.S. Bankruptcy Court for the Southern District of New York—within the Second Circuit’s jurisdiction—was able to eliminate $221,385 in student loan debt. The bankruptcy court in that case applied the Brunner test, but without the “punitive standards” it said some other courts have imposed.
The Fifth Circuit, which covers McCoy’s home state of Texas, is known to have one of the harshest interpretations of Brunner, said John Patrick Hunt, a law professor at the University of California, Davis. In addition to the Brunner test, the court requires a showing of “total incapacity” to ever pay the loan.
A bankruptcy court judge in the Fifth Circuit once wrote that the law in that circuit poses such “an incredibly high burden” on debtors that in 15 years, he had never been able to discharge student loan debt over a lender’s objections.
“It would be helpful to have some consistency,” said Scott Buchanan, executive director of the Student Loan Servicing Alliance, a trade association representing student loan servicers. “It used to be that there was a lot more consistency in interpretation.”
Student loans are treated differently than other debt because there’s no collateral and the payoff of the investment continues for a lifetime, Buchanan said.
Without consistency, loan servicers would need to start pricing loans differently in different parts of the country, Buchanan said. So a consistent standard, whether Brunner or otherwise, would be helpful to the industry, he said.
Congress vs. Courts
The Fifth Circuit says it’s up to Congress, not the courts, to revise the standards for student loan debtors.
Because student loans are backed by taxpayers, Congress intentionally made them hard to eliminate, the appeals court said in a 2019 opinion. The Fifth Circuit’s “demanding standard” fulfills that intent, it said.
There are signs that Congress might act soon.
Sen. Elizabeth Warren (D-Mass.) is expected to reintroduce a consumer bankruptcy reform bill that would allow student loan debt to be discharged on terms equal to most other types of debt. The Senate also is drafting a resolution calling for President Joe Biden to take executive action to cancel $50,000 of student loan debt for every borrower.
The courts historically are “hesitant to legislate from the bench” if Congress is about to advance a bill, said Jarret P. Hitchings, a commercial finance and corporate restructuring attorney at Duane Morris.
Nevertheless, the McCoy case comes at a “watershed moment” for student loans, he said.
“When this section of the bankruptcy code was adopted, you didn’t have such large numbers of student loan borrowers, and you didn’t have trillions of dollars in student loan debt,” he said.