A New Approach to Discharging Student Loan Debt?

Student loans carry a reputation for inevitability surpassed only by death and taxes. With good reason, too. In order to discharge a student loan in bankruptcy—the only way to shake it for good—a borrower in bankruptcy must show that being required to repay the loan would cause them “undue hardship.”

Making that showing has proven difficult indeed. In applying the “undue hardship” standard, most courts use the Brunner test, which requires petitioners to prove that they: (i) cannot maintain a minimum standard of living; (ii) won’t be able to do so for much of the repayment period; and (iii) made a “good-faith effort” to repay the loans (by, for instance, getting a job and/or minimizing expenses). The standard is so fact-specific that generalizations are difficult, but it’s the rare circumstance that meets all three prongs of the test. Anecdotal tales like the one about a woman making $10,000/year who couldn’t prove “undue hardship” abound.

But what if borrowers in bankruptcy did not have to prove “undue hardship” in order to get their student loans discharged? Step back and remember: Student loans cannot be discharged (except on showing of an “undue hardship”) only because Congress exempted them from the rules that apply to most debts. If a debt does not meet the Bankruptcy Code’s requirements for such an exemption, then, it can be discharged without a showing of undue hardship.

That definition leaves some wiggle room, and debtors are starting to exploit it. The Bankruptcy Code defines a non-dischargeable student loan as a “qualified education loan” having certain characteristics. Among other things, the loan must have been incurred solely for “qualified higher education expenses”, which means the “cost of attendance” at an “eligible educational institution.” Many students take out loans that arguably exceed their cost of attendance. If that is found to be the case, the whole loan would be subject to discharge (given that it was not solely for the cost of attendance). Also, a non-accredited school might not be considered an “eligible educational institution.”

These arguments are reportedly enjoying at least some success, but mounting them requires legal fees that most debtors can’t afford, and banks may choose to settle cases before any law can develop. If these arguments gain traction, however, they could have severe implications for investors, and raise even more alarms about the imminent bursting of a student loan bubble. At the very least, they would make clear: death and taxes really are the only things we’re sure of in life.