Legal Watch: Rethinking the Standard for Discharging Student Debt

Student-loan debt—now totaling more than $1.3 trillion—has garnered increased public attention, including in the recent presidential campaign. An important aspect of policy debates over that debt is what happens to borrowers unable to repay. With most forms of consumer debt, discharge in bankruptcy provides one option for struggling borrowers. But this alternative is often unavailable in the case of student loans, as borrowers must satisfy a stringent legal test known as the undue hardship standard to qualify for discharge.

Application of the undue hardship standard by bankruptcy courts can result in troubling outcomes. In one well-publicized case, a bankruptcy court refused to discharge $246,000 in student-loan debt incurred by Robert Murphy to finance his three children’s college educations. Murphy lost his job and was unable to find employment for several years. He and his wife claimed in bankruptcy proceedings that, after spending their retirement savings, they largely lived on her $13,200 yearly salary as a teacher’s aide. A federal judge on an appeals panel reviewing the case asked what conditions would constitute an undue hardship if Murphy’s did not.

Until the 1970s, student loans received the same treatment in bankruptcy as other types of consumer debt. While unsupported by empirical evidence, concerns arose that borrowers would take advantage of the bankruptcy rules to discharge student loans after getting jobs in well-paying fields such as medicine and law. In 1976, Congress made federally guaranteed student loans nondischargeable in bankruptcy during the first five years of repayment, absent an undue hardship. It extended the undue hardship standard to the initial seven years of repayment in 1990, and in 1998 Congress made the standard applicable throughout the loan period. Private student loans (those not guaranteed by the federal government) became subject to the standard in 2005.

Congress left it to the judiciary to define undue hardship. Most courts have adopted what is known as the Brunner test, articulated in Brunner v. New York State Higher Education Services Corporation. In that case, a federal district court reversed a bankruptcy court’s ruling that the plaintiff had established circumstances warranting a discharge of her student loans on the basis of undue hardship. Affirming the decision, the circuit court adopted the district court’s three-part inquiry for a borrower to demonstrate undue hardship. First, a borrower must prove an inability to repay the student-loan debt while also maintaining a minimal standard of living. Next, an individual must demonstrate additional circumstances that show an unlikeliness ever to be able to repay. Finally, a debtor must demonstrate that he or she made good-faith repayment efforts. Many student-loan debtors in bankruptcy proceedings are unable to satisfy this demanding legal test.

In recent years, some bankruptcy courts have tried to apply the undue hardship standard less harshly. In one of the best-known instances, judges discharged the debt of a sixty-eight-year-old woman, Janet Roth, with chronic health problems living on monthly Social Security benefits of $780. They rejected arguments by creditors that because her income one day might increase, she should be ineligible for a discharge. The court responded that the woman had been unable to repay despite efforts to maximize her income and that it would not force her to engage in “futile acts” when no realistic chance existed for repayment. One judge in Roth’s case filed a separate opinion arguing that it was time to replace the Brunner test with a more flexible inquiry.

Some regulatory relief has become available to distressed borrowers. US Department of Education guidance issued in 2015 instructed loan holders on when not to challenge efforts to declare undue hardship in bankruptcy. In other action, the department sought to make loan forgiveness easier to navigate for permanently disabled individuals. Additionally, the Obama administration urged Congress to make the undue hardship standard inapplicable to private student loans.

Judicial reinterpretation of the undue hardship standard and regulatory measures can provide some relief to distressed student-loan borrowers, but more action is needed. With the Higher Education Act already past due for reauthorization, Congress should take the opportunity to revise the standards for discharging student loans in bankruptcy. At the very least, it should consider exempting private loans from the undue hardship standard. Even better, Congress could limit the number of years to which the undue hardship standard applies to federally guaranteed loans and also direct bankruptcy courts to follow a more flexible test for granting discharges.

Neal H. Hutchens is professor of higher education at the University of Mississippi and a member of the AAUP’s Litigation Committee.