In a rare ruling, a bankruptcy court in California has allowed a borrower to discharge over $430,000 in student loans.
The bankruptcy code treats student loan debt differently from most other forms of consumer debt, such as credit cards and medical bills. Borrowers must generally prove that they have an “undue hardship” in order to discharge their student loan debt in bankruptcy. These restrictions initially only applied to federal student loans, but were subsequently expanded to cover private student loans following the passage of a 2005 bankruptcy reform bill.
The “undue hardship” standard applied to student loan debt is not adequately defined in statute, so bankruptcy judges have established various tests (which vary by jurisdiction) to determine discharge eligibility. The most common of these tests is the Brunner test.
In order to try to prove that they meet the undue hardship standard, borrowers must initiate an “adversary proceeding,” which is essentially a lawsuit within the bankruptcy case that is brought against the borrower’s student loan lenders. Through the adversary proceeding, the borrower must present evidence showing that they meet the undue hardship standard, while the student lenders present opposing evidence. The adversary proceeding can be a long and invasive process for borrowers, and can get quite expensive for those who retain a private attorney. Student loan lenders may also have significantly more resources than borrowers, which can give them an edge in the litigation. As a result, many student loan borrowers are unsuccessful in proving undue hardship, and many others don’t even try.
But a bankruptcy judge in California ruled earlier this month that a student loan borrower with a string of bad luck met this difficult standard.
The borrower had taken on substantial student loan debt to go to medical school (hundreds of thousands of dollars in student loan debt is not uncommon for graduates of medical degree programs, given anticipated high earnings). However, the borrower was unable to match for residency after completing his medical degree. He was forced to take a variety of low-paying jobs, and earned less than $35,000 per year between 2010 and 2017. In at least one year, he earned only $3,000. The borrower claimed he had applied for thousand of additional jobs during this timeframe, but was unsuccessful.
The borrower filed for bankruptcy, and went through an adversary proceeding to try to prove that he met the undue hardship standard. The court ultimately ruled in his favor. In support of its ruling, the bankruptcy court noted that the borrower’s expenses consistently exceeded his income, despite his consistent efforts to secure higher paying work. The court also noted his lack of a reserve of funds, the fact that his future employment prospects depended on incurring the additional expense of retraining, and his willingness to take any type of employment he could find during the preceding decade. The court further found that his overall financial circumstances were unlikely to substantially change in the future, based on the evidence presented.
The bankruptcy court concluded that the borrower’s overall student loan debt should be reduced from $440,000 to $8,291.67, and allowed the borrower to pay off the small remaining balance at the rate of $41.87 per month.
Notably, in issuing its decision, the court rejected an argument by the U.S. Department of Education that the borrower should be denied relief because he failed to take advantage of income-driven repayment programs, which can provide affordable payments and eventual loan forgiveness for federal student loan borrowers, even for borrowers with large balances. The court rejected this argument given that the large balance itself was impacting his credit and limiting his employment prospects. The court also noted that there could be significant tax consequences associated with eventual loan forgiveness under an income-driven repayment plan, and this factored into the court’s reasoning, as well.
The case, Koeut v. U.S. Department of Education, in the Southern District of California, is the latest in a series of cases throughout the country that have allowed borrowers to discharge their student loans in bankruptcy, despite the difficult procedure and challenging standard that they must meet in court.
There are efforts underway, however, to reform the bankruptcy code to more easily permit student loan discharges. Last week, Democratic lawmakers in the House and Senate unveiled the Consumer Bankruptcy Reform Act of 2020. The bill, if enacted, would change the bankruptcy code by simply eliminating the section of the code that exempts student loan debt from discharge. Student loans would be treated no differently from other forms of consumer debt, and could be discharged without an adversary proceeding, and without having to prove an “undue hardship.” The bill also enacts other significant reforms, including restructuring bankruptcy procedures, enhancing consumer protections against creditors, and expanding the dischargeability of certain other debts.
The bill has little chance of passing the Republican-controlled senate during the lame-duck session. But its chances could improve depending on the outcome of the January runoff elections in Georgia, which will determine which party controls the Senate after Joe Biden assumes the presidency on January 20.
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