How Student Loans are Treated in Bankruptcy
History of Student Loan Dischargeability
Prior to 1998, a student loan was dischargeable (you could eliminate it) in bankruptcy if the student loan was in repayment status (not including any deferment period) for at least 7 years at the time of your bankruptcy filing.
On October 7, 1998, the Bankruptcy Code was amended to make student loans nondischargeable if the student loan was made or guaranteed by the Federal Government unless you could show that nondischargeability would pose an “undue hardship” upon you and your dependents. Student loans still remained dischargeable if the student loans were not made or guaranteed by the Federal Government.
On October 17, 2005, the New Bankruptcy Law went into effect and drastically changed your ability to discharge student loans in bankruptcy. The New Bankruptcy Law in effect treats privately funded student loans just like government backed student loans.
Under the law, all educational loans, whether government backed student loans or privately funded student loans, are nondischargeable in bankruptcy unless you can show that nondischargeability would post an “undue hardship” upon you and your dependents.
Undue Hardship- The Brunner Test
The Bankruptcy Code does not define what constitutes an “undue hardship.” To determine whether an undue hardship exists sufficient to allow you to obtain a Hardship Discharge of your student loans in bankruptcy the Bankruptcy Court will apply the “Brunner Test.”
The Brunner Test is a 3-Part test first established in 1985 by the Second Circuit Court of Appeals. At the time the test was established it was not controlling in California.
On September 11, 1998, the Ninth Circuit Court of Appeals, which is controlling over California Bankruptcy Courts, adopted the Brunner Test. Since that time, the Brunner Test has been the controlling test that is applied by California Bankruptcy Judges in deciding whether to grant you Hardship Discharge of your student loans when you file for bankruptcy.
Under the Brunner Test, the Bankruptcy Judge applies a 3-Part test to determine whether an undue hardship exists sufficient for the Bankruptcy Judge to grant you a Hardship Discharge when you file for bankruptcy:
You must establish that you cannot maintain, based upon your current income and expenses, a minimal standard of living for yourself and your dependents if you are forced to repay your loans.
You must show that additional circumstances exist indicating that your current state of affairs is likely to persist for a significant part of the repayment period of your loans.
You must have made good faith efforts to repay your loans.
In practice, it is very difficult to obtain a Hardship Discharge under the Brunner Test. Once you pass the first part of the test- you establish that you cannot maintain a minimal standard of living if forced to repay your student loans- you must still show the Bankruptcy Court that your situation is not going to change for a significant part of your repayment period.
It will not be presumed by the Bankruptcy Court that your current state of affairs is not going to change for a significant part of your repayment period. Rather, you must make an affirmative showing and prove to the Bankruptcy Court that you have an insurmountable barrier to financial recovery that is likely to remain with you for a substantial portion of your repayment period.
Technically, under the Brunner Test, your barrier to financial recovery does not necessarily need to be so extreme that it rises to the level of a physical disability, learning disability, mental illness, or other similar extreme circumstance.
In reality, Bankruptcy Courts frequently reserve granting a Hardship Discharge to the extreme case- a case where you are physically unable to work and there is virtually no chance that you will recover and obtain gainful employment in the future.
Even if you have an extreme case, you must further show that you have made good faith efforts to repay your student loans. This means, for example, attempting to work out a repayment plan, consolidating your loans under the Federal Direct Loans consolidation program, and other similar good faith efforts to repay your educational loans prior to filing bankruptcy and requesting a Hardship Discharge.
Partial Discharge
Discharging student loans in bankruptcy is not always an all or nothing proposition. Bankruptcy Judges have equitable powers and may exercise their equitable powers to partially discharge a portion but not all of your student loans based upon your individual circumstances.
To obtain a partial discharge of your student loans you will still need to meet all 3 parts of the Brunner Test with respect to the portion of your educational loans that you are seeking to discharge. If and only if you meet all 3 parts of the Brunner Test, then the Bankruptcy Judge may exercise his or her discretion to grant you a partial discharge of your student loan debt.
HEAL Loans
Health Education Assistance Loan (HEAL) Act loans, commonly referred to as HEAL Loans, are subject to an even stricter standard (stricter than the Brunner Test) and are harder to discharge than any other type of educational loan debt. In particular, discharging a HEAL Loan in bankruptcy requires a finding by the Bankruptcy Court that, among other findings, it would be “unconscionable” not to discharge your HEAL Loan. Unconscionability is a very difficult standard to meet.
Adversary Proceeding Required
If you can establish that your case meets the standard for granting a Hardship Discharge or partial discharge of your student loan debt, you will need to file an Adversary Complaint with the Bankruptcy Court requesting a determination that your loans are discharged in your bankruptcy case.
What is an Adversary Complaint/Proceeding?
An adversary complaint is a separate lawsuit filed in the US Bankruptcy Court seeking to deny the debtor the bankruptcy discharge and possibly to enter a judgment against the debtor. The adversary complaint may seek to deny the discharge as to all creditors or as to only the particular creditor who filed the lawsuit. An adversary complaint typically relates to debtor’s bad behavior before the bankruptcy was filed or bad behavior in connection with the bankruptcy case itself.
A typical adversary complaint is filed by a creditor who believes it was wronged by debtor’s bad behavior prior to the bankruptcy case being filed. Examples of debtor’s wrongful behavior relate to: incurring credit card debt without the ability or intent to repay; taking payday loans without the ability or intent to repay; alimony; child support; taxes; fraud; false representations; false pretenses; breach of fiduciary duty; embezzlement; larceny; or willful and malicious injury.
Adversary complaints also could be filed by a standing trustee or the U.S. Trustee who believes a debtor engaged in wrongful behavior in connection with the bankruptcy case. Examples of debtor’s wrongful behavior relate to: making fraudulent oaths; making false claims; transferring or destroying property with an intent to hinder, delay or default a creditors; concealing, destroying, or failing to maintain books and records; failing to explain the loss of assets; and refusing to obey any court order.
And as discussed above, an adversary complaint may be filed by the debtor seeking to have a student loan discharged.
Contact Us
Contact us today to schedule a consultation with a San Diego Bankruptcy Lawyer to determine whether your situation merits a Hardship Discharge or partial discharge of your student loan debt
Mark A. Reed, Esq.
7710 Balboa Avenue
Suite 316
San Diego, CA 92111
Phone: 858-277-0232 Fax: 858-277-2627
We are a debt relief agency. We help people file for bankruptcy relief under the Bankruptcy Code.