“Undue hardship” seems like an easy hurdle to clear.  If you are broke, the choice may be buying food or paying on the student loan, right?  Unfortunately, courts have taken a very narrow and hard-line approach in construing the undue hardship standard.  Consequently, it is very difficult to discharge student loans in bankruptcy.  A good example of this is found in the recent case of Wallace v. Educational Credit Management Corp., 2010 WL 5764771 (Bky.S.D. Ohio Dec. 1, 2010). 

The bankruptcy debtor in Wallace graduated with bachelor’s degree in sociology and over $30,000 in student loan debt. Wallace was able to work one year making a little over $12,000 before being forced to quit working due to complications from diabetes. Over the next few years he lost one eye, and had a kidney and pancreas removed.  By 2008, he was legally blind and receiving $811 each month in social security disability.  His monthly expenses were determined to be $790. 

Wallace and his attorney filed an adversary case in the bankruptcy court seeking to discharge the student loan debt under the undue hardship standard.  The Bankruptcy Court for the Southern District of Ohio looked at three factors (known as the Brunner test) in reaching its decision: 

1. whether Wallace could maintain a “minimal” standard of living if forced to repay the student loan debt;
2. whether additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the student loan repayment period; and
3. whether Wallace made a good faith effort to repay the student loans. 

The Ohio Bankruptcy Court decided that while the first prong of the Brunner test was met, Wallace “failed to demonstrate that his state of affairs is likely to persist for a significant portion of the repayment period of the Loan.” The Bankruptcy Court ordered Wallace to pay $20 per month, but stayed final judgment on the issue until 2012 and would review the case.  In a bit of ironic prose, the court stated that “It remains to be seen into which group Wallace will land, whether he will find work or remain unemployed.”  

As you can see from the Wallace case, student loans are very difficult to discharge.  If you believe you can meet the undue hardship test, discuss your with an experienced bankruptcy attorney.  While not impossible, discharging student loans is a very high bar to clear.

Stafford Loans during a Chapter 13 bankruptcy presents a problem for the student.  You will need permission from the bankruptcy trustee and bankruptcy court to incur additional debt.  These requests are handled on a case-by-case basis, so consult with your bankruptcy attorney if you want to take loans to attend school during a Chapter 13 bankruptcy. 

Credit-based financial aid is a different story.  This type of financial aid includes student loans from private lenders such as Sallie Mae.  Applying for credit-based loans is the same as applying for an unsecured personal loan.  Your credit history is considered and your bankruptcy will play a part in the decision to give you the loan. 

Your credit is also considered if you are a parent applying for a parent loan like the PLUS (Parental Loan for Undergraduate Students) Loan and the Graduate PLUS (a loan for Graduate students) Loan.  These federally guaranteed parent loans are credit based and federal regulations state that a parent with a bankruptcy within the past five years is automatically disqualified from obtaining a PLUS Loan for his or her child, unless there were extenuating circumstances or the borrower obtains a creditworthy endorser.  However, if you are denied a PLUS Loan, your child qualifies for increased unsubsidized Stafford loan limits.  Stafford loans remain in forbearance while the student attends school, while a PLUS Loan is subject to immediate repayment. 

If you are a student or parent who needs money for school after a bankruptcy, speak with your student financial aid advisor and your bankruptcy attorney.  Bankruptcy can help eliminate your personal debt and free money for college, or college loan repayment.

Consequently, many bankruptcy debtors are caught in a student loan trap of being unable to pay on the student loan and the interest continues to accrue.  While discharging the student loan may not be possible, there are options for dealing with a student loan during and after bankruptcy. 

First, the student loan lender or collection agency is strictly forbidden from engaging in any collection action during the bankruptcy.  This protection (known as the “automatic stay”) may last from a few months during a Chapter 7 to several years during a Chapter 13 repayment plan.  Interest may continue to accrue and will be tacked-on at the end of the bankruptcy case. 

Second, if the student loan was not defaulted prior to the bankruptcy filing (meaning no payment for more than 270 days), the account will usually be re-aged and is considered current upon the conclusion of the bankruptcy case.  This is a good time to negotiate with the lender for a payment plan you can afford.  If the student loan was defaulted prior to the bankruptcy, the lender may offer a loan rehabilitation program. 

Finally, your student loan lender has many repayment options after your bankruptcy case ends, including the Income Based Repayment Plan which limits your loan repayment to 15% of your income and offers loan forgiveness after 25 years of repayment (or 10 years for public service employees). 

If you are struggling with student loan debt, speak to an experienced bankruptcy attorney and discuss your options.  Your attorney can explain the many ways for dealing with student loan debt and can help you decide on a course of action that is best for you and your family.

During the Committee hearing Rafael I. Pardo, an associate professor at the Seattle University School of Law who has studied the discharge of student loans in bankruptcy, challenged Congress “to clarify the undue hardship standard.”  Many courts view “undue hardship” as a high bar that is only met by a showing of exceptional circumstances (like physical or mental disabilities, or poor or no future earning potential) that result in an inability to both repay the student loans and provide a minimum standard of living for the debtor and the debtor’s family.  This is a very difficult burden for most debtors to meet, and consequently bars the discharge of student loans in most cases – even while other consumer debts like auto loans, credit cards, medical debts, mortgages, and even taxes are discharged in the debtor’s bankruptcy. 

Consumer bankruptcy attorney Brett Weiss, who testified on behalf of the National Association of Consumer Bankruptcy Attorneys and the National Consumer Law Center, called the situation “unfair” when other consumer loans are forgiven in bankruptcy proceedings while student loans are not.  As a result of these hearings, Rep. Steve Cohen (D-Tenn.) announced his plans to file legislation to “give private student loan borrowers more equitable treatment during the bankruptcy process.” 

For the time being it remains extremely difficult to discharge student loans.  However, there are other non-bankruptcy programs for debtors unable to repay their loans.  In some cases debtors may qualify for reduced payments, deferment, forgiveness or cancellation.  Chapter 13 bankruptcy can also provide a way to cure defaulted student loans, or pay them off during the bankruptcy.  If you have student loan debt, discuss your situation and options with a qualified bankruptcy attorney.