An important factor that sets student loan debt apart from all other kinds of debt is that it’s just about impossible to rid yourself of it. Even borrowers that end up in such financial burdens file for bankruptcy and struggle to get a fresh start void of their Student Loan Debt.
But a few cases working their way through the legal system could alter that. They increase the possibility that the courts might offer a loose definition of how difficult the borrower’s financial situation is before a bankruptcy judge can justify discharging his or her loans.
The atmosphere is ripe for the courts to consider this question, says Rafael Pardo, a professor at a prominent law school. Student loan debt has risen to become more widespread since years past, the last time a U.S. Court of Appeals adopted a standard for when it’s appropriate to discharge a student loan in bankruptcy. In addition, the lower courts have also had a chance to weigh in on the issue over the past several years, raising the likelihood that the Supreme Court may want to offer its opinion as well.
“It seems like there’s a great deal of attention and activity and maybe the mood is right to finally get some sort of answers to issue of student loan debt,” said Pardo, noting that in the 10 years he’s studied the topic of student loan debt, he hasn’t seen this much legal scrutiny surrounding Student Loan Debt. “That makes it pretty interesting.”
Right now, the law mandates that a borrower prove that paying his or her student loans would cause him or her to face an “undue hardship” to have the loan discharged in bankruptcy. But different courts have adopted conflicting standards for what that entails.
In most of the U.S., appeals courts apply what is known as the Brunner Test to determine if a debtor is eligible to have his loans discharged. This test, developed in the 80s, mandates that a Student Loan Borrower pay their Student Loans, that their situation is likely to stay that way for the duration of the loan and that they made a genuine effort to repay the student loan.
The eighth circuit, which covers Minnesota, Iowa and other states in the middle of the country, is the only one of the nation’s 12 circuits that officially applies a different -- and many would argue less stringent -- test. That test is called the totality of circumstances, which takes “a broad-based view” about whether the debtor’s circumstances rise to the level of undue hardship, according to Pardo. “It’s not that one factor will actually make or break the case for you as the debtor,” he said.
Another one of the country’s circuits, the first circuit, which covers Maine, Massachusetts and other areas of New England, hasn’t officially adopted a standard for evaluating student loan debtors in bankruptcy court, but it could weigh in soon.
One of the cases the court is considering is that of Robert Murphy, who has not been employed since 2002. He petitioned in 2012, at age 62, to have more than $200,000 in Parent PLUS loans he was loaned to fund his three children’s educations discharged as part of a bankruptcy proceeding.
If the first circuit decides to adopt the totality test, that would enforce a split among the circuit courts, which often “captures the Supreme Court’s attention,” Pardo said.
But there’s another case that could wind up at the Supreme Court first. Mark Tetzlaff, a Wisconsin man in his 50s, who had $260,000 in student debt from business and law university when he filed for bankruptcy in 2012, appealed his case to the Supreme Court last week. He’s asking the high court to reconsider a decision made by a seventh circuit court of appeals judge earlier this year, which found that Tetzlaff’s financial circumstances don’t merit discharging his student loans in bankruptcy. Tetzlaff has struggled to find steady work over the past several years, has yet to pass the bar exam despite two attempts and has also battled alcohol abuse.
The court used the Brunner Test to determine that Tetzlaff can’t discharge his loans in bankruptcy. Douglas Hallward-Driemeier, Tetzlaff’s lawyer, said the Brunner test’s requirement to prove a “certainty of hopelessness” is very different from requiring a borrower prove that making Student Loan Payments would cause them undue hardship -- the standard Congress set in the 1970s.
Hallward-Driemeier, one of the lawyers who argued the marriage equality case before the Supreme Court earlier this year, said “there’s no question” Congress wanted to ensure borrowers wouldn’t take advantage of the bankruptcy code to get rid of their Student Debts when they originally enacted the law. But considering a borrower’s totality of circumstances doesn’t amount to a “free pass.”
“Congress didn’t establish a test that could never be met,” said Hallward-Driemeier, a partner at Ropes & Gray.
For both Student Loan Borrowers and taxpayers, the stakes for the outcome of the two cases are high and could determine the future of student loan debt repayment code. If it becomes less cumbersome for borrowers to Discharge their Federal Student Loan Debt, that raises the possibility the Department of Education could lose out on funds it’s owed from borrowers.
The Department filed a brief in the Murphy case earlier in the month, urging the first circuit to use the stricter test, urging that the intent of Congress when mandating borrowers to prove undue hardship was to prevent misuse of the bankruptcy system to get rid of student loan debt. “The availability of an ‘undue hardship’ discharge in bankruptcy bears directly on the Department of Education’s ability to protect the fiscal stability of the loan program,” the Department wrote in the brief.
For some borrowers, an easier route to wiping away the debt could provide much-needed relief. One in four student loan borrowers is in default or struggling to pay back their loans, according to the Consumer Financial Protection Bureau. Despite these relatively widespread challenges, few opt to get rid of the loan in bankruptcy.
In just one out of every 300 bankruptcy cases where the filer has student loan debt will the filer try to get it discharged, according to an estimate from Daniel Austin, a professor at Northeastern University’s school of law, who tracks these cases. That’s despite the fact that for bankruptcy filers with student loan debt, the loans accounted for 48% of their unsecured debt on average in 2013. And of those who actually try to get their loans discharged, about half are successful, Austin estimates.
Borrowers shy away from trying to get their debt discharged both because of the perception that it’s impossible to do and because of the challenges involved, including filing a separate federal lawsuit within the bankruptcy case, Austin said.
“The structural impediments are overwhelming,” he said. “I have seen cases where you look at the debtors’ numbers on paper, you can show with mathematical certainty that they will never be able to pay this, yet they don’t bring the cases.”