While it is possible to discharge student loan debt in bankruptcy, the test currently utilized by bankruptcy courts in the majority of states makes it a serious challenge. To qualify for such a discharge, you must show that paying the debt would impose an “undue hardship” on you and your dependents. In determining whether you have met the burden of establishing undue hardship in Arizona, the bankruptcy court applies the “Brunner test,” which comes from a Second Circuit Court of Appeals decision known as In re Brunner. The Ninth Circuit Court of Appeals, in which Arizona is located, adopted the Brunner test in a case called In re Pena.
Under the Brunner test, you must demonstrate all three of the following: 1) based on your current income and expenses, you cannot maintain a “minimal” standard of living for you and your dependents if you are forced to repay the student loans; 2) additional circumstances exist indicating that your current state of affairs is likely to persist for a significant portion of the repayment period of the student loans; and 3) you have made good faith efforts to repay the loans. It is a strict standard that does not allow a bankruptcy judge to consider all relevant facts about the debtor and the student loans (known in legal terms as “the totality of the circumstances”).
The second prong of the Brunner test is especially complicated because it involves looking into the future to evaluate the likelihood that your current financial situation will persist. In re NYS, a 2006 Ninth Circuit Court of Appeals decision, provides some guidance by laying out an unexhaustive list of factors to consider as possible “additional circumstances” under the Brunner test. These factors are: 1) serious mental or physical disability of the debtor or the debtor’s dependents which prevents employment or advancement; 2) the debtor’s obligations to care for dependents; 3) lack of/severely limited/poor quality of education; 4) lack of usable or marketable job skills; 5) underemployment; 6) maximized income potential in chosen educational field and no other more lucrative job skills; 7) limited number of years remaining in the debtor’s work life to allow payment of the loan; 8) age or other factors that prevent retraining or relocation as a means for payment of the loan; 9) lack of assets that can be used to pay the loan; 10) potentially increasing expenses that outweigh likely increases in the debtor’s income or potential appreciation of value in the debtor’s assets; and 10) lack of better financial options elsewhere.
The procedure for discharging student loan debt in bankruptcy involves filing an “adversary proceeding” against the student loan creditor. This is necessary because student loans are otherwise automatically excluded from the discharge that you receive in bankruptcy. The term adversary proceeding essentially means a lawsuit against the creditor brought within your bankruptcy case. In such a lawsuit, you will argue that you have met the requirements for showing undue hardship under the Brunner test and are therefore entitled to a discharge of your student loan debt. The creditor will likely argue that you have failed to establish one or more prongs of the Brunner test and should not be discharged of the debt.
Inasmuch as an adversary proceeding is similar to other types of litigation, it begins with you filing a complaint to determine dischargeability of the student loan debt. The creditor then files an answer to your complaint raising its defenses. Thereafter, discovery ensues (interrogatories, requests for production, depositions, etc.), and culminates in an evidentiary hearing (trial without a jury) where testimony is given and evidence presented to the bankruptcy court. The judge will subsequently make a decision as to whether your student loan debt is discharged or not.
An obvious problem in pursuing a student loan discharge in bankruptcy is how do you afford to pay an attorney to litigate with the creditor? Bankruptcy attorneys need to be paid for their work and the costs of litigation rise as the adversary proceeding progresses from one stage to the next. It’s a dilemma: if you had the money to pay attorneys’ fees, then you would be able to make payments on your student loans, right? Unfortunately, there is no easy answer in a Chapter 7 liquidation bankruptcy. If you are not able to afford an attorney, then you can choose to represent yourself or perhaps be lucky enough to find pro bono legal counsel.
In a Chapter 13 reorganization bankruptcy, however, it is possible for your attorney to get paid for representing you in an adversary proceeding brought after the bankruptcy filing as an administrative expense. The attorney files one or more applications for approval of attorneys’ fees with the bankruptcy court, and the fees are paid out of the pool of funds derived from your monthly plan payments. The Chapter 13 plan must meet funding requirements for this option to work, as it is not always feasible for a debtor to pay attorneys’ fees on top of the other debt that must be paid during the term of the plan.
Should you decide against attempting to discharge your student loan debt in bankruptcy, you may find that filing a bankruptcy to discharge other forms of consumer debt gives you just the relief you need. By getting rid of credit card payments, medical bills, or vehicles that you cannot afford to keep with a Chapter 7 bankruptcy, you can free up income to apply towards student loan payments. A word of caution: beware of private student loans with “ipso facto” clauses in the contracts, as they may lead to an acceleration of the debt and demand for payment in full, even if you are not delinquent on payments and merely because you filed a bankruptcy petition. You could end up having to litigate the issue of whether such an automatic default clause is enforceable under the Bankruptcy Code with the private student loan creditor in an effort to stop collection.
Alternatively, if reorganizing your debt under Chapter 13 of the bankruptcy code is appropriate, then you will receive relief from your student loans during the plan term (typically 3-5 years). The student loan obligation falls into the same classification as other unsecured debt in a Chapter 13 plan, and the creditor receives a distribution from the payments that you make over the plan term. Upon completing the plan, you will resume paying on the portion of your student loan debt that was not paid through the plan. In the majority of cases, there is little paid towards the student loan debt through the plan, but you will have resolved other debt issues that made it harder to pay your student loan.
In lieu of bankruptcy, the answer to a federal student loan debt problem may lie in one of the Direct Loan and Federal Family Education Loan Program Repayment Plans, such as the Income-Based Repayment Plan, the Income-Contingent Repayment Plan, or the Pay As You Earn Repayment Plan. Other possible options include deferment or forbearance, as well as forgiveness (for example, public service loan forgiveness or teacher loan forgiveness), cancellation, or a non-bankruptcy discharge (for example, a total and permanent disability discharge or a closed school discharge). For information, visit the U.S. Department of Education website at: https://www.ed.gov/.
If you are in default on one or more private student loans, the student loan company has a deadline to sue you or the debt becomes unenforceable. This is known as a statute of limitation and does not apply to federal student loans. If you are sued on a private student loan, you should seek advice from an attorney regarding any defenses you may have to the lawsuit, including but not limited to a statute of limitations defense. Should it prove to be a valid and enforceable debt, there is still hope of reaching a settlement with the creditor, either before or after a lawsuit has commenced.
I would be happy to speak with you about your student loan debt and whether bankruptcy can help. Please don’t hesitate to call me at 480-344-0981, or via email at firstname.lastname@example.org. As a reminder, the information I’ve shared in this post is not intended to constitute legal advice or create an attorney-client relationship.