On November 17, 2022, the U.S. Department of Justice put out new guidance to Justice Department attorneys regarding requests to discharge student loans in bankruptcy cases.
Pursuant to 11 U.S.C. §523(a)(8), certain student loans may not be discharged in bankruptcy unless the bankruptcy court determines that payment of the loan would impose an undue hardship on the debtor and the debtor’s dependents.
It is the undue hardship standard that has prevented discharge of student loans in bankruptcy cases for the vast majority of debtors in the past. The seminal case that sets forth the factors a debtor must show in order to prove an undue hardship is, Brunner v. New York State Higher Education Services Corp., 831 F.2d 395 (2d Cir. 1987). To discharge a student loan under the Brunner test, a bankruptcy court must find that the debtor has established: (1) the debtor cannot presently maintain a minimal standard of living if required to repay the student loan, (2) circumstances exist that indicate the debtor’s financial situation is likely to persist into the future for a significant portion of the loan repayment period, and (3) the debtor has made good faith efforts in the past to repay the student loan.
Typically, Justice Department attorneys would oppose discharge of federal student loans, arguing that debtors could not show an undue hardship under the Brunner test. This has been an extremely high bar for debtors to overcome.
New Guidance for Justice Department Attorneys
The new guidance from the Justice Department advises its attorneys to stipulate to the facts demonstrating that a debt would impose an undue hardship and recommend to the court that a debtor’s student loan be discharged if three conditions are satisfied: (1) the debtor presently lacks an ability to repay the loan; (2) the debtor’s inability to pay the loan is likely to persist in the future; and (3) the debtor has acted in good faith in the past in attempting to repay the loan.
Although this guidance looks similar to the Brunner Test, the guidance on how Justice Department attorneys evaluate these conditions has drastically changed.
1.Whether debtor presently lacks ability to repay the loan
First, the Justice Department attorneys are instructed to use the IRS Standards to determine the debtor’s allowable expenses. Then, they should compare those allowable expenses to the debtor’s income to determine whether the debtor has income left over after expenses to make the student loan payments. If the debtor’s allowable expenses exceed their gross household income, then this condition is satisfied. Even if debtor’s expenses exceed the IRS Standard expenses, debtor can provide a reasonable explanation for the excess and such an analysis will be done on a case-by-case basis. Basically, if debtor would not be able to maintain a minimal standard of living after deducting all of debtor’s allowable and reasonable expenses from their gross household income, then this condition is satisfied. In certain circumstances where a debtor has some discretionary income to pay towards their student loan debt, but not enough income to satisfy the minimum student loan payment, the Justice Department attorneys are instructed to consider the potential for a partial discharge of their student loan debt.
2.Whether the debtor’s inability to pay will likely persist in the future
The second factor for discharging a student loan debt, is whether the debtor’s current inability to repay the debt while maintaining a minimal standard of living will likely persist for a significant portion of the repayment period.
A presumption that a debtor’s inability to repay debt will persist is to be applied in certain circumstances, including: (1) the debtor is age 65 or older; (2) the debtor has a disability or chronic injury impacting their income potential; (3) the debtor has been unemployed for at least five of the last ten years; (4) the debtor has failed to obtain the degree for which the loan was procured; and (5) the loan has been in payment status other than ‘in-school’ for at least ten years.
In addition to the presumptions set forth above, debtors may present facts that the debtor believes are relevant to their future ability to repay the student loan.
3.Whether the debtor has acted in good faith in attempting to repay the student loan
If debtor has taken at least one of the following steps, then this would be used as evidence to demonstrate good faith:
- making a payment;
- applying for a deferment or forbearance (other than in-school or grace period deferments);
- applying for an Income Driven Repayment Plan;
- applying for a federal consolidation loan;
- responding to outreach from a servicer or collector;
- engaging meaningfully with Department of Education or their loan servicer, regarding payment options, forbearance and deferment options, or loan consolidation; or
- engaging meaningfully with a third party they believed would assist them in managing their student loan debt.
In addition to these steps, debtor can submit other evidence that shows good faith such as debtor’s efforts to obtain employment, maximize income and minimize expenses. Also, evidence of good faith can be shown where a debtor’s family or personal obligations significantly reduce their employment opportunities or increase their expenses.
Whether a debtor’s federal student loan debt would be discharged in bankruptcy is ultimately up to the bankruptcy judge presiding in that case, however the likelihood of student loan debt being discharged through bankruptcy should dramatically increase, if the Justice Department attorneys stipulate that the debtor has met the undue hardship standard.