NCBJ 2021: Legislative Wish Lists and Realities

This is a combination of two programs. One of the NCBJ plenary sessions offered a Shark Tank like program where three lawyers pitched their proposals to reform the Bankruptcy Code. Meanwhile, at the ABI luncheon, Bill Brandt and Robert Keach offered their prognostications as to what might actually change in the Code. Since both programs involved legislation, I have chosen to combine them here. As you read through this article, you should note that the first part contains the idealism of would-be reformers while the second part contains the realpolitik. 

Shark Tank

Student Loans

In the first program, John Rao of the National Consumer Law Center offered his proposal to amend 11 U.S.C. Sec. 523(a)(8) to rollback dischargeability of student loans to the law as it existed in in 1998 when student loans could be discharged after seven years or on a showing of undue hardship.  He said that the seven-year period deals with the concern that people can come straight out of school and file bankruptcy. He said it's not a complete solution. He said we still need to deal with cost of higher education. 

To make the case for change, he gave the illustration of Karen in Arkansas. She borrowed $10,000 thirty years ago. She never used her degree. Over thirty years, she paid $20,000 but still owed $106,000. Mr. Rao said that there is something fundamentally broken with a system if that is how we treat our debtors. Now the federal student loan creditors can garnish her Social Security and tax refunds and even the Earned Income Tax Credit. There is no statute of limitations on federal student loans so her debts will only disappear when she dies. 

Why did Congress change the law?  (Congress changed the law in 2005 to add some private student loans to the list of non-dischargeable debts and eliminate the ability to discharge student loans after seven years). He pointed out that there was not a single Congressional hearing or GAO report on abuse. He characterized the change in law as a Congressional gimmick to balance the budget. 

Mr. Rao was asked if his proposal would protect the public fisc. There are $1.7 trillion in federal student loans. Why not require payment of disposable income over period?

Mr. Rao responded that most debts are performing. Only about 10% in default. There is no evidence that denying discharge increases revenues to government. Instead, the federal government can capitalize the interest and seek returns that would make a predatory lender blush. The problem with requiring debtors to complete a chapter 13 is that about 50% of Chapter 13 debtors never get a discharge.

Mr. Rao was asked about his proposal to leave undue hardship in in his proposal. He was asked whether it be better to have objective criteria for undue hardship. Mr. Rao said that objective criteria would help but we already have a workable standard for undue hardship in connection with reaffirmation agreements and it would make sense to use that standard. However, he pointed out that the debtors who need relief the most can't afford to litigate. 

He was asked whether his proposal would roil the markets. Wouldn't lenders increase the price to address the risk? He pointed out that the pricing only affects private lenders. When private loans were made non-dischargeable in 2005 there was either no decrease in rates or an actual increase based on different studies.

President Biden has proposed cancelling some student loan debt. Doing this would be a stimulus to economy according to Moody's as more people would be able to buy homes and have children. However, requiring bankruptcy to get that cancellation would avoid the moral hazard of general cancellation. 

KERPs

 

Metta Kurth pitched a proposal to close loopholes to BACPA's limitations on "pay to stay." She called her proposal "stop the heist." In 2005, BAPCPA limited Key Employee Retention Programs ("KERPs") by requiring that a company demonstrate three things: that the person receiving the KERP has received a better offer, that their services are essential and that the amount of the KERP is either not more than 10 times the mean amount paid to non-management employees for similar purposes or, if no similar amounts were paid out in the prior year, it did not exceed 25% of any similar payment made to an insider during the prior year. 11 U.S.C. Sec. 503(c).     

Some companies shifted away from KERPs and went to "keeps," incentive payments to be earned for meeting certain benchmarks. Ms. Kurth said that "keeps" had a greater sense of integrity. However, other companies made an end run around the KERP rules by simply making these payments pre-petition. She gave the example of JC Penney which paid out $7.5 million to four executive five days before the petition. 

Ms. Kurth proposed to amend 11 U.S.C. Sec. 548 in three ways:

(a) Existing Sec. 548(a)(1)(B)(ii)(IV) states that insider compensation given for less than reasonably equivalent value and outside of the ordinary course of business can be recovered as a fraudulent transfer. She would extend this to apply to all insider compensation given during the 90 days before bankruptcy.

(b)  She would also add a provision that insider compensation would be presumed to be for less than reasonably equivalent value if it was greater than the normal pre-bankruptcy compensation and did not meet the requirement for a KERP; and

(c)  Make non-dissenting directors who approve compensation in violation of this provision liable similar to state laws applicable to illegal dividends. 

She was asked if companies would just give out insider bonuses 91 days before bankruptcy if her proposal was adopted. She answered that the petition date is often fluid and that 90 days will catch most abuse. 

She said that her proposal would motivate companies to use a "keep" or stay within guardrails for KERPs during the runup to the petition.

She acknowledged that her proposal would not fix the imbalance in executive compensation. 20 years ago, executives earned 70 times the wage of their typical worker while today that ratio is now 200 times.

She said that she was not trying to fix entire system, just the perception of abuse.

(Ed.: While I admire Ms. Kurth's enthusiasm, her proposal would continue the trend of making the Bankruptcy Code resemble the Tax Code in its complexity. The problem with ever more specific prohibitions is that ever more clever lawyers will find ways around them. To be very clear, she had identified a very real and very serious problem. My quibble is with the specifics of her proposal rather than the need for it)

The Means Test

Eric Brunstad proposing the means test as the gateway for determining substantial abuse. He proposed going back to the standard existing before BAPCPA when Bankruptcy Judges had discretion to find substantial abuse based on the circumstances of the case rather than a statutory presumption. 

He said that the means test was a solution in search of a problem that never existed and a bad solution at that.

He said that judges know abuse when they see it and have ample tools to address it when it actually arises.

He asked the rhetorical question of where did the means test come from? He said it came from the history of credit card underwriting. At one time, credit card underwriting was done on an individual basis. Then it went to a portfolio underwriting system. The model predicted 4% default rate. As time went on, credit cards became less profitable. He said that the credit card companies wanted to squeeze a couple more bucks out of the system by making bankruptcy more difficult and expensive to pursue. (Ed. Prof. Ronald Mann described this as the "sweatbox" in an influential paper). 

He said that the means test was a very inefficient solution. If you are $1 above the test, you are deemed to be a substantial abuse. 

Prof. Brunstad said that the empirical data said abuse was not out there. He also said that a one size fits all test was not useful. He quoted Tolstoy who said, "All happy families are alike; each unhappy family is unhappy in its own way.” He said that by analogy, every abusive debtor is abusive in its own way. 

He stressed that there was not a problem with too many people filing bankruptcy. According to Sen. Elizabeth Warren, 43 million people were in financial distress after the Great Recession, but only 1.5 million filed bankruptcy.  He said that people do not file for bankruptcy willy-nilly

He repeated the proverb that you can't get blood out of stone and then described the means test as a very expensive blood test for the stone.

He said that this kind of discretionary thing (i.e., ferreting out abuse) is what bankruptcy judges are paid to do.

He also said that there is a huge externality problem. He asked who gets the benefit and who bears the cost? The credit card companies reap the benefit from debtors who continue to pay because they cannot afford to file bankruptcy. The cost is borne by higher fees paid by debtors. He said that if a debtor is required to file chapter 13, it is like a 25% tax. 

In the end, the audience voted to invest in all three proposals. Unfortunately, legislative reform depends on a dysfunctional Congress, not what bankruptcy judges and professionals would like to see. That offer a nice segue into the second legislative program I watched.

ABI's Program on Legislative Likelihoods

The three proposals contained in the Shark Tank program were each thought provoking. However, when the American Bankruptcy Institute put on a program on likely changes to legislation, it focused on different proposals altogether. Bill Brandt and Robert Keach are both ABI members who have been active in proposing legislation. Although ABI does not take positions on legislative as a group, its individual members have been active in lobbying Congress. I want to stress that the very opinionated and outspoken Mr. Brandt and Mr. Keach were speaking for themselves rather than for the ABI as an institution. 

SubChapter V

Mr. Brandt started the conversation off with discussion of SubChapter V. He said that when it was passed, the debt limit of $2.7 million was too low. Shortly after it was passed, they were able to increase the limit to $7.5 million but only on a temporary basis. Now he said that the goal would be to increase the limit to $20 million. However, at higher limits, SubChapter V would take on more of a hybrid nature. He said that U.S. Trustee fees would need to kick in at somewhere between $7.5 million to $10.0 million to keep the program funded. He also said that legislation would likely give courts the option to have a creditors' committee beginning at $12-$15 million.

He said that if the debt limit was increase to $20 million, it would cover 95% of Chapter 11 cases. He said that this would take the wind out of the venue issue, which he described as "our abortion issue."

This raises two very interesting questions. Was he assuming that mega SubChapter V cases would not be forum shopped? If the law allows forum shopping and litigants see an advantage to doing so, why would they stop? Also, it wouldn't address the problem of the large public companies seeking out favorable venues to the detriment of smaller creditors, employees, retirees and other constituencies. Also, as a Texan, I am very familiar with the emotions triggered by abortion. On the one hand are those with moral certainty about the importance of lives as yet unborn while on the other there is the moral certainty of those who want to control their own bodies. Abortion stirs the outrage of moral certainty in its combatants. Is bankruptcy venue really that divisive or was Mr. Brandt merely engaging in hyperbole?

 Mr. Keach acknowledged that he had lost the debate over having a facilitating trustee in SubChapter V and that it was good that he lost. He described the trustee as one of the reasons why the Small Business Reorganization Act has worked so well.

Mr. Brandt said that raising the SubV debt limit could make its way into a reconciliation bill because it would raise fees. He also explained that because the support of Sen. Grassley was critical that SubChapter V was intentionally made similar to Chapter 12.

Venue

Mr. Brandt had a very cynical view on venue reform. He said that with this President and Rep. Nadler chairing the House Judiciary Committee, venue would be a non-starter. He said that venue was a good way for Sen. Cornyn and Sen. Warren to raise a lot of money but that it would not be a factor for the balance of this decade.

Mr. Keach said that the option to allow affiliate filings was designed to placate New York bankruptcy lawyers but "no one in New York believes that."

(Ed.: Dissenting Opinion here. For the last three years, Sens. Cornyn and Warren have worked together on a venue bill. This year bills have been introduced into the Senate and House at an earlier stage with more co-sponsors than before. As cases like Purdue Pharma draw national outrage, bankruptcy venue will continue to build momentum. However, I must acknowledge that our scrappy, grass-roots crusade has very determined and well-organized opposition). 

Mr. Brandt said that there was a study that concluded that the bankruptcy industry had the same effect for the Delaware economy as having a minor league baseball team would have. He also said that having increased debt limits for SubChapter V would be a pretty good second choice for the venue reformers. 

Mr. Brandt noted that the fire for venue reform has weakened as the New York-Delaware duopoly has expanded to include Houston and Virginia. (Ed.: Dallas, TX, Corpus Christi, TX and Charlotte, N.C. have also been the recipients of recent attempts at forum shopping. Will forum shopping become so widespread as to draw a collective "meh" from the bar? As the blogger, I get to ask the questions, but I honestly don't have an answer).

He said that 10-15% of the Senate will always oppose venue reform making it an uphill battle. 

He also said that another needed reform would be to allow a single asset real estate debtor to be a SubV debtor if it was a landlord to a small business debtor.

Third Party Releases

Mr. Keach mentioned that when Jon Oliver did a program on third party releases, he had a researcher spend an hour with Mr. Keach. He said that Mr. Oliver gave the issue a very serious presentation. He then said that the issue was not going anywhere. He characterized it as a solution in search of a problem. He said that it was not the bankruptcy system that was broken but the tort system. He said that bankruptcy delivers money to victims faster and more efficiently than the tort system. He said that it is easy to forget that what we are about is compensating people. He said that if you want to punish people, prosecute them. "If you can't prosecute them, then shut up."

Mr. Brandt said that legislation barring third party releases even with an opt out were going nowhere. He said it was a chance for Democrats to say that they voted against Darth Vader. 

Student Loans

Mr. Brandt said that the Fresh Start Bill proposed by Sen. Dick Durbin is the closest bill that might actually achieve passage. It would reinstate dischargeability after ten years and is close to the ABI Commission's proposal. However, he said it was "probably not a this year thing." He added that bankruptcy reform always starts out with consumer provisions. He indicated that it would not be this Congress. Probably the next Congress or the one after that and it would be part of a bill with lots of ornaments on it.

He said that one problem with achieving bankruptcy reform is that there is not an association of past and future debtors but that student loan borrowers vote. Unfortunately, they cannot afford campaign contributions. 

Mr. Keach said that the purveyors of private student loans hired really good lobbyists in the past but that maybe the problem is becoming too significant to ignore.

Final Thought: I really appreciated the fact that Mr. Brandt and Mr. Keach didn't pull any punches. I may not have agreed with them, but they certainly gave their unvarnished opinions without resorting to polite euphemisms. 

Second Circuit Says Student Obligation Was Not Excepted From Discharge

Congress has made it very difficult to discharge a student loan. However, as illustrated by a recent decision from the Second Circuit, not all obligations owed by students in connection with their schooling are excepted from discharge. Homaidan v. Sallie Mae, Inc., 2021 U.S. App. LEXIS 20934 (2^nd Cir. 7/15/21).

NCBJ Panel Discusses New Consumer Loan Products

One of the best panels that I attended at NCBJ was New Consumer Loan Products and Potential Bankruptcy Issues    The panel included Tyler Brown from Hunton Andrews Kurth, Carol Evans from the Federal Reserve Bank of Washington, D.C., Prof. Adam Levitin from Georgetown University Law Center and Gary Reeder, Vice-President of Innovation and Policy at the Center for Financial Innovation.

Fifth Circuit Grants Small Victories to Student Loan Debtors

The news for student loan borrowers in bankruptcy is usually so grim that even a small victory is cause to sit up and take notice.   The Fifth Circuit recently handed student loan debtors two small victories, ruling that dischargeability of student loans was not subject to arbitration and that bar exam loans could be discharged.  The cases are Case No. 18-20809, Stephanie Marie Henry v. Educational Financial Service (Matter of Stephanie Marie Henry)(Fifth Cir. 10/17/19) and Case No. 18-20254, Evan Brian Crocker v. Navient Solutions, LLC (Matter of Evan Brian Crocker)(Fifth Cir. 10/21/19).   The opinions can be found here and here.

No Arbitration of Student Loan Discharge

The Henry case is pretty straightforward.  Ms. Henry filed chapter 7 bankruptcy and received a discharge.  Later she sought a determination that the debt had been discharged.   Educational Financial Service, a division of Wells Fargo, moved to compel arbitration.   The bankruptcy court denied the motion and the Fifth Circuit affirmed.  

The Undue Hardship Test Is Really Harsh

The Fifth Circuit has released a new opinion which underscores just how hard it is to discharge a student loan under the undue hardship standard.   Thomas v. Department of Education (In re Thomas), 931 F.3d 449 (5th Cir. 2019).    

A Sympathetic Debtor

Vera Thomas wanted to improve her station in life.  She was working at a call center in Southeastern Virginia earning $11.40 per hour with benefits.  In 2012, she decided to enroll in a local community college.   She took out two loans for $3,500.00 each for her first two semesters.   She did not return for a third semester and her loans went into repayment.   In spring of 2014, she paid back about $82 on her loans.

Republican Tax Plan May Expand Dischargeability of Private Student Loan Debt

In an application of the law of unintended consequences, the Republican plan to eliminate the deduction for student loan interest may render private student loans subject to discharge in bankruptcy.  

In 2005, Congress amended 11 U.S.C. Sec. 507(8) to add the following category of non-dischargeable debts:

any other educational loan that is a qualified education loan, as defined in section 221(d)(1) of the Internal Revenue Code of 1986, incurred by a debtor who is an individual

A Story of Student Loan Hell

Occasionally I receive emails from people who have read the blog wanting to share their stories or objecting to what I wrote about their case.    They are a poignant reminder that the legal issues we deal with affect real people.   When I write about a case, I am writing about the facts as found by the Court.   The story that comes out of the official court record may be very different from how the individuals involved saw it.   Today I received an email from a woman who offered to share her story about her 30 year ordeal with student loans.   I am reprinting it below as received except that I explained some of the abbreviations she used.  While I can't vouch for the accuracy of the account, I do believe that she is describing how it looks to her.   Here is a story of student loan hell from Florida:

Dear Bankruptcy Attorney:

 
I'm in Florida but all bankruptcies are thru the Federal court system.  I have old student loans (taken out 1981-1983) for a total of $8,000 at 9% interest ($720 per year for 10 years) thru the GSL program (which was not Stafford at the time).  The promissory note (“PN”) said the Department of Education (“DOE”), my bank and I had to be in agreement if the note was to be changed.  The PN said (on the back) that the loans even if not repaid in full should not go past 15 years in repayment.

Dischargeability of Student Loans in Bankruptcy

This is a paper that I wrote for the Commercial Law League Spring Meeting on April 25, 2014.   The Commercial Law League, which is a national creditors’ rights organization, is debating whether to support greater dischargeability of student loans.

Dischargeability of Student Loans in Bankruptcy

Stephen W. Sather

Barron & Newburger, P.C.

Austin, TX

            Student loans play a major role in American society.   As of 2013, there was over $1 trillion in outstanding student loans. See Chopra, Student Loan Debt Swells, Federal Loans Now Top a Trillion, Consumer Financial Protection Bureau, (July 17, 2013) accessed at http://www.consumerfinance.gov/newsroom/student-debt-swells-federal-loans-now-top-a-trillion  This  number is higher than the amount owed on either credit cards or auto loans and is second only to the amount owed on mortgage loans.   See Denhart, How the $1.2 Trillion College Debt Crisis Is Crippling Students, Parents and the Economy, Forbes (August 7, 2013), accessed at http://www.forbes.com/sites/specialfeatures/2013/08/07/how-the-college-debt-is-crippling-students-parents-and-the-economy/.     Over thirty-seven (37) million Americans representing approximately  20% of American households owe student loans.     Of outstanding student loan debt, $864 billion consists of federal student loans and $150 billion consists of private student loans.    See Hauser, Student Loan Debt in Bankruptcy, State Bar of Texas Advanced Consumer Bankruptcy Course (February 20-21, 2014).

            The education provided by a student loan may provide an entry into the middle class However, the debt incurred in obtaining this education is something that will likely remain with the student through every socio-economic class in which he travels.  

Prior to 1976, student loans were dischargeable the same as any other unsecured debts.    From 1976 to 2005, the dischargeability of student loans was restricted to the point where substantially all student loans are now excluded from discharge absent a finding of undue hardship.

•          1976:   Government-backed student loans are non-dischargeable for five years unless undue hardship proven.
•          1984:   Private loans funded or guaranteed by a governmental unit or non-profit are added to the list of non-dischargeable debts.
•          1990:   Period to discharge a student loan extended from five years to seven years.
•          1998:   Seven year period to discharge a student loan eliminated, leaving undue hardship as the only basis for a discharge.
•          2005:   Private student loans become non-dischargeable regardless of whether they are made, insured or guaranteed by a governmental entity or non-profit; test now turns on whether interest would be deductible under the Tax Code.      

Dischargeability of student loans is governed by 11 U.S.C. §523(a)(8) which provides:

(a)    A discharge under section 727, 1141, 1228 (a), 1228 (b), or 1328 (b) of this title does not discharge an individual debtor from any debt— (8) unless excepting such debt from discharge under this paragraph would impose an undue hardship on the debtor and the debtor’s dependents, for— (A) (i) an educational benefit overpayment or loan made, insured, or guaranteed by a governmental unit, or made under any program funded in whole or in part by a governmental unit or nonprofit institution; or (ii) an obligation to repay funds received as an educational benefit, scholarship, or stipend; or (B) any other educational loan that is a qualified education loan, as defined in section 221(d)(1) of the Internal Revenue Code of 1986, incurred by a debtor who is an individual.

I.                   I.  Types of Non-Dischargeable Obligations

There are four types of debts which are nondischargeable under 11 U.S.C. § 523(a)(8):

1.                  An educational benefit overpayment made, insured or guaranteed by a governmental unit or made under any program funded in whole or in part by a governmental unit or nonprofit institution.   11 U.S.C. §523(a)(8)(A)(i).

2.                  An educational loan made, insured or guaranteed by a governmental unit or made under any program funded in whole or in part by a governmental unit or nonprofit institution.  11 U.S.C. §523(a)(8)(A)(i).

3.                    An obligation to repay funds received as an educational benefit, scholarship or stipend.  11 U.S.C. §523(a)(8)(A)(ii).

4.                     Any other educational loan that is a qualified education loan under section 221(d)(1) of the Internal Revenue Code.   11 U.S.C. §523(a)(8)(B).

While Section 523(a)(8) broadly relates to debts incurred in connection with higher education, they differ as to the type of obligation involved and the identity of the party involved in making or guaranteeing the debt as shown by the following chart.

Type of obligation	Made, insured or guaranteed by a governmental unit or nonprofit	Not involving a governmental unit or nonprofit
Educational loan	§523(a)(8)(A)(i)	§523(a)(8)(B)
Educational benefit overpayment	§523(a)(8)(A)(i)
Obligation to repay funds received as an educational benefit, scholarship or stipend		§523(a)(8)(A)(ii)

Thus, an educational loan will be non-dischargeable (in the absence of a finding of undue hardship) as long as it is either made, insured or guaranteed by a governmental unit or nonprofit organization or if it is a qualified education loan under Section 221(d)(1) of the Internal Revenue Code.   As discussed below, these definitions encompass most public and private student loans.   In addition to the broad categories of loans, there are two additional categories for obligations to repay benefit overpayments, scholarships and stipends.

A.    An educational benefit overpayment/governmental unit or non-profit

An educational benefit overpayment made, guaranteed or insured by a governmental unit or a nonprofit is the least complicated exception to understand.   

An “educational benefit overpayment” is an overpayment from a program such as the GI Bill under which where students receive periodic payments while they are enrolled in school, but if the students receive payments after they have left the school, that is an educational benefit overpayment.

Matter of Murphy, 282 F.3d 868, n. 7 (5^th Cir. 2002)

B.     An educational loan/governmental unit or non-profit

This subsection has three main components:   1)  a loan,  2) for educational purposes  3) that a governmental or nonprofit makes, insures or guarantees.   Busson-Sokolik v. Milwaukee School of Engineering (In re Busson-Sokolik), 635 F.3d 261 (7^th Cir. 2011); Matter of Murphy, at 870.  

In order for there to be a loan, there must be “(i) a contract, whereby (ii) one party transfers a defined quantity of money, goods or services, to another, and (iii) the other party agrees to pay for the sum or items transferred at a later date.”   In re Chambers, 348 F.3d 650, 657 (7^th Cir. 2003).    Under this definition, a debt for unpaid tuition owed to the educational institution is not a “loan” and is not excluded from discharge as an educational loan.   Chambers, supra; In re Renshaw, 229 B.R. 552 (2^nd Cir. BAP 1999); In re Oliver, 499 B.R. 617 (Bankr. S.D. Ind. 2013).

The educational component refers to the intent of the parties when the loan was made rather than how the funds were actually used.   

Permitting students to discharge student loans in bankruptcy because the student spent the money on social uses, alcohol, or even drugs would create an absurd result. Students who used the loan proceeds to finance an education would retain the burden of paying them even after a chapter 7 discharge; irresponsible students who abused the loans would gain the benefits of discharge. Courts have emphasized two purposes when analyzing § 523(a)(8): (1) preventing undeserving debtors from abusing educational loan programs by declaring bankruptcy immediately after graduating; and (2) preserving the financial integrity of the loan system. Murphy's interpretation would create two perverse effects: (1) Dischargeability would reward irresponsible student borrowers and punish responsible borrowers; and (2) the federal government would have to pay out more to cover the costs of defaulting students' loans. Murphy's interpretation would create the type of absurd result that even rigid textualists seek to avoid.

Matter of Murphy, at 873; see also In re Busson-Sokolik, supra.

The requirement that the loan be made, insured or guaranteed by a governmental unit or nonprofit includes a wide variety of loan programs, including the William D. Ford Federal Direct Loan Program, the Federal Perkins Loan Program, the Federal Family Education Loan Program, Stafford Loans and PLUS Loans (Parent Loan for Undergraduate Students).    Many loans covered by Section 523(a)(8)(A)(i) are made under the Guaranteed Student Loan Program.

The Guaranteed Student Loan Program (hereafter Program), which was established as part of the comprehensive Higher Education Act of 1965, was designed to assure that colleges and students attending colleges would have reasonable access to low interest rate loans. S. Rep. No. 673, 89th Cong., 1st Sess. (1965), reprinted in 1965 U.S.C.C.A.N. 4027, 4030. Under the Program, educational loans from banks, credit unions, educational institutions, and other lenders are insured by the United States Department of Education or by state agencies or nonprofit organizations and reinsured by the Department of Education. 20 U.S.C. §§ 1078, 1084, 1085(d) (1988); see H.R. Rep. No. 595, 95th Cong., 2d Sess. 135, 140 (1977), reprinted in 1978 U.S.C.C.A.N. 5963, 6096, 6101.   If the borrower fails to make repayments because of death or disability, or is relieved of the obligation to pay through discharge in bankruptcy, the lender is entitled to repayment from the federal government. 20 U.S.C. § 1087; see H.R. Rep. No. 595, at 135, 140, reprinted in 1978 U.S.C.C.A.N. at 6096, 6101.

In re Pelkowski, 990 F.2d 737, 739-40 (3^rd Cir. 1993).   Loans made by nonprofit entities are also included within the scope of nondischargeability.   See In re Vuini, 2012 Bankr. LEXIS 5326 (Bankr. M.D. Fl. 2012)(loan made by Access Group, a 501(c)(3) entity, was non-dischargeable).   Loans made to parents or other persons other than students are included within the scope of non-dischargeable student loans.    In re Pelkowski, supra. 

C.     Obligation to repay an educational benefit, scholarship or stipend

This subsection covers agreements wherein a person receives a stipend or scholarship to attend college in return for an agreement to provide some form of public service such as teaching in an underprivileged area or serving in the Public Health Service.    If the person fails to honor the commitment made, the amounts advanced become repayable and are nondischargeable under section 523(a)(8)(A)(ii).    Burks v. Louisiana (In re Burks), 244 F.3d 1245 (11^th Cir. 2001); U.S. Dept. of Health and Human Services v. Smith, 807 F.2d 122 (8^th Cir. 1986).   

Some courts have interpreted the term “educational benefit” expansively to include  loans which would not fall within the other provisions of Section 523(a)(8).  Rabbi Harryy H. Epstein School, Inc. v. Goldstein (In re Goldstein), 2012 Bankr. LEIXS 6034 (Bankr. N.D. Ga. 2012)(obligation to pay tuition at day school); Carow v. Chase Student Loan Service, (In re Carow), 2011 Bankr. LEXIS 823 (Bankr. D. N.D. 2011)(private student loan); Micko v. Student Loan Fin. Corp. (In re Micko), 356 B.R. 210 (Bankr. D. Ariz. 2006)(loan made by an employee-owned S Corporation which operated similarly to nonprofit student loan provider).  This interpretation is contradicted by a trio of cases involving for-profit truck driving schools.   Scott v. Midwestern Training Center (In re Scott), 287 B.R. 470 (Bankr. E.D. Mo. 2002§; United Resource Sys. v. Meinhart (In re Meinhart), 211 B.R. 750 (Bankr. Colo. 1997); and McClure v. Action Career Training (In re McClure), 210 B.R. 985 (Bankr. N.D.Tex. 1997).    These cases are not consistent in their rationales.  The expansive cases appear willing to bend the law to extend protection to lenders who did not fall within the other provisions of the statute.      In contrast, the courts were definitely less sympathetic to for-profit entities which made the loans in order to generate business for themselves.  

The term “educational benefit” is not defined in the Bankruptcy Code, In re Carow, supra, and no higher court has addressed its meaning.   However, caution should be exercised in following the more expansive cases.    Section 523(a)(8) is an extremely dense statute.   Under the broad reading of “educational benefits,” there would be no reason to define types of nondischargeable student loans since they would all qualify as obligations to repay “educational benefits.”    London-Marable v. Sterling, 2008 U.S. Dist. LEXIS 106452 (D. Ariz. 2008).

D.    A Qualified Education Loan

The addition of “qualified education loans” to Section 523(a)(8) was intended to bring private for-profit student loans into the category of non-dischargeable debts.    Pardo and Lacey, The Real Student-Loan Scandal:  Undue Hardship Discharge Litigation, 83 Am. Bankr. L.J. 179 (Winter 2009).   However, the specific statutory language used which refers to Section 221(d)(1) of the Internal Revenue Code of 1986 leads to  a sea of cross-references within the Internal Revenue Code.    26 U.S.C. §221(d) contains the following definitions:

(d) Definitions.  For purposes of this section—    (1) Qualified education loan.  The term "qualified education loan" means any indebtedness incurred by the taxpayer solely to pay qualified higher education expenses--       (A) which are incurred on behalf of the taxpayer, the taxpayer's spouse, or any dependent of the taxpayer as of the time the indebtedness was incurred,       (B) which are paid or incurred within a reasonable period of time before or after the indebtedness is incurred, and       (C) which are attributable to education furnished during a period during which the recipient was an eligible student.    Such term includes indebtedness used to refinance indebtedness which qualifies as a qualified education loan. The term "qualified education loan" shall not include any indebtedness owed to a person who is related (within the meaning of section 267(b) or 707(b)(1) [IRC Sec. 267(b) or 707(b)(1)]) to the taxpayer or to any person by reason of a loan under any qualified employer plan (as defined in section 72(p)(4) [IRC Sec. 72(p)(4)]) or under any contract referred to in section 72(p)(5) [IRC Sec. 72(p)(5)].    (2) Qualified higher education expenses.  The term "qualified higher education expenses" means the cost of attendance (as defined in section 472 of the Higher Education Act of 1965, 20 U.S.C. 1087ll, as in effect on the day before the date of the enactment of the Taxpayer Relief Act of 1997 [enacted Aug. 5, 1997]) at an eligible educational institution, reduced by the sum of--       (A) the amount excluded from gross income under section 127, 135, 529, or 530 [IRC Sec. 127, 135, 529, or 530] by reason of such expenses, and       (B) the amount of any scholarship, allowance, or payment described in section 25A(g)(2) [IRC Sec. 25A(g)(2)].    For purposes of the preceding sentence, the term "eligible educational institution" has the same meaning given such term by section 25A(f)(2) [IRC Sec. 25A(f)(2)], except that such term shall also include an institution conducting an internship or residency program leading to a degree or certificate awarded by an institution of higher education, a hospital, or a health care facility which offers postgraduate training.    (3) Eligible student.  The term "eligible student" has the meaning given such term by section 25A(b)(3) [IRC Sec. 25A(b)(3)].    (4) Dependent.  The term "dependent" has the meaning given such term by section 152 [IRC Sec. 152] (determined without regard to subsections (b)(1), (b)(2), and (d)(1)(B) thereof).

          This definition is used to determine deductibility of interest on student loans.  Unfortunately,  it depends upon a series of definitions within the Internal Revenue Code.    To start with, a qualified education loan is 

•          indebtedness incurred by the taxpayer;
•          to pay “qualified higher education expenses;”
•          incurred on behalf of the taxpayer, the taxpayer’s spouse or a dependent of the taxpayer;
•            which qualified higher education expenses are paid or incurred within a reasonable time after the loan is incurred; and
•          attributable to education furnished while the student was an “eligible student;”
•          but does not include any indebtedness owed to a person who is related to the taxpayer.

Qualified higher education expenses means the cost of attending an “eligible educational institution” reduced by certain amounts excluded from gross income as a result of such expenses and certain scholarships.   26 U.S.C. §221(d)(2).   

An “eligible educational institution” “has the same meaning given such term by section 25A(f)(2)” as well as “an institution conducting an internship or residency program leading to a degree or certificate awarded by an institution of higher education, a hospital, or a health care facility which offers postgraduate training.”   26 U.S.C. §221(d)(2).     Section 25A(f)(2) defines “eligible educational institution” as an institution described in section 481 of the Higher Education Act of 1965 (20 U.S.C. §1088) which is eligible to participate in a program under title IV of the Higher Education Act of 1965.   Section 1088 does not contain a definition of “eligible educational institution” but does contain a definition of “eligible program.”    An “eligible program” is defined as:

(b) Eligible program.    (1) For purposes of this title, the term "eligible program" means a program of at least--       (A) 600 clock hours of instruction, 16 semester hours, or 24 quarter hours, offered during a minimum of 15 weeks, in the case of a program that--          (i) provides a program of training to prepare students for gainful employment in a recognized profession; and          (ii) admits students who have not completed the equivalent of an associate degree; or       (B) 300 clock hours of instruction, 8 semester hours, or 12 hours, offered during a minimum of 10 weeks, in the case of--          (i) an undergraduate program that requires the equivalent of an associate degree for admissions; or          (ii) a graduate or professional program.    (2) (A) A program is an eligible program for purposes of part B of this title [20 USCS §§ 1071 et seq.] if it is a pro-gram of at least 300 clock hours of instruction, but less than 600 clock hours of instruction, offered during a minimum of 10 weeks, that--          (i) has a verified completion rate of at least 70 percent, as determined in accordance with the regulations of the Secretary;          (ii) has a verified placement rate of at least 70 percent, as determined in accordance with the regulations of the Secretary; and          (iii) satisfies such further criteria as the Secretary may prescribe by regulation.       (B) In the case of a program being determined eligible for the first time under this paragraph, such determination shall be made by the Secretary before such program is considered to have satisfied the requirements of this paragraph.    (3) An otherwise eligible program that is offered in whole or in part through telecommunications is eligible for the purposes of this title if the program is offered by an institution, other than a foreign institution, that has been evaluated and determined (before or after the date of enactment of the Higher Education Reconciliation Act of 2005 [enacted Feb. 8, 2006]) to have the capability to effectively deliver distance education programs by an accrediting agency or association that--       (A) is recognized by the Secretary under subpart 2 of part H [20 USCS § 1099b]; and       (B) has evaluation of distance education programs within the scope of its recognition, as described in section 496(n)(3) [20 USCS § 1099b(n)(3)].    (4) For purposes of this title, the term 'eligible program' includes an instructional program that, in lieu of credit hours or clock hours as the measure of student learning, utilizes direct assessment of student learning, or recognizes the direct assessment of student learning by others, if such assessment is consistent with the accreditation of the institution or program utilizing the results of the assessment. In the case of a program being determined eligible for the first time under this paragraph, such determination shall be made by the Secretary before such program is considered to be an eligible program.  20 U.S.C. §1088(b).

An “eligible student” is defined by section 25A(b)(3), which provides:

 (3) Eligible student.  For purposes of this subsection, the term 'eligible student' means, with respect to any academic period, a student who--

      (A) meets the requirements of section 484(a)(1) of the Higher Education Act of 1965 (20 U.S.C. 1091(a)(1)), as in effect on the date of the enactment of this section [enacted Aug. 5, 1997], and

      (B) is carrying at least 1/2 the normal full-time work load for the course of study the student is pursuing.

20 U.S.C. §1091(a)(1) provides

(a) In general. In order to receive any grant, loan, or work assistance under this title, a student must--

   (1) be enrolled or accepted for enrollment in a degree, certificate, or other program (including a program of study abroad approved for credit by the eligible institution at which such student is enrolled) leading to a recognized educational credential at an institution of higher education that is an eligible institution in accordance with the provisions of section 487 [20 USCS § 1094], except as provided in subsections (b)(3) and (b)(4), and not be enrolled in an elementary or secondary school,

Meanwhile, section 1094 refers to

an eligible institution for the purposes of any program authorized under this title, an institution must be an institution of higher education or an eligible institution (as that term is defined for the purpose of that program) and shall, except with respect to a program under subpart 4 of part A [20 USCS §§ 1070c et seq.], enter into a program participation agreement with the Secretary.

            Notwithstanding the difficulty in navigating the statutory cross-references, courts have taken a practical approach to determining whether a lender is an “eligible education institution.”   The government maintains lists of eligible education institutions, notably at https://fafsa.ed.gov.  If an institution is included on the list, it is an eligible education institution and its higher education loans are qualified education loans.    Rumer v. American Educational Services (In re Rumer), 469 B.R. 553 (Bankr. M.D. Pa. 2012); Wills v. Sally Mae Servicing (In re Wills), 2010 Bankr. LEXIS 1478 (Bankr. S.D. Ind. 2010).

            The statutory definitions establish several limitations on what loans are considered qualified educational loans.    First, the debtor must be a taxpayer.   In the case of a Canadian resident alien who did not file tax returns in the United States, the Court found that the debtor was not a taxpayer and therefore his debts were dischargeable.    In re LeBlanc, 404 B.R. 793 (Bankr. M. D. Pa. 2009).    The provision addressing “qualified higher education expenses” would appear to exclude debts relating to private elementary and secondary school tuition and for-profit vocational schools.     Finally, because the definition of “eligible student” incorporates an individual enrolled at an eligible institution, a qualified educational loan would not apply to an individual who applied to but was not accepted by an eligible institution.

II.                 II.  Undue Hardship

If a student loan or other obligation falls within the language of Section 523(a)(8), the only way to obtain a discharge of the obligation is a finding of “undue hardship.”   While undue hardship is not a defined term, most courts follow a similar test.

 The Second, Third, Fourth, Fifth, Sixth, Seventh, Ninth, Tenth and Eleventh Circuits follow the Brunner test for undue hardship. Krieger v. Educational Credit Management Corp., 713 F.3d 882 (7th Cir. 2013); Spence v. Educational Credit Management Corp., 541 F.3d 538 (4^th Cir.2008); Educational Credit Management Corp. v. Mosley, 494 F.3d 1320 (11^th Cir. 2007); Barrett v. Educational Credit Management Corp., 487 F.3d 353 (6^th Cir. 2007); Educational Credit Management Corp. v. Pollys, 356 F.3d 1302 (10^th Cir. 2004); In re Gerhardt, 348 F.3d 89 (5^th Cir. 2003);  United Student Aid Funds, Inc. v. Pena, 155 F.3d 1108 (9^th Cir. 1998);  Pennsylvania Higher Education Assistance Agency v. Faish, 72 F.3d 298 (3^rd Cir. 1995); Brunner v. New York Higher Education Services Corp., 831 F.2d 395 (2^nd Cir. 1987)       Under the Brunner test, the debtor has the burden of proof to establish that:

(1)     he cannot maintain, based on current income and expenses, a "minimal" standard of living for himself and his dependents if required to repay the loans;

(2)     additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period; and

(3)     the debtor has made good faith efforts to repay the loans.

The Eighth Circuit applies a totality of the circumstances test which considers similar factors.   

Reviewing courts must consider the debtor's past, present, and reasonably reliable future financial resources, the debtor's reasonable and necessary living expenses, and "any other relevant facts and circumstances." (citation omitted). The debtor has the burden of proving undue hardship by a preponderance of the evidence. The burden is rigorous. "Simply put, if the debtor's reasonable future financial resources will sufficiently cover payment of the student loan debt - while still allowing for a minimal standard of living - then the debt should not be discharged.

Educational Credit Management Corp. v. Jesperson, 571 F.3d 775, 779 (8^th Cir. 2009).  The First Circuit has declined to adopt a specific test.    Nash v. Connecticut Student Loan Foundation, 446 F.3d 188 (1^st Cir. 2006).   

            The phrase “undue hardship” was taken from the Report of the Comm'n on the Bankr. Laws of the United States, H.R. Doc. No. 93-137, Pt. II § 4-506 (1973), reprinted in Collier on Bankruptcy, App. Pt. 4(c) at 4-710 (15th ed. rev. 2003).   Pollys, supra.   The Commission articulated a standard of ability to repay the student loans while maintaining a minimal standard of living to that considered by Courts under the Code.   

The Commission noted that in order to determine whether nondischargeability of the debt will impose an "undue hardship,"

the rate and amount of his future re-sources should be estimated reasonably in terms of ability to obtain, retain, and continue employment and the rate of pay that can be expected. Any un-earned income or other wealth which the debtor can be expected to receive should also be taken into account. The total amount of income, its reliability, and the periodicity of its receipt should be adequate to maintain the debtor and his dependents, at a minimal standard of living within their management capability, as well as to pay the education debt.

Pollys, at 1306-07.    Thus, the Brunner test can be said to rely on similar factors to those articulated by the Bankruptcy Reform Commission.

    When Congress originally adopted the undue hardship standard, it provided an alternative path to discharging student loans for those who had been paying on their loans for less than five years.   Today it is the sole vehicle for discharge of student loans.   Some courts have applied Brunner in such as strict manner as to make it all but impossible to meet.    In reviewing the cases, the Tenth Circuit stated:

Many subsequent courts employing the Brunner analysis, however, appear to have constrained the three Brunner requirements to deny discharge under even the most dire circumstances. See, e.g., Healey v. Mass. Higher Educ. (In re Healey), 161 B.R. 389, 395 (E.D. Mich. 1993) (debtor failed first Brunner prong, because, although she was unable to maintain a "minimal" standard of living on her current income, she did not demonstrate that she was "making a strenuous effort to maximize her personal income within the practical limitations of her vocational profile"); In re Walcott, 185 B.R. 721, 723-24 (Bankr. E.D.N.C. 1995) (debtor failed second Brunner prong because, since a $9.00 per hour position teaching literacy classes was "the highest hourly wage she has ever earned," "her current prospects appear brighter than at nearly any other time since her graduation"); In re Roberson, 999 F.2d at 1137 (debtor, who was divorced, unemployed, and living in a one-room apartment that did not have even a kitchen or toilet, failed second Brunner prong because he did not present a "certainty of hopelessness"); In re Stebbins-Hopf, 176 B.R. 784, 788 (Bankr. W.D. Tex. 1994) (debtor, who had nerve damage, bronchitis, and arthritis, and whose daughter had epilepsy, mother had cancer, and grandchildren had asthma, failed good faith prong because "she intentionally chose to help her family financially").

Pollys, at 1308.   One outspoken judge described the Brunner test as “let’s make it as tough as humanly possible to discharge a student loan.”    Speer v. Educational Credit Management Corp. (In re Speer), 272 B.R. 186, 193 (Bankr. W.D. Tex. 2001)(finding undue hardship where debtor lived in a travel trailer and his only luxury was $48 per month for cable TV).   Another judge has stated that Brunner is “too narrow, no longer reflects reality and should be revised.”    Roth v. Educational Credit Management Corp., 490 B.R. 908 (9^th Cir. BAP 2013)(Pappas, J., concurring).

            Several circuits have attempted to minimize the harsh effects of Brunner by allowing at least the possibility of a “partial discharge” of student loan debts.    In re Miller, 377 F.3d 616 (6^th Cir. 2004); Graves v. Myrvang (In re Myrvang), 232 F.3d 1116 (9^th Cir. 2000);   Alderete v. Educational Credit Management Corp. (In re Alderete), 412 F.3d 1200 (10^th Cir. 2005); Hemar Ins. Corp. of America, v. Cox (In re Cox), 338 F.3d 1238 (11^th Cir. 2003).

            In order to establish undue hardship, the debtor must file an adversary proceeding.   Some states have taken the position that their Eleventh Amendment immunity prevents  them from being sued for a determination of undue hardship[1].    However, the Supreme Court rejected this position using the legal fiction that a complaint to determine dischargeability was not a “suit” under the Constitution.    Tennessee Student Assistance Corp. v. Hood, 124 S.Ct. 1905 (2004).     The Supreme Court has also held that a chapter 13 plan may not properly provide for discharge of a student loan but that an unobjected to provision for discharge in a plan is enforceable.   United Student Aid Funds, Inc. v. Espinosa, 130 S.Ct. 1367 (2010).

            Under current law, discharge of a student loan is a precarious exercise.    In order to prove that he has an undue hardship, a debtor must file an adversary proceeding.    However, a pro se litigant will  most likely be  unable to prove the required elements which are technical in nature and a debtor who can afford to hire an attorney will likely have too many resources to establish undue hardship.   As a result, the only feasible way to obtain a hardship discharge may be to find an attorney who will represent the debtor on a pro bono or reduced fee basis.   

III.             III.  A Few Thoughts About Reform

The trend from 1976 to 2005 has been to reduce the dischargeability of student loans.    The nondischargeability of student loans was originally intended to prevent unscrupulous debtors from gaining an education and then discharging their debts and to preserve the solvency of the student loan system.   Federally subsidized and insured student loans exist to encourage individuals to invest in their education and better support their families and contribute to society.   The nearly absolute non-dischargeability of student loans stands in opposition to the very purpose of encouraging education through debt.    If a student obtains an education burdened by unmanageable debt, it is unlikely that he will be a productive member of society.   A decision made at a time of youthful immaturity can burden an individual for the remainder of his adult life.   

Section 523(a)(1) of the Bankruptcy Code provides a helpful contrast.    Under Sections  523(a)(1) and 507(a)(8)(A), federal income taxes may be discharged for years where the return was due more than three years prior to bankruptcy and the return was actually filed more than two years before bankruptcy.    This provision allows the government a reasonable time to collect delinquent federal income taxes[2].   If the taxes which fund our government can be discharged after a reasonable period of time, why should the same not  be true for student loans?

If Congress is not willing to generally allow discharge of student loans after a period of time, some reforms it might consider include:

•    Allowing private student loans to be discharged after seven years;
•    Allowing student loans to be discharged in chapter 11 or chapter 13;
•   Adopting a definition of “undue hardship” which does not require proof of absolute desolation; and
•    Allowing student loans to be discharged in a summary proceeding without the necessity for a costly adversary proceeding.

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[1] The Eleventh Amendment protects a state from being sued without its consent.    

[2] In contrast, trust fund taxes are never dischargeable.