The Non-Dischargeable Student Loan

By Cathy Ta

Obtaining a bankruptcy discharge of debts is the primary tool in providing the "honest but unfortunate debtor" a fresh start. Yet, a student loan made or guaranteed by a governmental unit or nonprofit is excepted from the bankruptcy discharge unless the debtor can show the debt would impose an "undue hardship" on the debtor or their dependents. When Americans owe more than $1.4 trillion in student loan debt, spread among 44 million borrowers, with the average Class of 2016 graduate holding $37,172 in student loan debt¹ while facing an unemployment rate of 5.6 percent and an underemployment rate of 12.6 percent, combined with the fact that the cost of higher education is growing more rapidly than median family income,² the question bears asking: Why are student loans singled out as non-dischargeable, unless "undue hardship" is determined, while other unsecured debts are automatically dischargeable, unless an exception to discharge applies?

Historical Background
It should be noted that student loans were presumptively discharged as part of the bankruptcy discharge until 1976. In 1976, Congress passed the Education Amendments of 1976 which then required a debtor to affirmatively show "undue hardship" to discharge a student loan; otherwise, the student loan would be non-dischargeable as an exception to the bankruptcy discharge.

This student loan exception, codified at 11 U.S.C. § 523(a)(8), was created to achieve two purposes: (a) to prevent abuses against the educational loan system by restricting the ability to discharge a student loan particularly after a student’s graduation; and (b) to safeguard the financial integrity of governmental units and non-profits that fund these loans.³ As the Second Circuit noted:⁴ because student loans are generally unsecured and recent graduates often have few or no assets, these debtors have an incentive to try to discharge their educational loans in bankruptcy. If successful, they can then enjoy the higher earning power the loans have made possible without the financial burden that repayment entails. Congress enacted § 523(a) (8) because there was evidence of an increasing abuse of the bankruptcy process that threatened the viability of educational loan programs and harm to future students as well as taxpayers. Congress recognized that this is an instance where a creditor’s interest in receiving full payment of the debt outweighs the debtor’s interest in a fresh start.

The "Self-Executing" Student Loan Exception
The Supreme Court has found that the student loan exception is "self-executing," in that a debtor must affirmatively secure an "undue hardship" determination; otherwise, a bankruptcy discharge order would not include the student loan.⁵ In order to obtain such a determination, the debtor must file a lawsuit, otherwise known as an adversary proceeding, in the bankruptcy case.

In the Ninth Circuit,⁶ a debtor can show "undue hardship" if they meet the three-part Brunner⁷ test: 1.) they cannot maintain, based on current income and expenses, a "minimal" standard of living for themselves and their dependents if required to repay the loan; 2.) additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period; and 3.) they have made good faith efforts to repay the loan.

Enforcement of the "Self-Executing" Student Loan Exception
Despite the "undue hardship" requirement, the Supreme Court still held valid an order confirming a plan that discharged a student loan when the debtor never obtained the required "undue hardship" determination. In Espinosa,⁸ the Supreme Court (in a unanimous decision) stated that confirmation of the plan should have been prevented in light of the debtor’s failure in meeting the "self-executing" student loan exception. Still, despite this "legal error," the Supreme Court narrowly construed that the confirmation order was not void given that United, the creditor, received actual notice of the proposed plan and failed to object, hence, forfeiting its rights.

The Continuing "Self-Executing" Student Loan Exception
Much has been written about the student loan exception since the Supreme Court’s Espinosa opinion, including whether it has opened the floodgates to aggressive litigation tactics by debtors who will "sneak in" a discharge of a student loan through a proposed plan, without going through the task of filing a lawsuit to obtain an "undue hardship" determination. But, as the Supreme Court noted in Espinosa itself, the potential for any bad faith litigation tactics has always been curbed by the severe penalties for improper or bad faith debtor conduct under bankruptcy law, including the risk of losing the bankruptcy discharge itself.

Moreover, while a debtor and a creditor could stipulate that a student loan causes "undue hardship" (and thereby no longer requiring an affirmative "undue hardship" determination) or a creditor could waive service of a summons or complaint, the Supreme Court did reinforce the "self-executing" nature of the student loan exception in Espinosa – by clearly advising bankruptcy courts that they must comply with § 523(a)(8)’s directive, meaning, bankruptcy courts must make an independent determination of "undue hardship" before a student loan may be discharged, whether or not through confirmation of a plan and whether or not the involved creditor fails to object or otherwise appear.

1 See https://studentloanhero.com/student-loan-debt-statistics/.
2 See http://www.epi.org/publication/class-of-2016/.
3 4-523 Collier on Bankruptcy P 523.14 (16th ed. 2017).
4 Cazenovia Coll. v. Renshaw (In re Renshaw) (2nd Cir. 2000) 222 F.3d 82, 86-87.
5 Tenn. Student Assistance Corp. v. Hood (2004) 541 U.S. 440, 450.
6 Educ. Credit Mgmt. Corp. v. Mason (In re Mason) (9th Cir. 2006) 464 F.3d 878, 882.
7 Brunner v. New York State Higher Educ. Servs. Corp. (2nd Cir. 1987) 831 F.2d 395, 396
8 United Student Aid Funds, Inc. v. Espinosa (2010) 559 U.S. 260. Riverside Lawyer, September 2017 11

This article originally appeared in the September 2017 edition of Riverside Lawyer magazine, a publication of the Riverside County Bar Association. Reprinted with permission.