Drowning in Student Loans? Are They Dischargeable in Bankruptcy?

With tuition rising by double digit percentage points over the years due to the state budget crunch, more and more students are graduating from college drowning in debt, including in some cases, six-figure debt. In my practice, and even from friends wondering or perhaps dreaming of ridding the debt, I am often asked whether student loans are dischargeable in bankruptcy. Since there seems to be some confusion regarding this issue, I have outlined a brief summary going back twenty years.

In 1978, the Bankruptcy Code (the “Code”) covered only higher educational loans "to a governmental unit, or a nonprofit institution of higher education." In 1979, the section was amended to expand the coverage to include educational loans "made, insured, or guaranteed by a governmental unit, or part by a governmental unit or nonprofit institution of higher learning" (the 1979 amendments avoided the disparities in the treatment of loans from different sources and broadened the coverage of the section).

In 1984, Congress expanded the section again to any nonprofit institution, by eliminating the "of higher education" language (courts have ruled that "institution" is equivalent to "corporation"). Therefore, nonprofit corporations were now protected from easy discharge actions.

The next amendment occurred in 1990, to expand the exception to cover certain educational benefit overpayments, as well as obligations to repay funds received as educational benefits, scholarships, or stipends.

In 1998, Congress left "undue hardship" as the only avenue for the discharge of a student loan. And finally, in 2005, Congress added a catchall to include private, for-profit loans that are qualified educational loans.

With each amendment, Congress has continually and consistently limited the possibility of discharging student loans.

Whenever an individual files for bankruptcy and they have a student loan debt, it is automatically deemed non-dischargeable. In order for the debtor to overcome this presumption, they must file an adversary proceeding (a court case inside the bankruptcy case) in bankruptcy court to determine whether they qualify for an “undue hardship”, which is an extremely tough burden to overcome.

Bankruptcy courts use tests to determine whether a borrower has an undue hardship. A common test requires the debtor show that (1) the debtor cannot maintain, based on current income and expenses, a “minimal” standard of living for the debtor and the debtor’s dependents if forced to repay the student loans; (2) additional circumstances exist indicating that this state of affairs is likely to continue for a significant portion of the repayment period of the student loans; and (3) the debtor has made good faith efforts to repay the loans.

Every situation and case is different, and judges decide each matter on a case-by-case basis. In Michigan, very few debtors even attempt to discharge student loan debt because the bar is set so high; and most that have tried have been unsuccessful.

Curtis & Curtis, P.C. is a full service law firm located in Jackson, Michigan providing superior legal services and advice to individuals, families and businesses throughout mid-Michigan since 1901.

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Categories: Creditors' Rights