Getting to “Maybe?” Student Loan Bankruptcy Discharge Under the Department of Education’s New Guidelines

“Sorry, bankruptcy can’t discharge student loans.” Have you said that before? Although legally wrong, that answer was practically correct in most cases. Bankruptcy student loan discharge involves the plaintiff paying a lawyer to prosecute a federal lawsuit proving the plaintiff lacks the money to repay student loans.

On the defense side, the student loan creditors fought every student loan complaint as if failure would burst the dam on $1.75 trillion of outstanding student loans.[1] The power differential between broke debtor plaintiffs and motivated, expert defendants led to the practically, although not legally, correct statement that student loans can’t be discharged in bankruptcy.

The Brunner Test

In order to discharge student loans in bankruptcy, a debtor must prove “that being forced to repay the student loans would cause an undue hardship on the debtor and the debtor’s dependents.” (11 USC §523(a)(8).) The Ninth Circuit follows the Brunner test. It requires that a plaintiff prove: (1) an inability to maintain a “minimal” standard of living if forced to repay the loans, (2) which is likely to last for many years and (3) good faith efforts to repay the loans.[2] Through Brunner, an undue hardship discharge became a foreboding crag surrounded by a deadly wasteland populated by orcs. Not many little people reached the summit.

What Changed

In November 2022, the Department of Justice (DOJ) defined what it believes undue hardship means for most of the federal student loan portfolio.[3] The DOJ created presumptions that certain facts would satisfy each of the three prongs of the Brunner test and it created a more streamlined pathway to summary discharge of student loan debt. The new guidance will reduce the uncertainty and the cost of pursuing discharge.

What Did Not Change

The new guidance did not change the need to sue the Department of Education through a bankruptcy case and to obtain a bankruptcy discharge. A borrower still needs to prove undue hardship. The guidelines also only affect federal loans owned by direct loan servicing. This excludes HEAL, FFELP and Perkins loans. Some student loan borrowers can consolidate these loans as direct loans in order to get them to qualify. Also note that the new guidelines only apply to cases that were pending or filed after the guidelines were released on November 17, 2022. Private or state student loans are unchanged.

“Can I discharge my student loan in bankruptcy?”

The answer is no longer “probably not,” it is “maybe! Let’s see!” The new DOJ guidance gives enough information to predict which cases will qualify for a stipulated discharge. Some highlights of the new guidance are explored below. This article does not intend to be a comprehensive review nor to substitute for a study of the guidance.

Minimum Standard of Living

The first prong of the test evaluates the debtor’s income. Income is demonstrated by the most recently filed tax return or by other evidence if the borrower’s income has changed since then. On the expense side, the DOJ compares the borrower’s budget to the IRS Collection Financial Standards. The DOJ will allow any expense up to the IRS standard while expenses that exceed the standard can be supported by evidence. This review is more generous in certain ways than the way the bankruptcy means test operates and it is much more generous than some that compared income to the poverty level.[4] In effect, the Brunner minimum standard of living has been replaced with an “average” standard of living test.

Duration of Hardship

A debtor-borrower will create a presumption that the hardship will last sufficiently long with a showing of any of the following: (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.[5] Even lacking evidence of a presumption above, the borrower may be able to show evidence of duration, especially where the school has closed down or with a history of low wages despite efforts to improve salary.

Good Faith Efforts to Repay

The good faith standard is wide open and will consider any of the following as evidence of good faith: “making a payment; applying for a deferment or forbearance (other than in-school or grace period deferments); applying for an IDRP 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… or engaging meaningfully with a third party they believed would assist them in managing their student loan debt.”[6] So basically, any sign of being a responsible, or at least responsive, borrower will weigh in the borrower’s favor.

Consideration of Assets and California Exemptions

The borrower’s assets can be reviewed when considering a borrower’s ability to repay student loans, but “liquidating a primary residence or retirement account is an extreme measure and… should be exceptionally rare.”[7] Further, the DOJ is warned to be careful in considering property that is exempt under bankruptcy law. California has some of the most generous bankruptcy exemptions in the country.

The Attestation

The borrower must seek a determination of dischargeability by filing an adversary proceeding within the bankruptcy case.[8] When the Department of Education makes an appearance, the borrower may submit to the DOJ an attestation that shows that the borrower qualifies under each of the Brunner elements. The attestation is accompanied by certain minimal evidence.

Stipulation of Undue Hardship

Where the DOJ agrees that the borrower has qualified under each element of the Brunner test, the DOJ will prepare a stipulation that in the opinion of the parties undue hardship exists and the subject debts should be discharged. The court then must exercise its independent review under Espinosa before entering an order on the stipulation.[9]
Of course, the guidance is not law and neither the court nor the DOJ are bound by it. Also, a borrower can still prevail where it does not meet the DOJ’s presumptions, but the borrower is likely to have to take the long road through litigation if the borrower fails to establish the presumptions necessary under the guidance. The DOJ may agree to stipulate to one or two of the Brunner elements that are supported by the attestation and proceed with litigation on the remaining elements. Also unknown is the extent to which the DOJ’s presumptions will inform the judgment of a trier of facts even where the guidance does not directly apply.

Discharge In Whole or In Part

The guidance allows the DOJ to recognize cases in which a borrower can afford to repay part but not all of the outstanding student loans “[w]here appropriate and permissible under governing case law.”[10] The law of the Ninth Circuit provides that “a bankruptcy court may exercise its equitable authority to partially discharge student debt under the Bankruptcy Code.”[11] So a borrower can find success in litigating to reduce a student loan to an affordable amount and term. Although the terms of partial repayment have not been fleshed out, the guidance refers elsewhere to a standard repayment plan for its evaluation which has a 10-year term.[12]

In October 2023, payments on $1.6 trillion in federal student loans recommence. Can student loan borrowers survive? With the beam of light shining from the DOJ’s new guidance, the answer is… “Maybe!”

[1] last checked 7/15/23
[2]Brunner v. New York State Higher Educ. Services, 831 F. 2d 395, 396 (2nd Cir. 1987).
[3] Guidance for Department Attorneys Regarding Bankruptcy Discharge last checked 7/15/23
[4] For example, In re Nys, 308 BR 436 (9th Cir. BAP, 2004)
[5] Guidance at 9
[6] Id. at 10
[7] Id. at 14
[8] FRBP 7001(6)
[9] United Student Aid Funds, Inc. v. Espinosa, 559 US 260 (2010)
[10] Guidance at 14
[11] In re Saxman, 325 F. 3d 1168, 1175 (9th Cir. 2003).
[12] Guidance at fn. 10