DISCHARGE STUDENT LOANS IN BANKRUPTCY
Attorney Neil E. Colmenares, P.C. are attorneys who concentrate in the complex area of Bankruptcy Law with a focus on helping individuals discharge Student Loans in Bankruptcy. Our Student Loan Bankruptcy Attorneys will help you eliminate Federal, State and Private Student Loans.
The Problem with Student Loans
Those who have Student Loan Debt know all too well how burdensome Student Loan obligations when not paid can be such as Wage Garnishments, Tax Refund Intercepts, Seizure of Government Benefits (such as Social Security), and the fact that these Student Loans continue to accrue outrageous interest rates along with ridiculous collection fees. To add insult to injury, most graduates are unable to find meaningful employment after graduation. For those lucky enough to find employment, their meager starting salary is not enough to pay for the necessities of life not to mention making student loan payments. All during this period the Student Loans continue to accrue interest.
A Possible Solution to Student Loan Debt: Bankruptcy
In a recent case, we were able to eliminate over $100,000 in student loan debt for one of our clients!* There is no amount of Student Loan liability that is too large or small to discharge in Bankruptcy.
The following are the general requirements for discharging Student Loans in Bankruptcy. Please note, these are general guidelines which should be reviewed with your Bankruptcy Attorney/Lawyer before taking any action.
Please note, the standard for discharging Student Loans in Bankruptcy is high. Although difficult, discharging Student Loans in Bankruptcy is NOT impossible.
First things First: you may not ask a bankruptcy court to enforce any non-bankruptcy remedies. You are limited to the options listed in this section. Also, it is important to know that most courts can grant full and/or partial discharge of student loans as well as restructure to terms of the student loan if Undue Hardship can be proved.
Can I Afford Bankruptcy? Once a bankruptcy case is opened, a separate lawsuit called an “adversary proceeding” must be commenced and won in order to receive a bankruptcy discharge of student loans.
An obvious but often overlooked point is how does someone who cannot pay their debts (including student loans) be expected to pay a lawyer to file a bankruptcy and an adversary proceeding since “undue hardship” implies near poverty financial circumstances? Personal experience has shown that the debtor often has a family member or friend pay for the bankruptcy and adversary proceeding or they tap into exempt assets.
Now, let’s talk about how federal and private loans are handled in bankruptcy.
All federal loans are student loans for bankruptcy purposes, which means you cannot get rid of your federal student loans in bankruptcy unless you can prove Undue Hardship.
Before trying to prove undue hardship in repaying your federal loans in bankruptcy, most bankruptcy courts will require that you “exhaust all administrative remedies” (see “federal administrative programs”) outside of bankruptcy before hearing a bankruptcy student loan discharge case.
If you cannot obtain a federal administrative discharge, then look into the repayment options available to you for your federal loans at https://studentaid.ed.gov/sa/repay-loans/understand/plans. This is a bare minimum requirement before most bankruptcy courts will entertain a student loan discharge case.
Special Note: State educational loans are student loans for bankruptcy purposes, which means you cannot get rid of your state student loans in bankruptcy unless you can prove Undue Hardship.
Exhaust all Private Loan Remedies: there is no federal administrative discharge of a private loan. However, before trying to prove undue hardship in repaying your private loans in bankruptcy, most bankruptcy courts will require that you have obtained all possible remedies pursuant to the promissory note signed (such as deferments, forbearances, etc., if available). It is imperative that you put your request in writing and save all correspondence either approving or denying all remedies available to you from the private lender.
Does the Private Loan meet the Bankruptcy definition of a Student Loan? Private student loans entitled to the non-discharge provision of the bankruptcy code can be found at 11 U.S.C. 523(a)(8)(B). In other words, 11 U.S.C. 523(a)(8)(B) defines what a private loan is for bankruptcy purposes. Private loans that do not meet this precise definition are not protected private student loans and should be discharged in bankruptcy without having to prove undue hardship.
Now, let’s look at what pretends to be a private student loan for bankruptcy purposes but is not. The following is literally “splitting hairs” but hey, this is what we lawyers do for a living to protect our clients’ interests.
Not a Taxpayer: A loan extended to non-resident alien who did not file a tax return during the relevant time period was not a “taxpayer” and loan extended did not qualify as a student loan under 26 U.S.C. 221(d)(1)(A) and 11 U.S.C. 523(a)(8). In re LeBlanc, 404 B.R. 793 (Bankr. M.D. Pa 2009).
If this test can be met, you should be able to argue your private loans are not “student loans” for bankruptcy purposes and should be discharged without having to prove undue hardship.
Not a Student: If you do not meet the specific definition of an “eligible student,” you can argue the loan is not a student loan and should be discharged (administratively—federal loans only or) via bankruptcy arguing the private loan is not a student loan for bankruptcy purposes and should be discharged without having to prove undue hardship. See 26 U.S.C. 25A(b)(3).
Ability to Benefit Test: If the school cannot prove the student’s ability to benefit from the course work, the student is not an “eligible student” and therefore the loan is not a student loan and should be discharged (administratively—federal loans only or) via bankruptcy arguing the private loan is not a student loan for bankruptcy purposes. The law gets tricky here depending on when the loan was incurred. See 34 C.F.R. 682.402(e)(1)(i)(A) (for FFEL loans) and 34 C.F.R. 685.215(a)(1)(i) (for Direct Loans).
Use Common Sense: If a convicted felon applies to law school but is unable to secure a state law license because of a felony conviction, the school will have a hard time proving the student’s ability to benefit from the education.
If this test can be met, you should be able to (Statutorily Discharge your federal loans outside of bankruptcy and/or) use this same argument that your private loans are not “student loans” for bankruptcy purposes and should be discharged without having to prove undue hardship.
Not a Qualified Higher Educational Expense: If the loan was not incurred to attend an “eligible education institution” (which by reference means the school was not “accredited”), the loan is most likely not a student loan and should be (administratively discharged outside of bankruptcy—federal loans only or) discharged in bankruptcy arguing the private loan is not a student loan for bankruptcy purposes. See 26 U.S.C. 221(d)(1).
To find out if your school is “accredited,” visit http://ope.ed.gov/accreditation/Search.aspx.
Debts from Non-Accredited Schools are not Student Loans: Debts from non-accredited school can be argued are not private student loans for bankruptcy purposes and should be discharged without having to prove undue hardship. See 20 U.S.C. 1001(a)(5), (b)(1), 1002 (b)(1)(D), (c)(1)(B).
To find out if your school is “accredited,” visit http://ope.ed.gov/accreditation/Search.aspx.
Difference between Loans and Tuition Bills: If there was no transfer of funds to the student’s account, one can argue the tuition bill is not a private student loan and should be dischargeable in bankruptcy without proving undue hardship. SeeInst. of Imaginal Studies v. Christoff, (Bankr. N.D. Cal., 2014), affd 9th Cir B.A.P. 510 B.R. 884 (2015).
Only educational loans owed to either the Department of Education and/or private student loan companies are presumptively non-dischargeable in bankruptcy. See 11 U.S.C. 523(a)(8)(B). In other words, most debts (assuming the debt was not incurred in the form of a loan) owed directly to schools (including tuition debts, housing, meals, etc.) are not considered student loans for bankruptcy purposes and should be dischargeable in bankruptcy without having to prove undue hardship. See In re Chambers, 348 F.3d 650 (7th Cir. 2003).
Not a Student Loan if Student Did Not Receive Money from Lender: One court held when the student does not receive loan funds from the lender but instead receives a tuition credit from the school (and student signed a promissory note in favor of the school), that this in not a “loan” for bankruptcy purposes as there were no “funds received” as per 11 U.S.C. 523(a)(8)(A)(ii) as the school was not a governmental or non-profit institution. See Inst. of Imaginal Studies v. Christoff, (Bankr. N.D. Cal., 2014), affd 9th Cir B.A.P. 510 B.R. 884 (2015).
Private Loans used for other than Cost of Attendance: Here is an often-overlooked argument that requires analysis of several statutes as well as reading the context in which the cases, which have interpreted this argument, were decided. A careful, objective analysis will lead a reasonable, objective person to the conclusion that private loan proceeds used for other than cost of attendance are not private student loans for bankruptcy purposes.
A non-dischargeable private student loan is:
(1) a ‘qualified education loan’ incurred solely to pay
26 U.S.C. Section 221(d)(1): “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)) to the taxpayer or to any person by reason of a loan under any qualified employer plan (as defined in section 72(p)(4)) or under any contract referred to in section 72(p)(5).”
(2) ‘qualified education expenses which are
26 U.S.C. Section 221(d)(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. 108711, as in effect on the day before the date of the enactment of the Taxpayer Relief Act of 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 by reason of such expenses, and (B) the amount of any scholarship, allowance, or payment described in section 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), 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) the ‘cost of attendance’ (the IRS Code does not set specific limits on these costs, referring instead to the Higher Education Act and its definition of appropriate costs “as determined by the institution.”) at a
20 U.S.C. Section 108711: “Cost of attendance: For the purpose of this subchapter and part C of subchapter I of chapter 34 of title 42, the term “cost of attendance” means (1) tuition and fees normally assessed a student carrying the same academic workload as determined by the institution, and including costs for rental or purchase of any equipment, materials, or supplies required of all students in the same course of study; (2) an allowance for books, supplies, transportation, and miscellaneous personal expenses, including a reasonable allowance for the documented rental or purchase of a personal computer, for a student attending the institution on at least a half-time basis, as determined by the institution; (3) an allowance (as determined by the institution) for room and board costsincurred by the student which – (A) shall be an allowance determined by the institution for a student without dependents residing at home with parents; (B) for students without dependents residing in institutionally owned or operated housing, shall be a standard allowance determined by the institution based on the amount normally assessed most of its residents for room and board; (C) for students who live in housing located on a military base or for which a basic allowance is provided under section 403(b) of title 37, shall be an allowance based on the expenses reasonably incurred by such students for board but not for room; and (D) for all other students shall be an allowance based on the expenses reasonably incurred by such students for room and board”
Since to qualify for the tax deduction of 26 U.S.C. Section 221(d)(1), the indebtedness must be “incurred by the taxpayer solely to pay qualified higher education expenses,” the Treasury Department regulations implementing 26 U.S.C. Section 221(d)(1) explain what is meant by the term “solely to pay qualified higher education expenses.” Loans meeting this standard are distinguished from “mixed-use” loans:
Mixed-use loans. Student J signs a promissory note for a loan secured by Student J’s personal residence. Student J will use part of the loan proceeds to pay for certain improvements to Student J’s residence and part of the loan proceeds to pay qualified higher education expenses of Student J’s spouse. Because Student J obtains the loan not solely to pay qualified higher education expenses, the loan is not a qualified education loan. See 26 C.F.R. 1.221-1(e)(4) ex.6; 64 Fed. Reg. 3257, 3258 (Jan. 21, 1999) (see “Explanation of Provisions” in preamble to proposed Treasury Regulations) (“Accordingly, mixed use loans are not qualified education loans. Similarly, revolving lines of credit (e.g., credit card debt) generally are not qualified education loans, unless the borrower uses the line of credit solely to pay qualified higher education expenses.”).
The IRS guidelines defer to educational institutions in how they define costs of attendance. Private loans that fund expenses beyond what the educational institution determines to be the reasonable costs of attendance should be considered “mixed use” loans and therefore wholly dischargeable. Typically, educational institutions develop these cost estimates for use in financial aid programs and for other purposes, so the reasonable cost of attendance information should be publicly available.
(4) ‘qualified educational institution’
26 U.S.C. 25A (f)(2): “Eligible educational institution – The term “eligible educational institution” means an institution – (A) which is described in section 481 of the Higher Education Act of 1965 (20 U.S.C. 1088), as in effect on the date of the enactment of this section, and (B) which is eligible to participate in a program under title IV of such Act.”
Page 37 of IRS publication 970 describes an eligible educational institution as “any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the U.S. Department of Education. It includes virtually all accredited public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions. The educational institution should be able to tell you if it is an eligible educational institution.”
(5) by a ‘eligible student.’
26 U.S.C. 25A (b)(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, and (B) is carrying at least ½ the normal full-time work load for the course of study the student is pursuing.
20 U.S.C. 1091: (a) In general In order to receive any grant, loan, or work assistance under this subchapter and part C of subchapter I of chapter 34 of title 42, 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 1094 of this title, except as provided in subsections (b)(3) and (b)(4) of this section, and not be enrolled in an elementary or secondary school;
20 U.S.C. 1094
(a) Required for programs of assistance; contents In order to be an eligible institution for the purposes of any program authorized under this subchapter and part C of subchapter I of chapter 34 of title 42, 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 of this subchapter, enter into a program participation agreement with the Secretary. The agreement shall condition the initial and continuing eligibility of an institution to participate in a program upon compliance with the following requirements:
(6) The institution will not provide any student with any statement or certification to any lender under part B of this subchapter that qualifies the student for a loan or loans in excess of the amount that student is eligible to borrow in accordance with sections 1075(a), 1078(a)(2), and 1078(b)(1)(A) and (B) of this title.2
20 U.S.C. 1075:
(a) Annual and aggregate limits
(1) Annual limits
(A) The total of loans made to a student in any academic year or its equivalent (as determined by the Secretary) which may be covered by Federal loan insurance under this part may not exceed—
(i) in the case of a student at an eligible institution who has not successfully completed the first year of a program of undergraduate education—
(I) $3,500, if such student is enrolled in a program whose length is at least one academic year in length (as determined under section 1088 of this title); and
(II) if such student is enrolled in a program of undergraduate education which is less than one academic year, the maximum annual loan amount that such student may receive may not exceed the amount that bears the same ratio to the amount specified in subclause (I) as the length of such program measured in semester, trimester, quarter, or clock hours bears to one academic year;
(ii) in the case of a student at an eligible institution who has successfully completed such first year but has not successfully completed the remainder of a program of undergraduate education—
(I) $4,500; or
(II) if such student is enrolled in a program of undergraduate education, the remainder of which is less than one academic year, the maximum annual loan amount that such student may receive may not exceed the amount that bears the same ratio to the amount specified in subclause (I) as such remainder measured in semester, trimester, quarter, or clock hours bears to one academic year;
(iii) in the case of a student at an eligible institution who has successfully completed the first and second years of a program of undergraduate education but has not successfully completed the remainder of such program—
(I) $5,500; or
(II) if such student is enrolled in a program of undergraduate education, the remainder of which is less than one academic year, the maximum annual loan amount that such student may receive may not exceed the amount that bears the same ratio to the amount specified in subclause (I) as such remainder measured in semester, trimester, quarter, or clock hours bears to one academic year; and
(iv) in the case of a graduate or professional student (as defined in regulations of the Secretary) at an eligible institution, $8,500.
(B) The annual insurable limits contained in subparagraph (A) shall not apply in cases where the Secretary determines, pursuant to regulations, that a higher amount is warranted in order to carry out the purpose of this part with respect to students engaged in specialized training requiring exceptionally high costs of education. The annual insurable limit per student shall not be deemed to be exceeded by a line of credit under which actual payments by the lender to the borrower will not be made in any year in excess of the annual limit.
(C) For the purpose of subparagraph (A), the number of years that a student has completed in a program of undergraduate education shall include any prior enrollment in an eligible program of undergraduate education for which the student was awarded an associate or baccalaureate degree, if such degree is required by the institution for admission to the program in which the student is enrolled.
Stated simply, if the private loans were used for other than the cost of attendance as determined by the school, it can be argued that the loans do not meet the bankruptcy definition of a private student loan and should be dischargeable in bankruptcy without having to prove undue hardship.
Pre—BAPCPA cases were un-sympathetic to mixed-use loans being discharged (Murphy v. Pennsylvania Higher Educ. Assistance Agency, 282 F.3d 868, 873 (5th Cir. 2002) suggesting that allowing ultimate use of loan funds to determine discharge-ability would encourage students to seek discharge of loans when the money went toward “social uses, alcohol, or even drugs”. See also In re Sokolik, 635 F.3d 261, 266 (7th Cir. 2011), cert. denied, 131 S. Ct. 3039 (2011), post-BAPCPA decision applying broad “educational purpose” standard to determine loan covered under § 523(a)(8).
For private loans covered by the new subsection (B) (using the 11 U.S.C. 221(d)(1) deduction), there are arguments for consideration of how the loan proceeds were used. The I.R.S. guidelines defer to educational institutions in how they define costs of attendance. Private loans that fund expenses beyond what the educational institution determines to be the reasonable costs of attendance should be considered “mixed use” loans and therefore wholly dischargeable.
Loans Not Made with an Educational Purpose should be Dischargeable: If the private loan was incurred as an employment benefit such as paying off an employee’s student loans as part of a hiring agreement, then the loan should be dischargeable because it was not for an educational purpose. See In re Segal, 57 F.3d 342 (3d Cir. 1995).
Consolidated Student Loans may be Dischargeable as Mixed Use Loans: If a private student loan is consolidated with other non-student loans, the entire new consolidated debt should be dischargeable as a “mixed use” loan (as per 26 U.S.C. 221(d)(1) and 26 C.F.R. 1.221-1(e)(4) ex.6).
Undue Hardship Standard Applicable to Most Student Loans
A student loan may be discharged in bankruptcy if payment of the debt will impose an undue hardship on the debtor and the debtor’s dependents. The lender has the burden of proving the existence of the student loan. Thereafter, the debtor has the burden of proving undue hardship. Most states have adopted the “Brunner” test (also known as the Undue Hardship Test) to determine undue hardship.
The Undue Hardship Test, a.k.a. the Brunner Test
(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 persist 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.
Most courts will require you to satisfy all three parts (prongs) of this test to discharge your student loans. Let’s examine how the courts have interpreted each prong of this test.
(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.
This prong requires you to look at your current (at the time of trial) financial condition. The court will judge your standard of living if forced to make your current monthly student loan payment.
What is a “minimal” standard of living? A “minimal” standard of living should include shelter and utilities, food and personal products, vehicles maintained, insured, and tagged, health insurance or the ability to pay for medical and dental expenses when they arise, at least a small amount of life insurance, and some funds for recreation, such as television or a pet. There is no requirement that your income fall below the federal poverty guidelines to satisfy this prong. If you have a hard time paying these basic items, it is likely you will pass this prong.
As you may have guessed, the lender (and sometimes the court) will scrutinize every expense as well as whether you (and your spouse) are working to your full potential. Be prepared!
(2) Additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period of the student loans.
This prong requires you to predict your future based on current facts and whether they are likely to change during the loan’s repayment term. The court in In re Nys, 446 F.3d 938 (9th Cir. 2006) listed these non-exhaustive factors to be considered which include:
(a) Serious mental or physical disability of the debtor or the debtor’s dependents, which prevents employment or advancement;
(b) The debtor’s obligations to care for dependents;
(c) The lack of or severely limited education;
(d) Poor quality of education;
(e) Lack of usable or marketable job skills;
(g) Maximized income potential in the chosen educational field;
(h) No other more lucrative job skills;
(i) Limited number of years remaining in work life to allow payment of the loan, age or other factors that prevent retraining or relocation as a means for payment of the loan;
(j) Lack of assets, whether or not exempt, which could be used to pay the loan;
(k) Potentially increasing expenses that outweigh any potential appreciation on the value of the debtor’s assets, whether or not exempt, which could be used to pay the loan;
(l) Potentially increasing expenses that outweigh any potential appreciation in the value of the debtors’ assets and/or likely increases in the debtor’s income;
(m) Lack of better financial options elsewhere; and
(n) Debtor’s future prospects for employment.
(3) The debtor has made good faith efforts to repay the loans.
This prong looks at your past conduct including efforts to obtain employment, maximize income, minimize expenses. See E.C.M.C. v. Mason, 464 F.3d 884 (9th Cir. 2006). Another factor used to determine good faith is whether the debtor’s financial condition resulted from factors beyond his/her reasonable control. See In re Birrane, 287 B.R. 490, (BAP 9th Cir. 2002).
Court’s also look at a debtor’s effort, or lack of effort, to negotiate a repayment plan. See United States DOE, v. Wallace, 259 B.R. 170 (Bankr. C.D. Cal. 2000). However, failure to look into repayment plans is not required to find good faith because to do so would replace rights given under the bankruptcy code with those of administrative remedies. Roth v. E.C.M.C., 490 B.R. 908 (9th Cir. Bap 2013). Other courts have held that lack of payments is not lack of good faith if the debtor did not have the financial ability to make them. See England v. United States, 264 B.R. 38 (Bankr. D. Idaho 2001).
Now contrast these last three cases with the fact that most courts will require you to look into repayment options per federal administrative remedies as a condition to hearing a student loan discharge case. Confusing? Contradictory? Silly? The point is that courts use contradictory standards based on their own sense of right and wrong.
These are only a few of the factors that are raised in proving good faith. If you are considering bankruptcy, I strongly urge you to call us to see if a student loan discharge-ability case is in your best interest.
Special Note 1: HEAL loans are not subject to the Undue Hardship standard, are non-dischargeable during the first seven years of the repayment period, and thereafter the bankruptcy court must find the denial of a discharge “unconscionable” (much more difficult than the Undue Hardship standard) to be discharged in bankruptcy.
Special Note 2: The First Circuit Court of Appeals (covering Maine, Massachusetts, New Hampshire, Puerto Rico, and Rhode Island) and the Eighth Circuit Court of Appeals (covering Arkansas, Iowa, Minnesota, Missouri, Nebraska, North Dakota, and South Dakota) do not use the Undue Hardship test but instead use a similar test entitled “Totality of Circumstances.” This test is not discussed here, as we are not licensed to practice law in those jurisdictions.
Once you have these documents, take the next step by Scheduling a Student Loan Bankruptcy Consultation.