Bankruptcy of Your Student Loans

Bankruptcy of Your Student Loans

Saturday, February 20, 2016


OK... Let's learn about "Undue Hardship"

Last time here, I asked the question "do you have what it takes to bankrupt your student loans?" In the first part of that posting I gave a brief description of a Chapter 13 Bankruptcy and that under a Chapter 13, the court basically takes a look at your financial condition, and if you are a wage earner, the court will work with you to find ways to repay the debts, by having you develop a repayment plan. In that plan you agree to make installments to those creditors you owe over a period of 3 to 5 years.

Now that is all well and good if you are employed, and can realistically manage a budget and stick to the court-ordered repayment arrangements. But... what if you are unemployed or severely underemployed with debts and obligations that you have zero chance of keeping up with? 

What if you are sick, elderly, disabled, or homeless, or destitute?  Well... I know that sounds a bit drastic, but there are millions who are at or near that point of desperation. And millions who have student loans that they cannot pay now - or even in the future.  I was there!

But before we identify what constitutes Undue Hardship (according to the US Bankruptcy code), let me complete the descriptions of the different bankruptcy chapters so you can learn what they are and be able to choose which chapter to file so you can get a "fresh start" and perhaps, get out from under that student loan that is growing faster than weeds on a hot summer day.

OK here we go.  The U.S. Bankruptcy Code is organized into nine "chapters" (like a book). Six of the chapters are written specifically to provide bankruptcy relief in various forms to various types of debtors.  The code was originally written using odd numbered chapters to allow for later additions if they became necessary.  For example, in 1986, Chapter 12 was added which is a chapter to assist farmers and fishermen with debt issues.

The first few chapters, namely 1, 3, and 5 are provisional chapters which provide definitions and a framework around which the other Chapters are written.  The Chapters that deal with debt relief are Chapters 7, 9, 11, 12 (mentioned above), 13, and 15.

Most times we hear of a Chapter 7, 11 or 13.  A Chapter 7 is used for Individuals and Businesses seeking a complete liquidation of all debts.  Chapter 11 is used by businesses for reorganization.  Chapter 13 is for Individuals seeking reorganization (as I talked about above). A Chapter 9 bankruptcy is reserved for municipalities, and Chapter 15 is for Cross-border or International Bankruptcies.  To date those are the chapters available in the U.S. Bankruptcy Code.

For student loan debts the two chapters available are Chapter 7 and Chapter 13

Chapter 7 is the most commonly used venue to get a fresh start. In a Chapter 7, all of the debtor's property that is considered non-exempt (a term I will detail later), is "liquidated" and under the supervision of an appointed "trustee", any property or "proceeds" are distributed among the creditors.  Basically you turn over any assets that you do not "exempt" or as I say it "want to keep", and then those assets are used to settle your outstanding debts.  By turning over any non-exempt property and converting to cash, the debtor does so in an effort to gain relief of liability from pre-bankruptcy debts, clearing away old debts in the process.

In a Chapter 13 bankruptcy the object is to maintain the debtors assets while taking into account the current income and future income if certain debts can be reorganized.  It differs in that not all of the debtor's assets are liquidated and the debtor agrees to a repayment plan as part of the reorganization of their indebtedness.  The repayment plan is approved by the bankruptcy court and should that plan be unmanageable, the court may intervene and re-visit the case and or demand other remedies.

As for the discharge of student loans, those debts are are included in either chapter 7 or 13 and are listed along with the other "unsecured debts" on bankruptcy official form Schedule F "Creditors Holding Unsecured Non-Priority Claims".

As I have mentioned before, student loans are what are referred to as "unsecured debt", because there is no collateral or material behind the note. They are also a non-priority claim and differ from what is called a Priority claim. Priority claims are non-dischargeable unsecured debts that receive special treatment in bankruptcy. The most common types of priority claims include certain tax obligations, alimony, and child support. In Chapter 7 bankruptcy, these debts are paid before general unsecured claims.

Educational debts must be listed and included with your other non-priority unsecured claims, but that does not mean they will be included in the discharge!

Let me be very clear!  Just because you list your student loans on the correct form when you file your bankruptcy, DOES NOT MEAN those debts will be discharged under a chapter 7 or 11 Bankruptcy.  Those student loans are "EXEMPT from discharge" and "Exempt" means NOT INCLUDED.

The only way to bankrupt and discharge your student loans is by filing what is known as an ADVERSARY PROCEEDING aka A COMPLAINT!  In both Chapters you will be told by the court or an attorney that in order to discharge your student loan debt for educational use, you must file an Adversary Proceeding often then referred to as your "Complaint".

The Adversary Proceeding in the form of a complaint is filed against the holders of your loans who are the "defendants" and you are the Plaintiff, in what is a civil action or lawsuit against the loan holders.  What you are seeking is a discharge of your loans which are by bankruptcy rules "exempt from discharge" under 11 U.S.C. §523 (a).

I am going to write out the ruling in such a way here as to show that the bankruptcy code is stating that student loans CANNOT BE DISCHARGED, as that is what is says when you read it as an exemption and without reading the "exception to provision" which is found in subparagraph (8) and begins with the word "unless".  (You need to read my posting from Monday 2/15/2016, and you will understand)

OK here goes... (skip the lined out words)

Section 523. Exceptions to Discharge
(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;

Did you follow that?  (a) says: "does not discharge debtor from any debt "for" 
then it goes into (A)(i) "educational benefit"... (e.g) "LOAN" made or insured or guaranteed by a governmental unit, or program funded by (the government) or non-profit institution.
it goes on... "or (B) any other educational loan that is a qualified education loan"

THERE, that says it!  Your educational loan or government student loan is not eligible to be discharged in bankruptcy!

But... what about the words I drew a line through?

ahhh yes!  Those words are what we are looking for here! And the magic word "UNLESS" is in that subparagraph!

(a)(8) is how we get to the point of understanding what we need to base our Adversary Proceeding on.  And here we find those other magical words "UNDUE HARDSHIP".

Let's read (8) in its entirety: "unless excepting such debt from discharge under this paragraph would impose an undue hardship on the debtor and the debtor's dependents"

There you have it. The legalize is unwound from its awkwardness and what we read is that Student loans are not dischargeable "unless" (by) excepting (that) debt it imposes (causes) an undue hardship on the (person filing the bankruptcy) and (or to) the debtor's dependents".

Bear in mind, prior to 1978, student loans were not, and I repeat were not, exempt from bankruptcy!

Congress added this language to the Bankruptcy Code in 1978 to discourage excessive discharges of student loan obligations based on a few students who filed bankruptcy right after graduating. 

However, because Congress did not provide a specific definition of undue hardship in the Code, bankruptcy courts are left to make that determination on a per-case basis. 

And after decades the definition of undue hardship remains a nebulous term and remains open to interpretation, and courts have had to develop some forms of criteria to reach determination of undue hardship.  Several so-called "tests" were created by bankruptcy courts over the years, and there remains great controversy surrounding the application of these tests to grant discharges based on undue hardship.

Today we generally see the courts have embraced two of those tests across the country. One test is commonly known as the Brunner Test and it is a three-prong test.  The other is known as the Totality of Circumstances Test.  Depending on where you live, the court will most probably use one of these tests to weigh the evidence of undue hardship that you bring to the table. In a later post, I will describe these tests, I won my case under the 1987 Brunner Test - which has been a subject of great controversy over several decades.

Perhaps I will stop here?  As to understand what constitutes "undue hardship" we will need to look at those "tests" and the interpretation of those tests by the bankruptcy courts, which by the way include 94 Federal Judicial Districts organized into 12 Regional Circuits each of which has a Circuit Court of Appeals.

If that is not enough to make you wonder why there is no consistency in what determines undue hardship, then consider that these courts also have a number of judges in those courtrooms and they have complete discretion on how they rule?

Until next time, best regards, Richard

Oh... and please leave comments, sign up for email notifications and feel free to ask any questions, and address any corrections needed.  Thank you and God Bless America!

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