Shortly before President Donald Trump was sworn into office, the Consumer Financial Protection bureau filed suit against one of the country’s largest student loan servicers.
According to court documents, Navient was guilty of two sins. First, it failed to properly credit additional payments on existing loans, although part of the blame may fall on borrowers. Under federal law, any excess funds on top of the minimum monthly payments are applied to principal and interest unless the borrower specifies otherwise, so many people who thought they were making additional principal reduction payments were basically just making regular payments in advance. Most payments go through lockboxes, an automated process that saves time but may result in confusion over funds applications. Secondly, and more importantly for bankruptcy purposes, the CFPB alleged that Navient steered distressed borrowers into forbearance agreements as opposed to alternative repayment plans.
In the wake of the lawsuit, a few borrowers have mulled a payment strike.
Discharging Student Loans in Bankruptcy
Many distressed student loan borrowers attempt to discharge their loans in bankruptcy. Before lawmakers amended the Bankruptcy Code in 1978, student loans were dischargeable in both Chapter 7 and Chapter 13 bankruptcies just like any other unsecured debt. But in the 1978 amendments, Congress inserted a provision that limited student loan discharge to cases involving “undue hardship,” a phrase that lawmakers intentionally left undefined to limit the political fallout this change caused.
Nine years later, the Second Circuit defined the phrase in Brunner v. New York State Higher Education Services Corporation. The court used a three-part analysis to determine if a debtor had an “undue hardship” under the new Section 523(a).
- – Consistent Payment History: Before they receive discharges, debtors must show that they made good-faith efforts to repay their loans, which usually means a regular, if somewhat sporadic, payment history.
- – Effect on Dependents: The debtor must convince the court that repaying the student loan is so onerous that the debtor’s family would be unable to sustain a minimal standard of living (i.e. above the poverty line).
- – Permanent: The hardship cannot be a business reversal or period of unemployment, but rather a disability that’s either permanent or expected to last through most of the repayment period.
The Brunner Rule also requires that the disability not be a self-inflicted injury; for examples, lawyers who are disbarred because of their own wrongdoing are not eligible for hardship discharges. Many commentators, and some dissenting judges as well, criticized the Brunner Rule throughout the 1990s and early 2000s, because it effectively eliminates discharge for anything other than a physical or emotional disability that occurs after the debtor finished school.
Reconsidering the Brunner Rule
The country is divided into eleven appeals circuits. Many circuits, including the neighboring Eighth Circuit based in St. Louis, have thrown out the harsh Brunner Rule and replaced it with a totality-of-the-circumstances analysis. However, the Seventh Circuit, which includes both Indiana and Illinois, reaffirmed the Brunner Rule in Tetzlaff v. Educational Credit Management Corporation. This case involved a law school graduate with over $260,000 in student loans who could not pass the bar due to chronic alcoholism and depression and may not even be eligible to sit for the test because of a prior criminal record. Despite his dire circumstances, the court mechanically applied the Brunner Rule, which clearly did not allow discharge under these facts.
In January 2016, despite the split in the circuits, the Supreme Court refused to review Tetzlaff, so it is still the law in this geographic area.
Reach Out to Experienced Lawyers
Student loans are dischargeable in bankruptcy in limited circumstances. For a free consultation with an experienced bankruptcy lawyer in Chicago, contact the Bentz Holguin Law Firm, LLC. We routinely handle cases in both Illinois and Indiana.