The Changing Face Of Bankruptcy And Student Loans

There is an old axiom among lawyers that “bad facts make bad law,” and the law regarding student loans and bankruptcy is an excellent example of this old saying.

Congress passed the Bankruptcy Act in 1867, and passed substantive amendments in 1898. The Bankruptcy Code remained essentially unchanged until 1938, when lawmakers introduced the “chapters” format which is so familiar today. Postsecondary education was still somewhat rare in 1938 and student loans were basically unheard of, so the 1938 act classified these obligations and unsecured debts and made them 100 percent dischargeable.

In the 1960s and 1970s, society changed radically, because of a confluence of social, economic, and political factors. This cauldron of change produced Brunner v. New York State Higher Education Services Corp., a 1982 decision from the Second Circuit in New York that fundamentally changed the relationship between student loans and bankruptcy.

The Brunner Rule

Before we get to the rule, a bit more background is necessary. When Congress started debating changes to the Bankruptcy Code in the late 1970s, some lawmakers believed that 1960s student protesters borrowed their way through college and had no intention to ever repay these loans; other lawmakers insisted that there was little no evidence to support this belief. In the end, Congress inserted a provision in the Bankruptcy Reform Act of 1978 that made student loans dischargeable only upon a showing of “undue hardship.” Congress did not define that phrase, leaving it up to the courts to decide.

Marie Brunner accumulated about $7,000 in college loans as a student in the 1970s, and even in that era, $7,000 was not an eye-popping sum of money. Despite the fact that she was apparently working and had made little or no effort to pay the loans, she almost immediately petitioned the Bankruptcy Court for a discharge.

To evaluate her claim, the Second Circuit adopted a three-prong test. Most all other federal courts in the United States promptly adopted the Brunner rule:

• – Minimal Standard of Living: To receive a bankruptcy discharge, student loan debtors must show that the payments are so burdensome that they cannot subsist above the poverty line.
• – Permanent: The complained-of hardship cannot be a job loss or business downturn, but rather a permanent obstacle that prevents repayment.
• – Good-Faith Repayment Effort: Only student loan debtors with good payment histories can receive a discharge.

In other words, bad facts make bad law. The Second Circuit adopted a test which would prevent the Marie Brunners of the world from obtaining discharges, and in so doing, the court adopted a test that prevented almost anyone else from obtaining similar relief, regardless of the merit of their claims. Realistically, under the Brunner rule, only debtors who are permanently disabled in a post-school accident or other such incident are eligible for student loan discharges.

Reconsidering the Brunner Rule

Some circuits have rejected the Brunner rule, because many of today’s students borrowed tens of thousands of dollars to get through school and they are hard-pressed to make the payments after they graduate.

Unfortunately, the Seventh Circuit, which includes both Illinois and Indiana, recently reaffirmed the Brunner rule in Tetzlaff v. Educational Credit Management Corporation (2015). The good news is that the panel thoroughly reviewed the three-part Brunner rule, and indicated that if Mark Tetzlaff’s circumstances were almost completely beyond his control, the court would have granted a discharge.

Someday soon, hopefully the Supreme Court will resolve the split in the circuits and do away with the outmoded Brunner rule. Until that happens, bankruptcy lawyers can certainly make good-faith arguments for discharge, if the student loan debtors have more loans than they can comfortably repay and if they suffer from misfortunes that are at least partially beyond their control.

Contact Aggressive Lawyers

Student loans may be dischargeable in consumer bankruptcies. For a free consultation with an experienced bankruptcy lawyer in Chicago, contact the Bentz Holguin Law Firm, LLC. Convenient payment plans are available.

Resources:

law.resource.org/pub/us/case/reporter/F2/831/831.F2d.395.41.87-5013.html

scotusblog.com/wp-content/uploads/2015/10/tetzlaff-op-below.pdf