Student loans subject to special standard in bankruptcy

The undue hardship standard is rigorous, but success rates for discharge are higher than might be expected

Bankruptcy is never a pleasant time for those involved. You feel your finances spiraling out of control, deal with incessant bill collectors over the phone or by mail and become more demoralized and depressed with each passing day as you struggle to figure out how to make ends meet and pay your bills.

A bankruptcy filing can seem like salvation, with its promise of debt relief and a financial fresh start. But if you have substantial student loans, you may have heard that even a bankruptcy may not be able to help and relieve your burden.

Are students like indentured servants?

Student loans are unusual. While they are called loans, but because of the difficulty in obtaining a bankruptcy discharge for them, one writer argued that they actually resemble the contracts of indentured servants. These contracts were often used in colonial times, where a worker would contract in exchange for passage to America, where they would then work for a set number of years to pay off the indenture.

It is unclear exactly why student loans have come to have such a special status. Congress held hearings in the 1970s discussing anecdotal stories of some individuals quickly discharging student loans after graduation, but reports at that time indicated less than 1 percent of student loans were handled in this fashion, but the die had been cast.

Congress began the process of tightening the screws on discharge, first requiring five years to pass before permitting discharge, then in 1990, it became seven years, and by 1998, they made undue hardship the only means of obtaining a discharge.

How much hardship is undue?

Undue hardship is not defined in the Bankruptcy Act, so courts had to fill in the blanks. An appeals court in the 1980s created a three-part test for undue hardship involving a debtor by the name of Brunner, so the test became known as the Brunner test.

The Brunner test creates a very difficult standard for many debtors to overcome. The first part requires a showing of undue hardship by demonstrating that given their current income and expenses, they would be reduced to a minimum standard of living.

Second, they must show that their income is unlikely to increase for a "significant portion" of the item required to repay their student loans, and third, they need to show that they have made a "good faith" effort to attempt repayment.

For many individuals with student loans, the difficulty with the Brunner test is often the speculative nature of the second requirement. How do you demonstrate that your finances are unlikely to improve?

In spite of this difficulty, if you have attempted to repay your loans and can show a detailed work history and of your attempts to obtain better jobs, you may want to discuss with your attorney the prospect of this type of discharge.

Your chances for discharge could be better than you might expect

The Brunner test is daunting; however, one researcher examined a group of bankruptcy cases where individuals filed the adversary proceedings to discharge student loans and discovered that 40 percent of them obtained a full discharge of the loans while another 14 percent received a partial discharge.

This may in part be due to the state of the economy in the immediate aftermath of the Great Recession and the considerable difficulty many new graduates had in finding any work. While a 40 percent success rate is not overwhelming it may be higher than the discharge rate for many Chapter 13 plans in some districts.

Bankruptcy is very fact specific. Whether you are eligible for a Chapter 7 or will need to file a Chapter 13, how much debt you have, the mix of secured and unsecured, your necessary day-to-day expenses, how much you earn and how stable your employment are all very important to the type of bankruptcy you can file and your likelihood of success.

If you are struggling to pay your bills and have been for too long, you should discuss your facts with a bankruptcy attorney. They can examine your situation and provide you with the options for obtaining genuine debt relief.