To its detractors, bankruptcy law’s “Brunner test,” which is used to establish the dischargeability (i.e., elimination) of student loan debts, stands out like a sore thumb. They claim it is a relic, yet it is controlling within the majority of federal circuits. As a matter of policy and precedent, most courts narrowly interpret the provisions barring the discharge of any student loan debts. Accordingly, in courtrooms, committees and classrooms, many deride the Brunner test as incompatible with the two animating purposes of the Bankruptcy Code in Chapter 7 (liquidation) cases: a fresh start for the debtor and equal treatment for all debts and creditors. Recently, the U.S. Department of Education may have breathed new life into these critiques — signaling there may be a policy shift with respect to the Brunner test.
While every discharge exception represents a policy decision, exemptions in bankruptcy law typically are interpreted narrowly when any ambiguity is present. Yet, for more than 20 years, a strict common law standard, first formulated by a Pennsylvania district court and later endorsed by the Second Circuit in Brunner v. New York State Higher Education Services Corporation, has governed whether a debtor has sufficiently shown the “undue hardship” required to discharge student loan debts.
Under the Brunner test, described in more detail below, a debtor may discharge educational debt due to undue hardship only if she can prove that she cannot maintain a “minimal” standard of living while repaying the debt, that this inability to pay will continue for most of the repayment period, and that she made good faith efforts to repay the debt.
While a small minority of courts use a totality of the circumstances test (totality test), which stresses slightly different factors (and at least four courts have adopted slightly modified versions of the Brunner test) about 70 percent of courts have adopted the Brunner test. As a result, Brunner has garnered the most attention from scholars, commentators and policymakers.
In an unpredicted twist, on Feb. 21, 2018, the U.S. Department of Education, led by Secretary Betsy DeVos, published a memorandum calling for comments that hinted the DOE might be considering eliminating or modifying the Brunner standard.
DOE’s Recent Moves
The DOE’s memorandum, published in the Federal Register, solicits public input on what sorts of borrowers seek to eliminate their student loans in Chapter 7 proceedings. In particular, the DOE requested comments on the following issues:
• Factors to be considered in evaluating undue hardship claims asserted by student loan borrowers in bankruptcy;
• Weight to be given to such factors;
• Whether the existence of two tests for evaluation of undue hardship claims results in inequities among borrowers seeking discharge for undue hardship; and
• How these considerations should weigh into whether undue hardship should permit discharge of education debts.
The memorandum suggests that the DOE may be open to revising the code’s “undue hardship” standard as construed in Brunner and its progeny. To the extent the memorandum has been cause for optimism for critics of the current standard, such optimism must be tempered by the fact that to date, the DOE under DeVos has appeared largely sympathetic to education lenders and servicers.
For example, on April 11, 2017, the DOE informed federal student loan debt collectors that they may ignore previous guidance, published by the Obama administration, that restricted the fees they could charge to borrowers who defaulted on their loans.
In the summer of 2017, the DOE ended its alliance with the Consumer Financial Protection Bureau in overseeing loan servicers when the DOE discontinued an information-sharing arrangement forged years earlier. And months later, on Dec. 20, 2017, the DOE partly reversed the Obama administration’s promise of completely erasing loans taken out by students of the for-profit Corinthian Colleges chain.
The tempo of this drumbeat seemingly increased in 2018. In an internal memo widely published in February 2018, the DOE argued that the nation’s loan servicers should be protected from state rules that may be tougher than federal law. “Congress created and expanded the Direct Loan Program with the goal of simplifying the delivery of student loans to borrowers, eliminating borrower confusion, avoiding unnecessary costs to taxpayers, and creating a more streamlined student loan program,” this memo reads. “Recently, several states have enacted regulatory regimes or applied existing state consumer protection statutes that undermine these goals,” it asserts. Just as the U.S. Department of Justice had recently argued in Massachusetts, and consistent with efforts in the U.S. House of Representatives to amend the Higher Education Act of 1965 (HEA), the memorandum took the position that federal law generally preempts state-level policing of student loan servicers.
In Pennsylvania, meanwhile, the DOE continued to vigorously defend the Brunner test — and, upon initial defeat, successfully appealed the bankruptcy court’s adverse determination to the district court.
Based on this record, many believed the current DOE would maintain a tough stance against student loan debtors and discourage courts from allowing such debts’ discharge through bankruptcy. The February memo challenges this assumption.
State of the Law and Student Loan Market: Past and Present
In 1973, reports of graduates trying to avoid federal loan payments prompted the Federal Department of Health, Education, and Welfare to approach the Congressional Committee on Bankruptcy Law. In response to that perceived threat to the integrity of the federal educational loan programs and future student lending posed by abuse of the bankruptcy process, Congress sought to craft an intentionally high standard for discharge in its overhaul of the nation’s bankruptcy system.
In 1978, Congress ensured that student loan debt could not be discharged under § 523(a)(8) of the new code unless either it first became due five years before the date of the bankruptcy filing or excepting such debt from discharge would impose an undue hardship. From the very beginning, § 523(a)(8) has exempted any student loan debt from discharge unless its repayment would “impose an undue hardship on the debtor and the debtor’s dependents.” With no guidance as to the meaning of “undue hardship” provided in the body of the code or in its legislative history, federal courts stepped into the vacuum. In Brunner v. New York State Higher Education Services Corporation, the Second Circuit implemented a standard for “undue hardship” first articulated by another circuit’s trial court.
Under the resulting Brunner test, once a creditor establishes the existence of an educational debt as defined in the code, a debtor can demonstrate an undue hardship only by proving (1) an inability to maintain, based on current income and expenses, a “minimal” standard of living for them and their dependents if forced to repay the loans; (2) additional circumstances indicating that this state of affairs is likely to persist for a significant portion of the relevant loans’ repayment period; and (3) their good faith efforts to repay the loans.
Seeing the Brunner standard as essential to safeguarding the financial integrity of the student loan program, nine of this nation’s 11 federal circuit courts have adopted Brunner. The remaining courts of appeal (namely, the First and Eighth Circuits) embraced a totality test, construed so strictly by many as to mirror Brunner in practice. Under that test, a court considers: (1) the debtor’s past, present and reasonably reliable future financial resources; (2) a calculation of the debtor’s and her dependent’s reasonable necessary living expenses; and (3) any other relevant facts and circumstances surrounding each particular bankruptcy case. Despite their differences, both of these approaches compel a debtor to show a “certainty of hopelessness” that he or she will ever have the ability to repay the loan.
Even as the Brunner definition of “undue hardship” spread (with minor modifications by various courts), its textual anchor — § 523(a)(8) itself — did not remain static. Instead, this exception underwent repeated legislative tinkering.
In 1990, Congress expanded the discharge exception in § 523(a)(8) in two ways. First, it increased its coverage from just any educational “loan” to any “educational benefit, scholarship or stipend payment.” Second, Congress increased the five-year statutory cutoff to seven years. In 1998, Congress finally eliminated the requirement that only those student loan debts that were less than seven years into the repayment period could be excepted from discharge in bankruptcy. Lastly, in 2005, Congress expanded the discharge exception in § 523(a)(8) to include, for the first time, private student loans.
As a result of these amendments, by 2018, there was no time limit for examining whether a debtor had made good faith efforts to repay a student loan, and the number and kinds of student loan debts potentially excepted from discharge had skyrocketed. Neither fact was true when Brunner was decided in 1987. In the meantime, the student loan market mushroomed far beyond anything the architects of America’s student loan system predicted.
When Brunner was decided, the amounts in controversy were typically small, and student loan discharge issues arose relatively infrequently. Even in 2008, two decades after Brunner, outstanding federal student loan debt totaled less than $600 billion. This sum, however, ballooned to $1.1 trillion at the end of 2012, topped $1.31 trillion in 2016, and passed $1.48 trillion by late 2017. The average borrower now graduates with approximately $33,000 of education debt. Over 44.2 million Americans have student debt, or nearly 10 percent of the citizens. At the same time, nearly half of all recent college graduates are either unemployed or under-employed, and even a bachelor’s degree no longer guarantees income security. The percentage of student debtors under the age of 30 who were at least 90 days late on their student loan payments, according to the New York Federal Reserve Bank, increased from 21 percent in 2004 to 35 percent in 2012. As one federal bankruptcy judge opined on Oct. 7, 2014: “The world changed ... Certainly, the costs of education and the level of student indebtedness has exploded.”
From 1973 through 2005, Congress repeatedly amended § 523(a)(8) to protect creditors including, particularly, the federal government. These revisions reflect deepening concerns in Congress about students’ ability to cast off their debts.
The Feb. 21, 2018, memorandum indicates the DOE may be open to revisiting the definition of “undue hardship” fashioned by the courts in a world of far fewer debtors and far smaller balances.
In 1978, arguments in favor of a strict definition of undue hardship centered on the existence of “a few serious abuses of bankruptcy laws by debtors with large amounts of educational loans, few other debts and well-paying jobs, who have filed bankruptcy shortly before leaving school and before any loans become due.” Many believe today’s policymakers, whose focus typically is on the larger pool of debtors with education loans who may never be able to pay them back, will seek to loosen the standard.
Critics of such loosening argue that concern for debtors must be weighed against changes that would prevent students from disadvantaged backgrounds from funding a postsecondary education. To adjust for the risk of fewer recoveries and to prevent a surge in uncollectable debt, basic economics suggests that lenders will be forced to increase interest rates for student loans and tighten the standards for issuing such loans. While fewer borrowers will be able to assume significant debt, at the same time, fewer borrowers will be able to qualify for loans to finance their education — a perverse result seemingly incompatible with the purpose of the federal student loan program.
In addition, no matter how the Brunner test is changed, lenders and debtors will be faced with uncertainty as they try to determine how a new test could be applied. Such unpredictability necessarily will lead to increased litigation for both debtors and creditors. Both the defense and plaintiffs bars will face the challenge of litigation across the nation’s 94 bankruptcy courts, guided by sparse jurisprudence.