Getting Schooled: Student Bankruptcy in America

“All I know is that I wanted to go to school, I had student loans available to me, and I took them out.”   This unthinking sentiment, expressed by a man named Robert in Default: The Student Loan Documentary, is a familiar sentiment among students.

Few students actually read the “promissory notes”—often over ten pages of dense text (Example here (PDF))—that they are asked to sign before taking out student loans, and those that do often do not understand or appreciate the consequences of signing anyway. Indeed, Robert is not some eighteen-year old high school graduate: hanging on the wall behind him in the documentary is a diploma from Fordham Law School.

This sentiment is problematic. In 2014, more than one in every ten dollars owed on student debts was more than 90 days overdue, a delinquency rate greater than any other kind of debt. Additionally, at over $1.2 trillion, more debt is owed in the U.S. on student loans than on credit cards, and the amount is growing every day.

Bankruptcy Process

But there’s a problem with student debt that goes beyond the sheer volume and delinquency rates: student debts are harder to get rid of than nearly any other kind of debt.

Typically, when a person files for bankruptcy, the court will arrange for a process by which the total amount that the person must pay is less than she otherwise owes. Certainly, the debtor does not get off scot-free; she may lose her home or a portion of her wages to pay this reduced amount, and her credit score will be downgraded. But in the end, the total amount of debt she ends up paying is reduced, and any remaining debts are eliminated (or “discharged”). With no more debts, the person can start fresh.

The problem with student debts is that they do not get discharged with everything else. This is the doing of a nasty little provision buried in Chapter 5 of the Bankruptcy Code, 11 U.S.C. §523(a), which deals with exceptions to the fresh start. For debts like student loans that fall under rule 523(a), a creditor can still come and collect on the debt even after the bankruptcy process is over and all other debts have been discharged.

While most of rule 523(a) deals with bad behavior (hiding assets and lying to the court) or various kinds of fees and taxes, 523(a)(8)—seemingly anomalously—includes student debt as one type of debt that cannot be discharged. Lose your house? Your life savings? Most of your wages? Doesn’t matter. You still owe your student debts in full. As Robert from the documentary explains, “For whatever reason, Congress has decided to treat student loan debt completely differently than every other type of debt. So you can discharge your gambling debts in bankruptcy, but you can’t discharge your student loan debts.” In bankruptcy, a horse race has a better payoff than Harvard.

Is There a Way Out?

Some are quick to mention that there is a way to get around 523(a)(8). Within the statute, Congress added an “exception to the exception” that allows students to discharge even their student debts if they can prove that these debts are causing them “undue hardship.”

Although the statute itself does not define what constitutes undue hardship, most courts (all but the 1^st and 8^th circuits) have adopted the standard set out in a case known as Brunner, which was decided by the second circuit in 1987. Worded simply, the Brunner standard finds that there is “undue hardship” when the debtor shows (1) a current inability to repay their loans, (2) a future inability to repay their loans, and (3) a good faith effort to repay these loans.

What this standard means in practice is ultimately hard to say. On it’s face, the Brunner test is not exactly lenient—a future inability to repay loans for the entire life of the loan still requires a pretty serious level of destitution.

But a bigger problem is that most debtors never choose to bring an “undue hardship” challenge in the first place. In a nationwide study of bankruptcies involving student debt, one author found that only 0.1% of debtors actually attempt to have their student loans discharged for undue hardship, even though 40% of that 0.1% actually succeed.

But the point is this: It should not matter why the remaining 99.9% of bankrupt debtors with student loans do not seek the undue hardship exception to rule 523(a). It should not matter if they are deterred because they do not think they will succeed, or if—more likely—they have no idea the exception exists in the first place.

Students should not be required to rely on an obscure exception to an exception to receive the same kind of treatment as every other debtor. No doubt, the student debt bubble is a many-headed monster. But chopping off rule 523(a)(8) and its arbitrary provisions would be a good place to start.

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