Friday, September 21, 2007

Educational expenses and bankruptcy

This month is a month of transition for us and many of our clients-vacations are over, the seasons are changing and many of us have children who are going (albeit reluctantly) back to school. This month we’re going to look at educational expenses and bankruptcy.

Before 1976, debtors could discharge their student loans and other educational debt in bankruptcy. In 1976, Congress amended the Higher Education Act (“HEA”) to make federally insured and guaranteed student loans nondischargeable if the debt had first become due less than five years prior to the bankruptcy filing and its repayment would not impose an undue hardship on the debtor and his or her dependents. Despite efforts to repeal this provision of the HEA and make educational debt dischargeable again, Congress retained the conditional dischargeability of educational debt when it enacted the Bankruptcy Code in 1978. Since then, Congress has further limited the dischargeability of educational debt by both broadening the class of creditor that can take advantage of the exception to discharge and tightening the conditions under which educational debt may be discharged.

Unfortunately for both debtors and courts interpreting the Bankruptcy Code, the section concerning educational debt merely says:

“A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt - unless excepting such debt from discharge under this paragraph would impose an undue hardship on the debtor and the debtor's dependents, for - an educational benefit overpayment or loan made, insured, or guaranteed by a governmental unit, or made under any program funded in whole or in part by a governmental unit or nonprofit institution; or an obligation to repay funds received as an educational benefit, scholarship, or stipend; or any other educational loan that is a qualified education loan, as defined in section 221(d)(1) of the Internal Revenue Code of 1986, incurred by a debtor who is an individual.”

As the Bankruptcy Court for the Western District of Texas said in 2001, “the statute Congress crafted in gives the Courts absolutely no guidance as to what would constitute ‘undue hardship’ other than a Webster’s dictionary.” Consequently, bankruptcy judges have had a difficult time determining what debtors should be granted or denied discharge of educational debts. The courts have devised several tests for undue hardship, but the most frequently used test was articulated by the Second Circuit Court of Appeals in Brunner v. New York State Higher Education Services Corp. The Brunner test for undue hardship requires a three-part showing:

(1) that the debtor cannot maintain, based on current income and expenses, a “minimal” standard of living for herself and her dependents if forced to repay the loans; (2) that additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period of the student loans; and (3) that the debtor has made good faith efforts to repay the loans.

Failure to by the debtor to prove any of these factors can result in denial of discharge of the educational debt.

For more information about how educational expenses and debts can impact a bankruptcy filing, please contact Shenwick & Associates.