NY Times: Judges Rebuke Limits on Wiping Out Student Loan Debt

By TARA SIEGEL BERNARD

On a typical day in her last job, Janet Roth left home at 4 a.m. each day and drove 40
miles to a tax preparation office in Glendale, Ariz. When she finally got back home,
she had less than an hour before starting her 6 p.m. shift decorating cakes at
Walmart. She worked until midnight, giving her just a few hours to sleep before
starting all over again.

Ms. Roth, 68, worked in many jobs over the years, but she never made quite
enough to pay back the $33,000 she borrowed years earlier for an education degree
she couldn’t afford to complete, and certainly not the $95,000 it ballooned to in
default.

She filed for bankruptcy, wiping out five figures in medical debts. But erasing
student loans requires initiating a separate legal process, where borrowers must
prove that paying the debt would cause an “undue hardship.”

To prepare her case, she copied down statutes at a local law library and watched
episodes of “Law and Order.” Her efforts paid off: Ms. Roth’s loans were discharged
in 2013.

That Ms. Roth, now living on Social Security, managed to succeed in what is known
as a notoriously difficult process is not even the most remarkable aspect of her case.
Instead, the ruling captured the attention of other judges and legal scholars
because of a judge’s bluntly worded written opinion that rebuked the widely adopted
hardship standard used to determine whether a debtor is worthy of a discharge.

The judge, Jim D. Pappas, in his concurring opinion for the bankruptcy
appellate panel decision in the United States Court of Appeals for the Ninth Circuit,
said the analysis used “to determine the existence of an undue hardship is too
narrow, no longer reflects reality and should be revised.”

He added: “It would seem that in this new, different environment, in
determining whether repayment of a student loan constitutes an undue hardship, a
bankruptcy court should be afforded flexibility to consider all relevant facts about
the debtor and the subject loans.” But the current standard, he wrote, “does not
allow it.”

Judge Pappas isn’t the only critic. Although plenty of cases still hew closely to a
strict interpretation of the test, some judges and courts have signaled in recent years
that they believe the rigid standard — known as the Brunner test — should be
reconsidered, even if they are still bound to it now.

“The world has changed,” said Michael B. Kaplan, a federal bankruptcy judge for
the District of New Jersey, who criticized the standard in an opinion article.
“Certainly, the costs of education and the level of student loan indebtedness has
exploded.”

Because the bankruptcy code never defined “undue hardship,” the courts
needed to develop their own definition. Most courts adopted the Brunner test, which
originated from a precedent-setting ruling in 1987, in which a woman named Marie
Brunner filed for a discharge of her debt less than a year after she completed a
master’s degree.

To stop debtors from trying to prematurely cancel their debts, the case laid out a
three-pronged test: Individuals must prove they made a good-faith effort to pay the
loan by finding work and minimizing their expenses. Debtors must also show they
could not maintain a minimal standard of living based on their income and expenses
if they had to repay the debt.

But then, in arguably the most challenging prong, the court must consider
whether that situation is likely to persist for a significant part of the repayment
period — which essentially requires the judge to predict the debtor’s future, ensuring
what some courts have described as a “certainty of hopelessness.”

“How do you prove things won’t change for the better in the future?” said Daniel
A. Austin, associate professor at Northeastern University School of Law.

Bankruptcy scholars and judges said the test made sense at the time it was
adopted because even if debtors could not pass the test, their debts — which were far
more modest then — would automatically be discharged in bankruptcy five years
after their repayment period started.

But the legal landscape has changed substantially since then. Before 1977,
student loans could be discharged in bankruptcy alongside other debts like credit
card balances. Congress toughened the law in 1976, adding the five-year period, and
again in 1990, when the waiting period was extended to seven years.

In 1998, the waiting period was eliminated. So now, all debtors must prove
undue hardship to erase their student debts. (In 2005, Congress added private
student loans to the mix of federal education debt that could not be discharged, even
though the loans are not backed by the government.)

“You can see why courts would have developed a harsh standard in those cases
where consumers had sought discharge of loans soon after they came due, without
waiting five or seven years,” said John Rao, a lawyer with the National Consumer
Law Center. “But it is kind of ridiculous to be applying the same standard now when
there is no longer a right to an automatic discharge.”

Another noteworthy case, also from 2013, involved a “destitute” paralegal
named Susan Krieger, then about 53, who lived in a rural area of Illinois with her
mother, according to court documents. Ms. Krieger received a bachelor’s degree in
legal studies and a paralegal certificate, graduating when she was 43. But after a
decade-long search, she couldn’t find a job.

The Educational Credit Management Corporation, the guaranty agency hired to
battle student debtors in court, argued that Ms. Krieger should enroll in an
income-based repayment program, even though she probably wouldn’t end up
paying anything. Ms. Krieger’s remaining balance of about $25,000 was eventually
discharged.

But it was the written opinion of a well-regarded judge in the Krieger case,
questioning the application of the Brunner test, that has been repeatedly cited by
other judges. In the ruling, Frank H. Easterbrook, then chief judge for the United
States Court of Appeals for the Seventh Circuit, seemed to signal that requiring
debtors to prove their futures were “hopeless” was taking the undue hardship
standard too far.

He wrote that it was important not to allow “judicial glosses,” like the language
in the Brunner case, “to supersede the statute itself.”

Rafael I. Pardo, a bankruptcy law professor at Emory Law, said Judge
Easterbrook’s opinion was a reminder to other courts that carried a lot of weight. “If
this highly respected, highly cerebral conservative judge is saying this, that is a big
deal,” he added. “It is a clarion call that some judges should be more forgiving when
applying the law.”

Judge Easterbrook and Judge Pappas weren’t the first to criticize the Brunner
standard. That distinction may belong to Judge James B. Haines Jr., who spent 25
years as federal bankruptcy judge in Maine before retiring in 2013. In an opinion in
2000, he said that some courts reach too far in trying to define undue hardship.

He said he never felt shackled by Brunner’s three-prong test because the higher
court in his jurisdiction never adopted that standard, leaving him free to consider
another standard, whereby judges can consider the “totality of the circumstances.”

“Throughout my time on the bench, I heard many student loan cases,” said
Judge Haines, now a professor at Maine University School of Law. “The totality of
the circumstances test gave me sufficient structure, with a fair ability to balance all
pertinent facts.”

Many of those facts have become more dire over the last decade. Among debtors
filing for bankruptcy with student loans, the average amount of student debt has
doubled to nearly $31,000 in 2014 from $15,350 in 2005, according to an analysis by
Professor Austin of Northeastern. But perhaps more important, student loans as a
percentage of the filer’s annual gross income have also increased substantially. In
2014, 16 percent of all bankruptcy filers had student loans that totaled more than 50
percent of their annual income, compared with 5.4 percent in 2005.

This year, President Obama instructed several governmental agencies to review,
by Oct. 1, whether the treatment of student loans in bankruptcy should be altered.
Congress could tweak the bankruptcy code, perhaps reinstating a waiting period
before debts can be canceled. Judge Kaplan, in New Jersey, said perhaps 10 or 15
years was the right number. Otherwise, the existing hardship standard could be
overridden if a circuit court hears a case en banc, meaning all of the judges in a
circuit decide together.

All of those are long shots, for the time being. A larger part of the problem is
that only a tiny percentage of debtors attempt to discharge their student loans in
bankruptcy, perhaps because of the perception that it isn’t possible or is too hard.

But debtors’ best chance at having their student loans wiped away may simply
be to try.

© 2015 The New York Times Company.  All rights reserved.