"Undue Hardship" Under Section 523(a)(8): Can the Debtor's Student Loans Be Discharged?

The provisions of Section 523(a)(8) generally qualified education loans from discharge, unless the denial of a discharge would "impose an undue hardship" on the debtor. Although the words "undue hardship" are not defined in the Bankruptcy Code, two tests have been developed to assist the courts in making such a determination. This EIA examines court trends in this area.

EXCERPT: The Brunner Test

Of the two tests currently in use to assist a court in making such a determination, the most popular is the three-prong standard, first articulated by the Second Circuit in Brunner v New York State Higher Educ. Serv. Corp. In the Brunner decision, the Court held that for a debtor to successfully obtain a discharge of the student loan(s) based upon "undue hardship," that debtor must demonstrate that "(1) the debtor[s] cannot maintain, based on current income and expenses, a 'minimal' standard of living for [themselves and 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[s have] made good faith efforts to repay the loans." This Brunner test, in one form or another, is currently used by most of the circuits in the United States to determine whether or not a debtor has demonstrated "undue hardship."

"Totality of the Circumstances" Test

The other test used to determine whether or not a debtor has met its burden, denoted the "totality of the circumstances" test, has been officially adopted by the Eighth Circuit, and, since 2010, has been unofficially accepted by the courts of the First Circuit.

Those courts adopting this second test "consider: (1) the debtor's past, present, and reasonably reliable future financial resources; (2) a calculation of the debtor's and [their] dependent's reasonable necessary living expenses; and (3) any other relevant facts and circumstances surrounding each particular bankruptcy case" to determine whether or not a student loan should be discharged.

Practice Pointers

No full or partial discharge of student loan debt is available unless all three prongs of the Brunner test are met.

To satisfy the first prong of the Brunner test, courts require a sufficiently detailed schedule of living expenses, and a modification of lifestyle to a "minimal standard of living."

Much focus has been put upon the second prong of the three-prong Brunner criteria-additional, exceptional circumstances of a continuing inability to repay the loan that will continue over a prolonged period of time. Courts have interpreted "[t]he type of 'additional circumstance' that would affect the debtor's continuing ability to repay [to be] a circumstance that impacted on the debtor's future earning potential but which was either not present when the debtor applied for the loans or has since been exacerbated."

Consensual third-party releases are generally allowed. However, as a matter of due process, they should be highlighted in the materials, probably in the ballot itself right next to the vote, and certainly in the initial executive summary of the plan in the disclosure statement. If the information on the release is buried on page 88 of the plan and page 156 of the disclosure statement, a creditor might have a due process argument with which to collaterally attack the release.

Under the first portion of the "totality of the circumstances - analysis, a ... court must consider the debtor's past, present, and reasonably certain future resources." Included within that are: the debtor's work history and earnings capacity.

Additionally, a court employing this test "may not engage in speculation when determining net income and reasonable and necessary living expenses." "To be reasonable and necessary, an expense must be 'modest and commensurate with the debtor's resources.'"

Finally, under the third portion of this test, the court looks at a number of factors, which can include:

(1) total present and future incapacity to pay debts for reasons not within the control of the debtor; (2) whether the debtor has made a good faith effort to negotiate a deferment or forbearance of payment; (3) whether the hardship will be long-term; (4) whether the debtor has made payments on the student loan; (5) whether there is permanent or long-term disability of the debtor; (6) the ability of the debtor to obtain gainful employment in the area of the study; (7) whether the debtor has made a good faith effort to maximize income and minimize expenses; (8) whether the dominant purpose of the bankruptcy petition was to discharge the student loan; and (9) the ratio of student loan debt to total indebtedness.

Conclusion

Congress had two specific purposes in enacting Section 523(a)(8), both of which have been addressed by the courts in the current presumption of non-dischargeability of student loan debt. It is not clear, however, that the tests that are currently being used to measure "undue hardship" are completely in line with the realities of life in 2012. Expect this area of the law to continue to evolve as the courts adjust those tests to reflect recent societal and economic changes.

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