Bankruptcy For Student Loans: Discharge Is More Possible Than You Think

Discharging student loans in bankruptcy has historically been thought of as nearly impossible. A few notable cases within the past few years are starting to change this narrative.

To discharge student loan debt outside of death, disability, or Borrowers Defense to Repayment Discharge, you must declare either Chapter 7 or Chapter 13 bankruptcy.

Chapter 7 vs. Chapter 13 bankruptcy

With Chapter 7 bankruptcy — think “liquidation” — most of your property is sold and used to pay off your debt. A Chapter 7 bankruptcy filing can be better for folks with limited incomes who can’t pay back all or portions of their debt to various creditors and lenders.

Chapter 13 bankruptcy calls for a “reorganization” of your assets. Unlike Chapter 7, your property isn’t sold when you file for Chapter 13 protection. You must successfully complete a court-mandated repayment plan for your debt, which can allow you to keep your property.

Why discharging student loans in bankruptcy wasn’t that simple

On top of needing to file for bankruptcy, a change in Bankruptcy Code in 1998 eliminated the original seven-year waiting period to indefinite (from when payments became due to when they could be eligible for discharge through bankruptcy). This made student loans dischargeable in Chapter 7 or Chapter 13 Bankruptcy ONLY when there’s an undue hardship. This is a unique standard other debt, such as credit card debt and medical debt, don’t have to meet.

It’s up to the court to decide whether a borrower meets the “undue hardship” standard. Courts apply different tests, but most use the Brunner test, which comes from Brunner v. New York State Higher Education Services Corporation. The Brunner test requires proof of the following:

1. The debtor cannot maintain, based on current income and expenses, a minimal standard of living for the debtor and the debtor’s dependents if forced to repay the student loans.

2. 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.

3. The debtor has made good faith efforts to repay the loans.

In a recent case — Kevin Jared Rosenberg v. N.Y. State Higher Education Services Corp., Jan. 7, 2020 — a federal judge in New York (Hon. Cecelia G. Morris, Chief U.S. Bankruptcy Judge) discharged more than $220,000 in federal student loans based on the case’s conclusion that Rosenberg satisfied the Brunner test.

The Rosenberg case court order also noted the Brunner test has received criticism for being too high a standard for most bankruptcy petitions to meet.

Brunner test: Early interpretations led to harsh rulings

Those who’ve been out of school and struggling with student loan payments for many years, like Mr. Rosenberg, should find the Brunner test itself fairly straightforward. However, many cases have imposed punitive standards in the course of interpreting the Brunner case that aren't actually contained in that case ruling.

Other cases have mixed the Brunner test with other court decisions and standards, such as Briscoe v. Bank of N.Y. in 1981 ruling that the borrower’s undue hardship wasn’t exceptional enough stating: 

“the dischargeability of student loans should be based upon the certainty of hopelessness, not simply a present inability to fulfill financial commitment… The words ‘undue hardship’ are not defined by the Code, but are words of art, and are left to the discretion and judgment of the Court.”

For another example, the Jean-Baptiste v. Educ. Credit Mgmt. Corp. case in 2018 perpetuates this standard that her undue hardship wasn’t considered hopeless. It also declares the debtor must establish their inability to pay the student loan debt is likely to persist for a significant portion of the repayment period “in order to satisfy the second Brunner factor.”

Over time, these interpretations — or misinterpretations — of the Brunner test have taken the place of the actual language of the Brunner ruling. Some courts have even called it “bad faith” when someone struggling with repaying a student loan attempts to discharge that debt in bankruptcy court.

No wonder bankruptcy professionals believe it’s nearly impossible to have student loan debt discharged!

McDaniel v. Navient: Precedence for bypassing Brunner test

On August 31, 2020, McDaniel had $200,000 in private student loans discharged. This case is notable because the court ruled that McDaniel didn’t need to prove undue hardship since her loans weren’t only used for her school’s cost of attendance. The bankruptcy court held that the borrower’s private student loans were not “an obligation to repay funds received as an educational benefit” thus not susceptible to the Brunner test.

This ruling could certainly be referenced for cases to come which could continue to move the needle on the interpretation of an “obligation to repay funds received as an educational benefit”. However, it might be limited to the 10th Circuit’s jurisdiction for now, which only includes Colorado, New Mexico, Oklahoma, Utah and Wyoming.

Let’s talk about Leary v. Great Lakes Education Loan Services

Sheldon Leary was successful in discharging $416,877.56 in federal student loans during bankruptcy. But the judge also imposed more than $378,000 in penalties on Great Lakes in September 2020. This lawsuit is more related to the student loan servicer’s negligence, rather than the previously discussed Brunner test.

In 2015, Mr. Leary initiated a bankruptcy adversary proceeding against his loan servicer, Great Lakes Higher Education. Great Lakes didn’t participate in the adversary proceeding, nor did the Department of Education. Neither one even responded to it. As a result, in March 2016 the bankruptcy court ruled in Mr. Leary’s favor and discharged his federal student loans, since his petition was unopposed.

Great Lakes tried to continue collecting on the debt, going as far as threatening to garnish Mr. Leary’s wages. Meanwhile, completely ignoring the multiple notices and orders sent to them in connection with the discharge-judgment from March 2016.

Mr. Leary filed a motion for contempt, arguing that Great Lakes wasn’t honoring his bankruptcy judgment discharging his federal loans. Great Lakes acknowledged receipt of this but failed to respond to court orders. Judge Glenn imposed a $123,625.52 sanction which was ignored, as well.

The final outcome

At a hearing in August 2020 (more than FOUR years after Mr. Leary’s judgment), Great Lakes’ Counsel blamed an “unintentional procedural error” for Great Lakes’ failure to respond or participate in past hearings and sanctions orders.

Judge Glenn wrote:

“The Court finds this cavalier excuse wholly unsatisfactory. “Great Lakes’ …has been a named defendant since September 2015 — seriously prejudiced Mr. Leary.”

With that, the court affirmed the prior bankruptcy discharge of Mr. Leary’s $416,877.56 in federal student loan debt. It also TRIPLED sanctions against Great Lakes to $354,629.62, including an additional $24,000 penalty on Great Lakes. This penalty was to be paid to Mr. Leary directly “for the harm he suffered over the last five years as a result of negative credit ratings, aggravation, loss of sleep and worry, harassment, pain and suffering, in addition to contributing marital strain.”

The judge also ordered both Great Lakes and the Dept. of Education to report the discharged loans as “paid in full” to credit bureaus.

How do these cases help student loan borrowers at large?

We had emails flowing in about Mr. Leary’s case once it hit the media — honestly, his case is an anomaly. If Great Lakes had responded to Mr. Leary’s bankruptcy adversary proceeding, they wouldn’t have been sanctioned for not responding or fined for Mr. Leary’s suffering.

I’m more confident in bankruptcy cases like Rosenberg’s or McDaniel’s that move the needle away from the myth that student loans are impossible to discharge in bankruptcy.

Bankruptcy is an available and beneficial option for anyone struggling with debt. A petitioner under the bankruptcy code always has the option to come before the court and ask, in good faith, that debt be discharged — no matter what kind of debt it is. Your first step to pursuing a bankruptcy option is to consider seeking legal assistance.

If the Brunner test doesn’t seem to apply to you, but you still need help navigating student loan programs and repayment options, consider student loan repayment assistance.

Student Loan Planner®’s experts are highly experienced in slaying monster student loan balances. We’ve helped over 3,600 clients take on over $935 million worth of student debt. We can create a custom plan for you, too. You don’t have to go it alone anymore.

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