2nd Circ. Ruling May Stifle Student Loan Discharge Flexibility

April 21, 2021Articles Law360

The path to discharging student loans in bankruptcy is presently very narrow, requiring that debtors demonstrate that repaying the debt would be an undue hardship.

For nearly 25 years, bankruptcy courts throughout much of the country have applied a test established by the U.S. Court of Appeals for the Second Circuit in Brunner v. New York State Higher Education Services Corp. to determine if a debtor's repayment of student loans is an undue hardship.[1]

In application, the Brunner test has proven to be a difficult burden for debtors to overcome, with discharge of student loan debt typically granted only for debtors who have demonstrated dire circumstances impeding their ability to repay the debt in both the present and for the foreseeable future. Some have termed this a "certainty of hopelessness" standard.[2]

In recent years, some bankruptcy courts have more flexibly applied the Brunner test to allow for at least partial discharge of a debtor's student loan debt, potentially signaling an emerging trend.

Perhaps most notably, in a January 2020 U.S. Bankruptcy Court for the Southern District of New York opinion, Rosenberg v. New York State Higher Education Services Corp., a debtor's entire student loan debt was discharged as an undue hardship, with the court opining that that the Brunner test had been warped over time, subsuming the "certainty of hopelessness" standard that was more punitive than the original design of the Brunner test.[3]

The Second Circuit, the Brunner test's progenitor, recently had an opportunity to revisit the test in In re: Tingling, decided on March 11.[4]

This was a potentially pivotal decision, as a signal of flexibility by the Second Circuit in applying the Brunner test could result in a deluge of bankruptcy filings by debtors seeking an opportunity to discharge their student loan debt, while a reaffirmation of the rigors of the Brunner test could send a chilling message to courts considering a more malleable approach.

The Second Circuit ultimately took the latter path, as it explicitly disagreed with the assertion that the Brunner test had become too onerous a burden for debtors. By confirming the intended strictness of the Brunner test, the Second Circuit effectively sent a message that unless Congress amends the Bankruptcy Code to ease the undue burden standard, discharging student loan debts will remain a difficult task for debtors.

Some history may help elucidate the interplay between student loans and bankruptcy and give context to the Tingling decision. When the Bankruptcy Code was first enacted in 1978, student loan debt could be discharged either after the passage of five years since the repayment obligation commenced, or if repayment would impose an undue hardship on the debtor and his/her dependents.

In 1990, the five-year waiting period was extended to seven years, and then in 1998, the Bankruptcy Code was amended to remove the waiting period altogether, leaving establishing undue hardship as the only means to discharge student loan debt as set forth in Section 523(a)(8) of the Bankruptcy Code.

The elimination of the waiting period was made despite the recommendation of the National Bankruptcy Review Commission in its 1997 report to eliminate the hurdles to discharge in Section 523(a)(8) entirely and to treat student loan debt like other unsecured debt. Section 523(a)(8) was further amended in 2005 to encompass private student loans in addition to government-issued or government-backed loans.

In its present form, Section 523(a)(8) of the Bankruptcy Code provides:

(a) A discharge under section 727, 1141, 1192, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt — (8) unless excepting such debt from discharge under this paragraph would impose an undue hardship on the debtor and the debtor's dependents, for — (A)(i) 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 (ii) an obligation to repay funds received as an educational benefit, scholarship, or stipend; or (B) 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.[5]

Through the widely adopted Brunner test, student loan debt may be discharged as an undue hardship under Section 523(a)(8) if the debtor establishes by a preponderance of the evidence that:

  • She cannot maintain, based on current income and expenses, a minimal standard of living for herself and her dependents if forced to repay the loans;

  • Additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period; and
  • She has made good faith efforts to repay the loans.

Since the Brunner test was conceived in 1987, student loan debt has increased substantially, while discharging student loan debt has become more difficult through the aforementioned amendments to Section 523(a)(8).

In 2019, the American Bankruptcy Institute's Commission on Consumer Bankruptcy released a report in which it termed student loan debt as "one of the most significant economic problems facing the United States."[6]

The report noted that student loan debt has tripled since 2006 to over $1.5 trillion, and that student loans have the highest delinquency rate among household debts.[7] The report further cited studies showing that student loan debt constrains economic activity for borrowers in a variety of ways.[8]

In light of the statistics, the ABI commission made several recommendations to reform treatment of student loans in bankruptcy, including revising the Bankruptcy Code to again allow for discharge of student loan debt after seven years since the repayment obligation began or after completion of a five-year Chapter 13 bankruptcy plan, among other suggestions.

Possibly sensing the tension between mounting student loan debt and the rigidity of the Brunner test, some bankruptcy courts have recently more adaptably applied the Brunner test to allow for at least partial discharge of student loan debt.[9]

For instance, in Hunter v. New Jersey Higher Education Student Assistance Authority decided in 2018, the U.S. Bankruptcy Court for the District of New Jersey determined that based on the debtor's monthly surplus income, it was appropriate to discharge the debtor's student loan obligations maturing before June 2037 as an undue hardship, while preserving obligations maturing after the date.

As a result, the debtor's monthly student loan bill decreased from $2,609.24 to $414.26.[10]

In a similar decision, Manion v. Modeen, a few months later, the U.S. Bankruptcy Court for the Western District of Wisconsin allowed for a partial student loan discharge reducing the debtor's monthly student loan repayment obligation from $694 to $208.[11]

Then, as mentioned above, in January 2020, the U.S. Bankruptcy Court for the Southern District of New York discharged a debtor's entire $221,385 student loan debt as an undue hardship.[12]

In Rosenberg, Chief U.S. Bankruptcy Judge Cecelia Morris opined that "[t]he harsh results that often are associated with Brunner" were the result of a "quasi-standard of mythic proportions" that grew from subsequent cases applying the Brunner test overly retributively.[13] The court resolved to "not participate in perpetuating these myths."[14]

The court then applied the Brunner test in line with what it believed to be the Second Circuit's original design, observing that the debtor's negative net monthly income, the fact that the repayment period had ended and the full amount of the loan was due and payable, and that the debtor had made a good faith effort to repay the loan, satisfied the Brunner test's standard for discharge.

This decision, occurring within the Second Circuit and the high-profile Southern District of New York, coupled with the economic hardships resulting from the COVID-19 pandemic, fueled speculation that borrowers may increasingly file for bankruptcy and commence adversary proceedings to discharge their student loan debt in the hope of finding an emerging trend of judicial flexibility in applying the Brunner test.

However, for those hoping for emerging prospects to discharge student loan debt, the Second Circuit's decision in Tingling signaled that it is not inclined to revisit the structure of the Brunner test and that the test was indeed designed to be a high threshold.

In Tingling, the bankruptcy court determined that the debtor's student loan debt was nondischargeable as the debtor failed to prove undue hardship under the Brunner test. The district court affirmed.

The debtor, aligning with Judge Morris' view in Rosenberg, argued that the Brunner test had become too onerous a burden for debtors to satisfy.

The Second Circuit, however, explicitly disagreed and reaffirmed the elements of the Brunner test that it adopted nearly 25 years earlier. In particular, the Second Circuit noted that the Brunner test "reflects the Section 523(a)(8) statutory scheme exhibiting 'clear congressional intent ... to make the discharge of student loans more difficult than that of other nonexcepted debt.'"

The Second Circuit found that the debtor failed to satisfy any of the three prongs of the Brunner test, specifically noting that:

  • The debtor's income exceeded federal poverty levels and allowed her to make loan repayments while maintaining a minimal standard of living, and that the debtor failed to take steps to improve her financial condition and reduce her discretionary expenses;
  • The debtor is relatively young at 52 years old, in good health, possesses two graduate degrees, and has no dependents, and thus able to maintain her present income level; and
  • The debtor did not utilize repayment options available for certain of her loans and did not make a good faith effort into negotiating or repaying the other group of loans.[15]

For the reasons noted by the ABI commission, bankruptcy judges faced with debtor actions to discharge student loan debt may feel a tension between the limited path to discharge in Section 523(a)(8) and the notion that bankruptcy is intended to provide debtors with a fresh start.

However, the Second Circuit's recent pronouncement in Tingling, and in particular, the fact that it disagreed with the assertion that the Brunner test has evolved to become too high a burden for debtors to satisfy, will likely be seen as a loud message to bankruptcy courts across the country that may have considered implementing a more flexible approach to the Brunner test.

Had the Second Circuit taken a view along the lines of Judge Morris' in Rosenberg, a wave of bankruptcy filings aimed at discharging student loan debt may have followed, and courts may have exhibited increased comfort with granting at least partial discharges. But with the Second Circuit standing by the Brunner test, any large-scale relief in bankruptcy for student loan debt will likely be contingent on congressional action.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] Brunner v. N.Y. State Higher Educ. Servs. Corp. , 831 F.2d 395 (2d Cir. 1987).

[2] See, e.g. In re Jean-Baptiste , 584 B.R. 574, 588 (Bankr. E.D.N.Y. 2018).

[3] Rosenberg v. N.Y. State Higher Educ. Servs. Corp ., 610 B.R. 454 (Bankr. S.D.N.Y. 2020).

[4] 2021 WL 922448 (2d Cir. March 11, 2021).

[5] 11 U.S.C. § 523(a)(8).

[6] The ABI Commission's Report is available at https://consumercommission.abi.org/.

[7] Id. at 3.

[8] Id.

[9] As an alternative to the Brunner Test, the Eighth Circuit Eighth Circuit has adopted a more flexible "totality of the circumstances" test for undue hardship, which requires that a debtor establish by a preponderance of the evidence that a continued repayment obligation would impose an undue hardship through consideration of (1) the debtor's past, present, and reasonably reliable future financial resources; (2) the debtor's reasonable and necessary living expenses; and (3) any other relevant facts and circumstances. In a 2019 decision, for example, a bankruptcy court in the Northern District of Iowa applied the totality of the circumstances test to discharge approximately $130,000 of the debtor's student loan debt as an undue hardship, leaving a repayment obligation of approximately $24,000. See Swafford v. King , 604 B.R. 46 (Bankr. N.D. Iowa 2019).

[10] See Hunter v. New Jersey Higher Educ. Student Assistance Auth., adv. pro, no. 15-02052-JKS (Bankr. D.N.J. April 27, 2018).

[11] See Manion v. Modeen , adv. pro. no. 17-00071-cjf (Bankr. W.D. Wis. June 8, 2018).

[12]Rosenberg v. N.Y. State Higher Educ. Servs. Corp ., 610 B.R. 454 (Bankr. S.D.N.Y. 2020).

[13] Id. at 458-59.

[14] Id. at 459.

[15] In re Tingling , 2021 WL 922448 at *4.

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