On October 7, 1998, President Clinton signed the Higher Education Amendments of 1998 (the 1998 HEA), which provided federal funding for education loans at a reduced rate of interest. The 1998 HEA also contained two specific changes regarding the collection of student loans. The first relates to 11 U.S.C. §523(a)(8) and the dischargeability of student loans; and the second, to the enforcement of state court judgments by the federal government for unpaid student loans.² Section 971 of the 1998 HEA eliminates the automatic seven-year discharge requirement of §523(a)(8).³ In addition, §484 of the 1998 HEA provides that the United States may register a state court judgment for an unpaid student loan in federal district court by filing a certified copy of the judgment and a copy of the assignment or transfer. As such, the United States will no longer have to file a complaint to secure a separate judgment for an unpaid student loan that has been adjudicated by a state court.⁴ The 1998 HEA applies only to cases filed after October 7, 1998, and does not affect pending cases.

The effect of the legislation is obvious; no longer may student loans be discharged simply because of the age of the obligation. Debtors will have to file declaratory relief complaints to contest the dischargeability of the student loans as being an undue hardship on the debtor and/or the debtor's dependents.⁵ As such, there will be at least some increase in the filing of adversary proceedings to address the dischargeability of the student loans. Additionally, while there are administrative measures in place through the Department of Education (DOE) to pay these loans, such as income-contingent repayment plans, it is doubtful that those initiatives will limit the number of adversary complaints filed. Further, under the new law, DOE is not compelled to compromise any of the student loans through litigation. While individual Department of Justice attorneys may informally implement local plans to deal with "undue hardship" complaints, it is too early to tell whether DOE will promulgate any bases for consensually discharging student loans under §523(a)(8).

Given the foregoing, several observations may be made regarding the impact of the amendment to §523(a)(8).⁶ There is still no consensus as to what constitutes "undue hardship." For example, the U.S. Bankruptcy Appellate Panel of the Ninth Circuit recently observed that there are at least four tests for determining undue hardship. In re Taylor v. United Student Aid Funds Inc. (In re Taylor), 223 B.R. 747, 754, n. 15 (9th Cir. BAP 1998). They may be summarized as follows:

The first test is whether the debtor can show that: (1) there has been a good faith effort to repay the loan; (2) the debtor cannot maintain a minimal standard of living for the debtor and its dependents; and (3) the debtor's state of financial affairs is likely to exist for a significant portion of the repayment period. Bruner v. New York State Higher Educ. Servs. Corp., 831 F.2d 395 (2d Cir. 1987). The second test requires as well that there be a good faith effort to repay the loan, but also requires the court to determine whether it is reasonable to require the debtor to pay the loan in view of the debtor's future income and expenses, and whether discharge of the loan thwarts legislative intent. Bakkum v. Great Lakes Higher Educ. Corp. (In re Bakkum), 139 B.R. 680 (Bankr. N.D. Ohio 1992). The third test appears to adopt the above-stated Bruner test, but restates it differently. Cheesman v. Tennessee Student Assistance Corp. (In re Cheesman), 25 F.3d 356 (6th Cir. 1994), cert. denied, 513 U.S. 1081 (1995). The fourth test asks the court to apply the totality of the circumstances in determining whether the debtor is entitled to a hardship discharge. Johnson v. USA Funds Inc. (In re Johnson), 121 B.R. 91 (Bankr. N.D. Okla. 1990). Finally, there is a fifth test as to dischargeability, which essentially adopts Bruner, but also asks whether there is a "certainty of hopelessness" regarding the debtor's prospects of repaying the student loan. Coveney v. COSTEP Serv. Agent (In re Coveney), 192 B.R. 140 (Bankr. W.D. Tex. 1996).

Over the past few years, a majority view has emerged as the proper basis for adjudicating "undue hardship," with most bankruptcy courts and several circuit courts, including the Third and Seventh Circuits,⁷ adopting the Bruner test.⁸ Given that undue hardship is now the only basis for discharge under §523(a)(8), the need for uniformity in how the test is applied will enable courts to deal with any attendant rise in adversary proceedings.⁹

The elimination of the seven-year discharge provision does suggest, however, that Congress now views "undue hardship" not as a debtor protection, but rather as a creditor protection. Consequently, fresh start is no longer the issue, but whether the non-payment of the student loans violates public policy.¹⁰ Further, detractors of the new measure will argue that repeal of the seven-year discharge provision will penalize those who seek to educate and improve themselves, while allowing other individuals with overwhelming debt incurred through other means to have a truly fresh start. Regardless, the bar to having a student loan discharged may have been raised, and the circumstances that warrant an undue hardship discharge may have to be more extreme than previously considered.

The change in the legislation raises challenges for creditors as well. While lenders will welcome the change to §523(a)(8), there will be costs to lenders as a consequence of the amendment. More resources may have to be spent litigating dischargeability complaints. Creditors may have to develop policy considerations for not contesting discharges if the burden of defending the lawsuits becomes too time-consuming and expensive. Further, bankruptcy may no longer be a basis for writing off student loans or listing a student loan as uncollectible. Few practitioners, whether creditor or consumer attorneys, will dispute the notion that everyone should honor and pay their student loans. The question now focuses on the cost to the consumers and creditors in determining the dischargeability of these loans, and the judicial resources that will be expended in adjudicating undue hardship complaints.

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Footnotes

¹ The views expressed in this article are Mr. Gargotta's and do not necessarily reflect the views of the Department of Justice. Return to article

² This is the third in a series of columns on student loans. In "Preferentially Paying Student Loans in Chapter 13 Cases; A Survey," XIII ABI Journal No. 3, p. 19 (April 1994), this column commented on the ability of chapter 13 debtors to discriminately pay student loans over other unsecured obligations. In "'Undue Hardship' and the Discharge of Student Loans," XV ABI Journal No. 4, p. 10 (May 1996), this column commented on case law developments for the undue hardship exception to the non-dischargeability of student loans. Return to article

³ Former §523 states in part that a student loan may be discharged if either one of two conditions are met: (1) that the student loan first became due more than seven years (exclusive of any suspension of repayment period) before the date of the filing of the petition or (2) "excepting such debt from discharge under this paragraph will impose an undue hardship on the debtor and the debtor's dependents." Recall that §523(a)(8) deals only with non-HEAL (Health Education Assistance Loans) loans. The discharge of HEAL loans is governed by 42 U.S.C. §292f(g). Return to article

⁴ Previously, the U.S. Attorney could only enforce a state court judgment for unpaid student loans by filing a complaint in federal district court to enforce the judgment under the Federal Debt Collection Procedures Act. Return to article

⁵ The burden of proof to show undue hardship is clearly on the debtor. See, e.g., Bachner v. Illinois (In re Bachner), 165 B.R. 875, 880 (Bankr. N.D. Ill. 1994); Evans v. Higher Education Assistance Foundation (In re Evans), 131 B.R. 372, 374 (Bankr. S.D. Ohio 1991). Return to article

⁶ Certain defenses still remain intact. For example, courts have allowed a partial discharge of the loan under §105 as a means for limiting the impact of §523(a)(8). See Gammoh v. Ohio Student Loan Comm'n (In re Gammoh), 174 B.R. 707, 711 (Bankr. N.D. Ohio 1994). The debtor may argue that the obligation as defined under §523(a)(8) is not a loan. In re Segal, 57 F.3d 342 (3d Cir. 1995). Further, a question may exist as to whether the lender is a "governmental unit." TI Federal Credit Union v. Delbonis, 72 F.3d 921 (1st Cir. 1995). Conversely, the debtor may have to contest the accrual of post-petition interest on the obligation during bankruptcy. Pardee v. Great Lakes Higher Education Corp. (In re Pardee), 218 B.R. 916 (9th Cir. BAP 1998) (majority view is that interest does accrue during bankruptcy). Return to article

⁷ See, e.g., In re Faish, 72 F.3d 298 (3rd Cir. 1995); In re Roberson, 999 F.2d 1132 (7th Cir. 1993). Return to article

⁸ Zacherman, "Discharging Student Loans in Bankruptcy: The Need for a Uniform 'Undue Hardship' Test," 65 U. Cinn. L.R. 691 (Winter 1997). Return to article

⁹ The National Bankruptcy Review Commission, which had recommended repeal of §523(a)(8), argued that any supposed abuse by debtors to avail themselves of the discharge of student loans through §523(a)(8) was at best anecdotal. In re Hornsby, 144 F.3d 433, 437, n.4 (6th Cir. 1998). Return to article

¹⁰ This concern that undue hardship protects the debtor was expressed in Salvin, "Student Loans, Bankruptcy, and the Fresh Start Policy: Must Debtors Be Impoverished to Discharge Student Loans?", 71 Tulane Law Review 139 (Nov. 1996). Return to article

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Journal Date:  Sunday, November 1, 1998 © American Bankruptcy Institute. All rights reserved. ABI is a (501)(c)(3) non-profit business (52-1295453)