Getting out from under crushing student loan debt might become a little easier if new proposed changes in bankruptcy rules take hold.
The proposed changes are part of a wide-ranging report by prominent members of the bankruptcy community, including former judges, academics and lawyers from both the debtor and creditor sides.
The recommendations from the American Bankruptcy Institute’s Commission on Consumer Bankruptcy are aimed in part at addressing issues that have made it more challenging for debtors to file bankruptcy. The 274-page report, released Wednesday, touched on issues including attorney costs, rainy day funds for debtors with unexpected expenses and the disproportionate number of African-American consumers in a certain type of bankruptcy proceeding.
Generally, bankruptcies are meant to get a debtor’s finances together while paying creditors under court supervision. One of the options is a Chapter 7 petition, where assets are sold off, proceeds go to the creditor and debts are discharged. Another option is Chapter 13 cases, which arrange installment payment plans.
In 2018, bankruptcy petitions hit their lowest mark since 2007 after a spike tied to the Great Recession. The rates dipped as the 10-year bull market charged on and unemployment hit a low point not seen in 49 years.
But some observers said there were others issues explaining the low numbers — one being that some people, already deep in the red, couldn’t afford to file for bankruptcy because the legal fees and court costs were too much. The report laid out several options on how to tackle the payment issue.
Another major obstacle to consumers getting a fresh start in bankruptcy: Their student loan debt, which is notoriously hard to discharge through the process.
Bankruptcy code hasn’t been updated since 2005
The bankruptcy code was enacted in 1978. Its last major update was in 2005. Much has changed, even since 2005, according to the report. One example was that Americans’ total student-debt load was so small in 2005, it wasn’t even listed in the Federal Reserve’s monthly reports on consumer debt.
That was then. Now Americans owe $1.5 trillion in student loans.
‘Debt hanging over the debtor forever has a cost.’
“Debt hanging over the debtor forever has a cost,” Elizabeth Perris, a retired bankruptcy judge who co-chaired the commission report, said Thursday. “It’s a cost in terms of lack of purchase of houses, cars, having children and we just recognize that at a certain point for those people who want to avail themselves of bankruptcy, they ought to be able to get the fresh start and move on with their lives.”
The proposals offered by the commissioners serve a variety of purposes. The first is to provide recommendations to lawmakers should they ever have an appetite to reform the bankruptcy code, said Dalié Jiménez, one of the commissioners and a professor at the University of California-Irvine’s school of law.
Some of the most dramatic suggested changes to the treatment of student loans fall into this category, including a proposal that would allow borrowers to discharge student loans in bankruptcy seven years after they became payable.
“I’m not sure Congress would go that far,” said Jiménez, who was on the founding staff of the Consumer Financial Protection Bureau. Regardless, she said she was happy to see the body, which included members of the bankruptcy community from different sides, including creditor attorneys, embrace the idea that some of these loans should be discharged after a period.
Hope for borrowers who want to discharge their debt in bankruptcy
Borrowers should be allowed to discharge student loan debt from private lenders, the report recommends.
The report also reiterated a proposed change to the bankruptcy code that’s become more popular over the past few years — allowing borrowers to discharge private student loan debt in bankruptcy.
But even if Congress doesn’t decide to act on these proposals any time soon, the report’s suggestions could provide hope for borrowers. That’s because it offers suggestions on how judges could interpret the current bankruptcy code in a way could help struggling borrowers looking to have their student loans discharged.
Many judges are already looking for a way to treat distressed borrowers more leniently in bankruptcy, Jiménez said. “They need cases in front of them to do that and they need argumentative fodder,” she said. The report is “more likely to move the needle forward than one of them sticking their necks out there without a lot of backing.”
Changing the definition of ‘undue hardship’
Right now, borrowers can only have their student loans discharged in bankruptcy if it’s clear that paying back the debt would place an “undue hardship” on them. In most regions of the country, the standard of what constitutes an “undue hardship,” known as the Brunner test, is notoriously high. The report encourages judges to revisit that standard.
The Brunner test as it’s currently interpreted by most jurisdictions that use it, requires borrowers prove they can’t maintain a minimal standard of living if forced to repay their loans, that their circumstances are likely to persist, making it difficult for them to repay the loans in the future — a so-called “certainty of hopelessness” — and that they’ve made a good-faith effort to pay them back.
The report recommends judges instead evaluate whether the borrower could reasonably pay the debt back in contractual term of the loan — typically 10 years — and whether doing so would keep them from meeting basic living expenses, not push them into poverty.
‘This report offers more support for that, taking a fresh look at those two words — literally two words — undue hardship, and how those should be interpreted.’
“There are already courts which are looking at the Brunner test differently than they might be 15 years ago,” said John Rao, an attorney at the National Consumer Law Center and another one of the commissioners. That’s in large part because student debt has become a more ubiquitous and arduous burden than it was when the Brunner test was developed in 1980s. “This report offers more support for that, taking a fresh look at those two words — literally two words — undue hardship, and how those should be interpreted.”
Suggestions for the Department of Education
In addition to providing fodder for judges, the report also provides suggestions for how the Department of Education should treat student loan bankruptcy cases. Last year, the agency sought feedback about when it should fight petitions from borrowers to have their federal student loans discharged in bankruptcy.
The commission report suggests the Department set clear guidelines saying the agency and the companies it works with as part of the federal student loan program won’t oppose a student loan borrower’s efforts to have their loans discharged in bankruptcy if the borrower is eligible for Social Security or Veterans Affairs disability benefits or falls below certain poverty thresholds.
The Department of Education “should just give up in situations that look pretty terrible,” Jiménez said. “It’s just not worth it, it is really squeezing blood from a stone at that point.”
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