Op-Ed Review / Massachusetts Lawers Weekly
The recent decision of Bankruptcy Judge Joan Feeney in the matter of Liberty Bay Credit Union v. Belforte underscores the on-going debate surrounding the issue of the exemption from discharge in bankruptcy of student loans that is permitted by the United States Bankruptcy Code.
In the Belforte decision, Judge Feeney held that the increase of an existing unsecured personal line of credit based on the debtor’s handwritten request to the lender credit union for additional funds “for tuition and books” for the debtor’s children, constituted “an obligation to repay funds received as an educational benefit” under section 523(a)(8)(A)(ii) of the Bankruptcy Code, and therefore could not be discharged in bankruptcy. That section is one of three categories of student loans under Section 523(a)(8) that are excepted from discharge, including: (1) loans made, insured or guaranteed by a governmental unit, or made under a program funded in whole or in part by a governmental unit or nonprofit institution; (2) a loan received as an educational benefit, scholarship or stipend; and (3) a qualified educational loan under the Internal Revenue Code.
Consequently, student loans receive the same treatment in bankruptcy as do debts such as those obtained as the result of fraud, larceny, domestic support obligations, certain taxes, and death or personal injury caused by the operation of a motor vehicle while under the influence, to name only a few examples of the kind of debts that cannot be discharged under the Bankruptcy Code.
To fully appreciate the significance of Judge Feeney’s decision, and the focus that it provides to the debate between lenders and consumer advocates surrounding the student loan discharge issue, a brief review of the economic context and legislative history of this controversial topic is instructive.
According to a report prepared for the National Association of Consumer Bankruptcy Attorneys (NACBA), Americans owe more on student loans than on credit cards. Student loan debt, both private and Federally-funded, is expected to reach $1 trillion this year. By contrast, unsecured credit card debt in 2012 is expected to cap in the vicinity of approximately $870 billion, down from $886 billion in 2009. Yet unsecured debt is dischargeable in consumer bankruptcies. With few exceptions, student debt is not.
Prior to 1976, student loans were dischargeable. With the enactment of the U.S. Bankruptcy Code in 1978, private student loans made by non-profit institutions of higher education were excepted from discharge, the apparent intention of Congress being to protect the national Defense Student Loan Program. An amendment to the Bankruptcy Code in 1984 struck the phrase “of higher education”, effectively exempting private loans made by all non-profits from discharge in bankruptcy. The most recent amendment to the Code, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), expanded the definition of student loans to include “an obligation to repay funds received as an educational benefit, scholarship or stipend”, as set forth in Section 523(a)(8)(A)(ii). By separating that phrase from the “governmental or non-profit” component contained in 523(a)(8)(A)(i), Congress made it crystal clear that student loans made by private lenders were also non-dischargeable.
The only meaningful basis for discharging student loans in a consumer bankruptcy case is by convincing the court that the loan causes an “undue hardship” on the debtor. But the legal standard for such a showing is stiff, and there is no statutory definition of “undue hardship”. And, of course, the issue of discharge must be litigated. As one might expect, the litigation costs associated with proving “undue hardship” can often be more than a bankrupt debtor can afford in the face of a well-funded lender’s aggressive prosecution of its objection to discharge. Also, federal student loan programs offer a variety of repayment plans to ease the pain of defaulting borrowers, and the Department of Education has proposed a new set of rules to “help `disabled` borrowers receive forgiveness on their student loans” under the Federal Perkins Loan program, the Federal Family Education Loan program, and the William D. Ford Federal Direct Loan program. Statistically, of the 179,958 loans outstanding under those programs, there were 78,390 disability applications
Thus, the groundwork for the debate. Private lenders contend that changing the Bankruptcy Code to eliminate the student loan discharge exemption will simply drive up interest rates by increasing the risk of loss. Allowing borrowers to file bankruptcy and walk away from their debt will leave future recipients with more expensive loans, higher tuitions, and fewer loan opportunities. Moreover, they argue, the real “institutional” villains are the schools, colleges and universities driving up the excessively high cost of education in America.
On the other hand, proponents advocating changing the Bankruptcy Code believe that the huge national student loan debt is a major concern. NACBA has called on Congress to pass legislation permitting the discharge of student loans in the same way that unsecured credit card is dischargeable. Illinois Senator Dick Durbin has been a leading advocate for the bankruptcy discharge of student loans, having introduced similar, albeit unsuccessful, bills over the past several years. In a recent study on the topic published by Mark Kantrowitz, publisher of Fastweb.com and FinAid.org, Mr. Kantrowitz submits that “the exception to discharge of federal and private student loans should be repealed to enable financially distressed borrowers to obtain a clean slate”, and goes on to suggest that “…bankruptcy discharge…will force lenders to offer more options for meaningful financial relief…and adopt more rational credit underwriting criteria that will prevent borrowers from graduating with excessive debt.”
The debate between lenders and consumer advocates swirls on. In the meantime, a generation of young Americans enters the workforce carrying an unprecedented level of debt, and bankruptcy courts have little leeway in relieving that burden, as was the case in Judge Feeney’s well-reasoned, articulate and appropriate decision in the Belforte case. Clearly, the responsibility for finding some resolution rests on the shoulders of Congress.