No, getting real does not mean a politician’s grand plans, no matter how close they may get to office. Nor wiping out all student debt and paying for it with a tax on “Wall Street” – which did not create the problem and would, ultimately, impact American’s stock-filled retirement plans – is not a realistic solution either. Beyond fairness and reason, real plans require legal grounding and the support of the courts. So, the markets should take notice that U.S. bankruptcy courts are signaling they may be ready to turn the tide in favor of borrowers.
Death, Taxes and Nondischargeability
As we’ve discussed, student loans carry a reputation for inevitability on par with death and taxes. This has not been too much of an exaggeration. In order to discharge a student loan in bankruptcy – the relief available for most consumer debts – a borrower must show that being required to repay the loan would cause them “undue hardship.” Most courts apply that standard using a stringent, fact-specific analysis called the Brunner test, which requires petitioners to prove that they:
- Cannot maintain a minimum standard of living;
- Won’t be able to do so for much of the repayment period; and
- Made a “good-faith effort” to repay the loans (e.g., by getting a job and/or minimizing expenses).
Given the difficulty of overcoming the Brunner test, borrowers have tried, without much success, to nibble around the edges of the language of the Bankruptcy Code. In 2017, we described how technical arguments for relief from student debt, based on the definition of a “qualified education loan” and other defined terms, had gained some traction in the courts. Still, the Brunner test has appeared a daunting obstacle to bankruptcy relief.
Judicial Interpretation Could Change with the Times
Recently, reports of a Navy veteran successfully showing “undue hardship” and obtaining discharge of $220,000 in student loans has borrowers wondering if the Brunner test is no longer insurmountable in the current environment. While it’s unclear how the particular debtor’s veteran status and situation may have tipped the analysis, it should be viewed as more than just an anomaly given the high-level of attention and reporting on the student loan debt level and impact on consumers and the economy.
To those who think it’s wrong for judges’ outcomes to be swayed by the news, keep in mind that bankruptcy courts are courts of equity and though their decisions must be grounded in the law, judges are afforded discretion in its interpretation. In the end, bankruptcy judges are both of this world and in this world, and for them to not be influenced by the environment may be asking the impossible.
The same court that granted discharge to the Navy veteran recently issued rules governing mediation of student loan disputes, including nondischargeability of student debt. The process will likely give borrowers a greater voice in dealing with servicers and lenders and a forum to air grievances that could influence outcomes. Other courts may follow suit.
Change may come slow as court decisions come down incrementally and new processes take effect, but a change in momentum is already here. And it’s based on the law and judicial activity and should start to be recognized by the credit markets.