A respite, however brief, can be refreshing, but the hope is always for more lasting change. For student loan borrowers, the hope has been for COVID-19 loan forbearance to lead to loan forgiveness. Such sweeping action doesn’t appear likely soon. But, there is an alternative that would be more targeted to the neediest borrowers and be more palatable to conservatives in Congress: making bankruptcy discharge more accessible for student loan borrowers. The courts have only inched slowly in this direction, but Congress may accelerate reform. The current Congressional proposal takes a long-term view that may be less disruptive to the credit market than many feared might occur with sudden changes to dischargeability standards.
COVID-19 Relief Is Coming to An End
President Biden recently extended his Executive Order pausing federal student loan payments until January 31, 2022. With this extension, President Biden signaled the need to continue to grant payment relief during the ongoing COVID-19 pandemic for millions of individuals — one in six adults and one in three young adults — saddled with an estimated $1.6 trillion dollars of student loan debt (over 90% of the total).
But the program, after all, was intended to be temporary and this extension is no exception. President Biden made clear in his recent announcement that this extension would be the final extension. Absent a change in the administration’s posture, which does not seem likely, individuals with federal student loan debt will be required to begin making payments again on February 1, 2022.
In keeping with the President Biden’s recognition that continued payment relief is warranted, U.S. Secretary of Education Miguel Cardona recently expanded the Public Service Loan Forgiveness (PSLF) program to include members of the clergy and other student-loan borrowers engaged in religious-oriented work in accordance with the U.S. Supreme Court’s decision in Trinity Lutheran Church of Columbia, Inc. v. Comer (where it was held a state program’s denial of a grant to a religious school for playground resurfacing, while providing grants to similarly situated non-religious groups, violated the freedom of religion guaranteed by the First Amendment to the United States Constitution. In addition, President Biden recently enacted automatic loan forgiveness for 323,000 student loan borrowers who have a total and permanent disability — the single largest student loan cancellation of his presidency.
Discharge in Bankruptcy
The Supreme Court and the Second Circuit have recently taken actions that impact efforts by individuals seeking to address their student loan debt burden through discharge in bankruptcy. These actions demonstrate the continued uphill climb for student loan borrowers who seek a fresh start through bankruptcy.
Specifically, the Supreme Court declined to review McCoy v. United States and Conti v. Arrowood Indemnity Company. Both cases involved appeals of student loan discharge denials. In doing so, the Court decided not to resolve circuit splits having to do with the “undue hardship” standard in section 523(a)(8) of the Bankruptcy Code (“Code”) — with some circuits applying the rigid Brunner Test which requires a showing of “total incapacity” to discharge student loans and other circuits requiring a “totality of the circumstances” standard.
To further complicate attempts by borrowers to leverage the Code for discharge, the Second Circuit in Homaidan v. Sallie Mae, Inc., et al. recently avoided analyzing the “undue hardship” standard by determining that a borrower’s private student loans were dischargeable in bankruptcy because the debtor could prove that the loans did not constitute an “educational benefit” within the meaning of the Code. Though the ruling is aligned with similar decisions in other jurisdictions, the holding is narrow and applies only to certain private student loans.
Congress May Actually Act
Senators Durbin and Cornyn recently proposed a bill to allow for discharge of federal student loans after a 10-year waiting period and to maintain the undue hardship rule for loans that are less than ten years old or for private student loans. The bill would also require certain colleges to partially reimburse the government if the loan gets discharged. The bill is said to have bipartisan support given its more targeted impact relative to loan forgiveness. By reserving the relief for those who have honored their obligations for 10 years, the bill alleviates concerns that lowering the standard for discharge would lead borrowers to de-prioritize payments and increase the likelihood of default.
But the potential still exists for more dramatic changes. The American Bar Association just announced its intention to lobby Congress to amend the Bankruptcy Code to eliminate the undue hardship requirement.
Although the approaches may differ, it appears we are starting to see some momentum in the area of bankruptcy reform.
Looking Ahead
As discussed in a recent Credit Chronometer post, the legal and political winds relating to student loan forgiveness may have a significant impact in the credit market. With President Biden declaring next January as the end of payment relief for student loans and with the federal courts appearing to “kick the can down the road” on the Brunner Test, it appears that borrowers’ last best hope is Congress.
Expecting Congress to pass the latest relief bill may truly be the triumph of hope over experience. In the meantime, loan servicers should be prepared for next February when borrowers will be forced to begin making payments on their student loans. The Consumer Financial Protection Bureau (CFPB) has been paying close to attention to servicers and how they have handled the end of mortgage forbearance programs. Expect similar treatment from the CFPB and Department of Education working in tandem when the student loan payment tap is turned on again.
Co-authored by Derick D. Dailey, a former federal prosecutor and litigation associate at Davis+Gilbert.
