Bankruptcy, Law Schools, Student Loans

The Tetzlaff Aftermath: Discharging Student Loans In Bankruptcy Might Be Easier Than We Thought

Columnist Shannon Achimalbe wonders: are potentially eligible people being dissuaded from even trying to discharge their student loans in bankruptcy?

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resume girlA few days ago, the U.S. Supreme Court declined to review the Tetzlaff case. Many will interpret this decision as a nod to the status quo’s high difficulty in discharging student loans in bankruptcy. While I am disappointed with the high court’s decision not to decide, I found that all may not be lost. As I was doing research for my last two articles (here and here), I came across some useful findings which I will share with you today. Specifically, discharging student loan debts through bankruptcy may not be as difficult as it appears to be.

A few years ago, Elie Mystal argued that the hopeless and financially destitute with large student loan debt should seriously consider filing bankruptcy. He cites to a study showing that 40% of filers received some form of discharge from the bankruptcy court. That study was conducted by Jason Iuliano, a Harvard Law graduate and a Ph. D. candidate at Princeton.

Iuliano’s study is worth reading. He reviewed every bankruptcy case involving student loans in 2007. He found that of the 169,774 student loan debtors filing bankruptcy, only 213 filed adversary proceedings, a necessary step to discharge student loans. And of that 213, 51 received full discharges, 30 received partial discharges and 25 received an administrative remedy. In other words, 0.1% of bankruptcy filers even tried to discharge their student loans. And of those who tried, 50% of them received some kind of relief from the court and 25% received a full discharge of their student loans.

Why do so few people attempt to discharge their student loans when they have already started bankruptcy proceedings? Iuliano believes that many eligible people do not try because they do not think they will succeed. This belief comes from many in the media stating that student loans are almost impossible to discharge in bankruptcy. Some have even erroneously stated that student loans cannot be discharged in bankruptcy under any circumstances.

Of course, people love to read about judges denying bankruptcy relief to blind, triple-amputee senior citizens with pancreatic cancer because they didn’t buy the cheaper, generic drugs from Canada. But many writers and experts stress the difficulty of discharging student loan debts in bankruptcy in order to encourage students to borrow as little as possible and to show the consequences of borrowing excessively.

Some have even talked to bankruptcy attorneys who declined their case. I suspect that many of these attorneys stick with simple Chapter 7 and 13 cases and do not take adversarial cases. And those who do charge large up-front fees due to the amount of work involved and the lenders’ strong likelihood of appealing a bad decision.

All of this appears to have the unintended consequence of dissuading potentially eligible people from even trying to discharge their loans.

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However, there are stories of people who were able to successfully discharge their student loans, although with great difficulty. In In re Walker, in an eloquently written opinion, the court found that the debtor established undue hardship using the totality of the circumstances test because she was able to prove that the student loan payments would prevent her from adequately providing for her children. This case was particularly interesting because the lenders argued that the debtor should not be granted a discharge because she had too many children.

Perhaps those with large student loan debts should be encouraged to seriously consider filing bankruptcy. Does this mean that one should file hoping to be one of the 50% that get partial discharge or the 25% that get full discharge? Of course not. But there are steps people can take to maximize their chances of negotiating down their debt through bankruptcy or otherwise.

First, try to hire an attorney, but don’t be afraid to negotiate or go to bankruptcy court alone if you have to. Iuliano states that debtors not represented by an attorney are just as successful as those who are represented by an attorney. However, hiring a competent attorney (even on a limited-scope basis) can make the process quicker and easier.

Second, research case law in your circuit to determine whether your current life circumstances and future outlook would meet the Brunner and the totality of the circumstances tests. You may have to trade in your luxury car for a used Toyota Corolla. If the thought of downgrading your lifestyle bothers you, then bankruptcy may not be for you.

Third, try to negotiate with the lender before filing bankruptcy. The Department of Education recently issued guidance as to when student loan servicers should not contest a debtor’s claim of undue hardship in bankruptcy. However, the letter also states that the servicers’ decisions are subject to audit and not following the guidelines will result in denial of claim payments to the servicer. So it is safe to say that servicers will contest any claim of undue hardship except for the most extreme.

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Finally, if you decide to file bankruptcy, expect a long, invasive, and contentious fight. You will be questioned about every purchase you made. You will be criticized not only for lavish spending but also for things normal people do, like saving for retirement, having cable TV, and shopping at Macy’s instead of Walmart. You may have to argue before an unsympathetic judge. Finally, if a bankruptcy judge grants an undue hardship discharge, expect multiple appeals.

In the end, bankruptcy is one of several options a debtor has to resolve their debts. While Iuliano’s empirical study suggests that discharging student loans in bankruptcy is not impossibly difficult as people seem to think, the process is time-consuming, expensive, and still risky.

An Empirical Assessment of Student Loan Discharges and the Undue Hardship Standard [SSRN]

Earlier: Are You There, SCOTUS? It’s Me, Tetzlaff. Why The U.S. Supreme Court Should Resolve The Student Loan Bankruptcy Conflict
Are You There, SCOTUS? It’s Me, Tetzlaff. The Harsh Bankruptcy Discharge Rules Are Not Protecting The Integrity Of The Federal Student Loan Program
Can You Show ‘Undue Hardship’ On Your Student Loans? You May Be Surprised.

Shannon Achimalbe was a former solo practitioner for five years before deciding to sell out and get back on the corporate ladder. Shannon can be reached by email at sachimalbe@excite.com and via Twitter: @ShanonAchimalbe.

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