Bankruptcy May Become A Way Out Of Student Loan Debt

While students get breaks on their loans in some ways, filing bankruptcy has never been one of them. But if a federal appellate opinion and action in Congress are any indicators, that could be changing.

Rural and Poor
The 7th U.S. Circuit Court of Appeals on Apr. 10 held that a woman’s student loan debt fell under the “hardship exception” to the general rule that such debt is not dischargeable in bankruptcy. The exception is nothing new; what’s notable about this case is that the court felt comfortable applying the exception in it.

Susan Krieger, 53, is simply poor. Living with her 75-year-old mother in rural Illinois, the household only brings in a couple hundred dollars a month from welfare programs, according to the opinion. Too poor to move, saddled with a broken car, and lacking Internet access, she can’t seek a job.

Krieger got the student loan in order to go to school to become a paralegal, but despite a decade of searching, she hasn’t been able to get a job – doing anything, much less legal work. She used a chunk of a divorce settlement to pay off the student loan but $25,000 was left unpaid.

Certain Hopelessness
The undue hardship exception applies when three conditions are met, according to the opinion:

  • based on her current income and expenses, the debtor wouldn’t be able to maintain a “minimal” standard of living if forced to repay the loan;
  • her situation is likely to persist for a significant portion of the repayment period of the loan; and
  • the debtor has made good faith efforts to repay the loans

Krieger’s facts met the test according to the bankruptcy judge, and the appellate court agreed. The three-part test can be boiled down, said the court, to “certainty of hopelessness,” and Krieger met it. While the opinion didn’t limit its holding to the specific facts of her case, a concurring judge did.

The 7th Circuit’s opinion is important because it shows that the exception can be applied to “a strange set of facts,” and because there are so few published appellate opinions about how the hardship exception works, much less ones in which the debtor wins, says Adam McNeile, a bankruptcy lawyer with Sheppard Mullin in San Francisco.

A Trend Developing
In a recent blog post, McNeile points to the Krieger case and to the introduction of a bill in Congress as two recent developments that “may signal that this bedrock principle is eroding,” referring to the difficulty in getting a student loan discharged in bankruptcy.

The bill in Congress, H.R. 532, would amend the Bankruptcy Code so that private student loan debt is treated the same as any other debt, “meaning it would be dischargeable in bankruptcy without the debtor having to prove undue hardship,” writes McNeile.

Federal student loans – those backed by the government, as opposed to those issued by banks, credit unions and other private lenders – would still be subject to the undue hardship test, making them more difficult to discharge.

“Although this bill has previously failed four times, the recent increased focus on student loan debt may give it a better chance of being enacted this time around,” McNeile tells He notes the noise surrounding the over $1 trillion in outstanding student loan debt that Americans have accumulated.

Private Loan Regulation
“For the past decade, private student loans have been the fastest growing and most profitable part of the student loan industry,” according to a press release from Rep. Steve Cohen of Tennessee, a co-sponsor of the bill. “The interest rates and fees on private loans can be as onerous as credit cards,” with some reaching 15 percent and higher.

“This can place a tremendous burden on student borrowers with private loans and unlike federal student loans, there is no government-imposed loan limit on private loans and no public regulation over the terms and cost of these loans,” said Cohen.

H.R. 532 is currently in the Subcommittee on Regulatory Reform, Commercial And Antitrust Law and has 27 co-sponsors, all Democrats.

McNeile indicates anything could happen. “As more and more borrowers default on their student loan debt, it is likely that we will see cases both similar and dissimilar to that of Ms. Krieger work through the courts,” he says. “Only time will tell how the law related to student loan debts will continue to evolve.”


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