Navigating Undue Hardship in Student Loan Bankruptcy: Requirements and Recent Guidance

Student loan debt can be a significant burden, and for some, it becomes insurmountable. Bankruptcy offers a potential avenue for relief, but discharging student loans through bankruptcy requires proving "undue hardship," a complex and often misunderstood concept. This article explores the requirements for demonstrating undue hardship in student loan bankruptcy cases, incorporating recent guidance from the Department of Justice and Department of Education.

The Challenge of "Undue Hardship"

Federal law makes it challenging to discharge student loans in bankruptcy. The legal standard for doing so is "undue hardship," but Congress has never defined this term. This lack of a clear definition has led to inconsistent interpretations by courts, making it difficult for borrowers to understand what they need to prove to obtain relief. As a result, courts needed to develop their own definition. The "undue hardship" burden is a standard that has generally been granted only in exceptional circumstances.

Establishing Undue Hardship: A Multi-Step Process

Discharging student loans through bankruptcy is a multi-step process that requires careful preparation and legal navigation.

Step 1: Filing for Bankruptcy

The first step is to file for bankruptcy under either Chapter 7 or Chapter 13 of the Bankruptcy Code. Most borrowers will file Chapter 7 bankruptcy or Chapter 13 bankruptcy.

Step 2: Gathering Evidence

After filing for bankruptcy, borrowers must gather evidence to support their claim of undue hardship. You’re not required to try to cancel your loans before your bankruptcy case ends. You can file the paperwork after you get your bankruptcy discharge. So take your time and gather all the available evidence to prove you have an undue hardship to the court.

Step 3: Filing an Adversary Proceeding

To formally request a discharge of student loans based on undue hardship, borrowers must file an adversary proceeding (AP) within their bankruptcy case. You have to take special steps in the bankruptcy case to ask the judge to discharge your student loans, including most private student loans. This is done by filing a petition for an adversary proceeding. The AP consists of the complaint and an adversary cover sheet. You’ll file both documents with the court.

Step 4: Litigating the Case

The adversary proceeding initiates a legal battle where the lender or student loan servicer can challenge the borrower's claim of undue hardship. The fight truly begins after the attorney for the lender or student loan servicer responds to the lawsuit. Over the next several weeks and months, you’ll exchange discovery, make court appearances, file motions, assess the merits of the case, and, possibly, have a trial.

Tests for Determining Undue Hardship

Since lawmakers never defined what debtors had to do to prove their financial hardship was undue, federal courts have spent years struggling to do it themselves using different tests. Ultimately, what qualifies as undue hardship for student loans shifts depending on the judge your case is in front of, your financial situation, and the efforts you’ve made to repay your loans before seeking debt relief in bankruptcy.

The Brunner Test

The Brunner test, established in Brunner v. New York State Higher Education Services Corp., is the most widely used standard for determining undue hardship. To stop debtors from rushing to bankruptcy court soon after graduating to wipe away their student debt, the court laid out a three-pronged test to gauge a borrower’s hardship. Under this test, a borrower must demonstrate:

That the borrower cannot maintain a minimal standard of living if forced to repay the student loans, based on current income and expenses.
That the borrower's financial situation is likely to persist for a significant portion of the repayment period.
That the borrower has made good faith efforts to repay the loans. Good Faith Effort to Repay: have you made good faith efforts to repay your student loans before filing for bankruptcy? For more information, see our page on discharging loans in bankruptcy.

The Totality of the Circumstances Test

A handful of other courts, mainly in the Eighth Circuit, found the Brunner Test too restrictive and instead adopted the more flexible totality-of-the-circumstances test. This test considers a range of factors related to the borrower's financial situation, including income, expenses, debts, and family circumstances, to determine whether repayment would impose an undue hardship.

Factors Considered in Undue Hardship Analysis

Several factors are typically considered when evaluating a borrower's claim of undue hardship, regardless of the specific test used by the court:

Income and Expenses: The court will assess the borrower's current income and necessary expenses to determine whether repayment of the student loans would leave the borrower with sufficient funds to maintain a minimal standard of living.
Employment History and Potential: The court may consider the borrower's employment history, skills, and potential for future earnings. The Guidance directs AUSAs to evaluate whether the borrower has taken an action that demonstrates good faith. The good faith inquiry should not disqualify borrowers who may not have meaningfully engaged with the repayment process due to possible misinformation, wrongful income driven repayment plan (IDR) determinations, or a lack of adequate information or guidance.
Family Circumstances: The borrower's family circumstances, such as the number of dependents and any extraordinary medical expenses, may be taken into account.
Health Issues: Significant health problems or disabilities can impact a borrower's ability to work and repay student loans.
Good Faith Efforts to Repay: The court will examine whether the borrower has made a good faith effort to repay the loans, such as exploring income-driven repayment plans or seeking deferment or forbearance.
Education and Skills: The court may consider the type of academic program in which the loan was incurred.

The Department of Justice Guidance

The Department of Justice, in coordination with Education, released new Guidance for Assistant United States Attorneys (AUSAs) defending adversary proceedings where borrowers are seeking to discharge student loan debt held by Education. In an effort to ameliorate the “historically low probability of success and … the mistaken belief that student loans are ineligible for discharge,” the Biden administration’s directive outlines a new test, and directs attorneys for the Department of Education and Department of Justice to recommend partial or full discharge where: the debtor presently lacks an ability to repay the loans; the debtor’s inability to pay the loan is likely to persist in the future; and the debtor has acted in good faith in the past in attempting to repay his or her student loans (notably absent from this guidance is the consideration of whether a debtor is optimizing earning potential).

This Guidance was the product of careful legal analysis, decades of bankruptcy litigation experience, and a recognition that there are likely more borrowers eligible for an undue hardship discharge in bankruptcy than currently seek one. Some borrowers have been deterred from seeking discharge of student loans in bankruptcy due to the historically low probability of success and mistakenly believing that student loans are ineligible for discharge. In clarifying through this letter that holders (other than the Department) may fulfill their regulatory obligations by following the analysis and process outlined in the November 2022 Guidance, Education seeks to allow parity and consistency in the undue hardship analysis across loan holders. To reduce borrowers’ burdens in pursuing an adversary proceeding by simplifying the fact-gathering process.

The November 2022 Guidance identifies specific, objective criteria that may be used to evaluate claims of undue hardship. The Guidance explains that consideration of student loan debt discharge requires an evaluation of a borrower’s past, present, and future financial circumstances, and is intended to apply in jurisdictions that follow either the Brunner test, see Brunner v. New York State Higher Education Services Corp., 831 F.2d 395 (2d Cir. 1987), or a “totality of circumstances” test, see, e.g., In re Long, 322 F.3d 549 (8th Cir. 2003), to determine undue hardship.

Minimal Standard of Living: The first factor in the discharge analysis under the Guidance seeks to determine whether the borrower can presently maintain “a minimal standard of living” while making student loan payments. To address this factor, the Guidance directs AUSAs to use the IRS Standards to determine the borrower’s “allowable” expenses and compare those allowable expenses to the borrower’s income. If the borrower’s allowable expenses exceed their gross income, this element of the analysis is satisfied. In addition to the IRS Standard expenses, the Guidance allows borrowers to identify circumstances in which their actual expenditures fall below the expenses required to maintain a minimal standard of living and to project the expenses they would incur if able to address needs that are currently unmet or insufficiently provided for.
Persistence of Inability to Repay: The second factor in the analysis is whether the borrower’s current inability to repay the debt while maintaining a minimal standard of living will likely persist for a significant portion of the repayment period. The Guidance directs AUSAs to rely on certain facts that create a presumption that this factor is satisfied. While these presumptions are rebuttable, we expect that to be uncommon and only based on concrete factual circumstances.
Good Faith: The third factor for discharge is whether a borrower has demonstrated good faith regarding the repayment of student loan debt. This analysis depends upon the borrower’s actions relative to their loan obligation. Good faith may be demonstrated in numerous ways, and the good faith inquiry “should not be used as a means for courts” or AUSAs “to impose their own values on a debtor’s life choices.” The Guidance directs AUSAs to evaluate whether the borrower has taken an action that demonstrates good faith. Studies have shown that the servicing of student loan debt has been plagued at times by administrative errors and the dissemination of confusing and inaccurate information, and that these issues may have affected borrowers’ responses to their loan obligations.

Documentation of Undue Hardship

To meet the goals discussed above, the Department of Justice in coordination with Education developed both legal guidance and an attestation form to gather key information from debtors outside the formal discovery process in the adversary proceeding. To assist the holder in evaluating a borrower’s past, present, and future financial circumstances, a borrower should typically be asked to provide relevant information using the form attestation included with the November 2022 Guidance. In most cases, that form should elicit sufficient information to determine whether a borrower can demonstrate an undue hardship without formal discovery. If a holder uses a different method, it should nevertheless request information about the borrower’s income and expenses to enable the holder to evaluate the borrower’s present ability to pay and should also seek information that will help the holder evaluate the other two factors.

Provision of Account Information to Borrower

One primary goal of the Guidance is to reduce the need for formal discovery prior to a stipulation. Holders are encouraged to facilitate this goal by providing borrowers and their counsel with all loan servicing and educational records available.

Outcomes of an Adversary Proceeding

After considering the evidence and arguments presented by both sides, the court will make a determination regarding undue hardship. Special Cases: Anything else that makes repayment impossible? The court can reach one of several conclusions:

Full Discharge: The judge determines that repaying the student loans would impose an undue hardship, and the entire loan balance is discharged.
Partial Discharge: The judge decides you can repay some but not all of your loans while maintaining a minimal standard of living.
No Discharge: You fail to pass the undue hardship test and owe the entire loan balance.
Settlement: Your lender agrees to reduce the balance owed on the loans.

Alternatives to Bankruptcy

Bankruptcy should be considered a last resort. There are other options for managing student loan debt, such as:

Income-Driven Repayment (IDR) Plans: Forgiveness. Each IDR plan will cancel your remaining balance after you make at least 240 monthly payments.
Loan Forgiveness Programs: Explore eligibility for federal loan forgiveness programs based on employment or other factors.
Negotiation with Lenders: Contact lenders to discuss options such as reduced interest rates or temporary payment suspensions.

Legislative Efforts for Student Loan Relief

Several legislative proposals have been introduced to reform the student loan bankruptcy process:

Student Borrower Bankruptcy Relief Act of 2019: 2019 - Sen. Dick Durbin (D. Illinois) and Rep. Jerrold Nadler (D. New York) introduced the Student Borrower Bankruptcy Relief Act of 2019. Rep. John Katko (R. Bankruptcy Code to remove the section that treats student loan debt differently from other dischargeable consumer debts.
Medical Bankruptcy Fairness Act of 2021: 2021 - Senate Democrats released the Medical Bankruptcy Fairness Act of 2021, which would allow borrowers to discharge their student loans without having to prove undue hardship.
Fresh Start Through Bankruptcy Act of 2021: 2021 - Sen. Durbin and Sen. John Cornyn (R. Texas) introduced the Fresh Start Through Bankruptcy Act of 2021.

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