Student Debt Discharge in Bankruptcy
posted by Gerard Magliocca
I have a question for all of you bankruptcy lawyers who read CoOp. Is there a principled reason for the rule that student debt is generally not dischargeable in personal bankruptcy? Or is the only real defense of this rule that “lenders lobbied Congress successfully on this one?”
May 29, 2012 at 6:06 pm
Posted in: Bankruptcy
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Responses (11)
Rob Pfister - May 29, 2012 at 7:08 pm
No principled reason whatsoever. The rule began with a defensible rationale: Allegedly, professionals (such as doctors and lawyers) were graduating from professional schools with lots of debt, and would then immediately file bankruptcy (before they had any income) to wipe the slate clean. So as originally enacted, the ban was limited — I believe 5 years. (That is, for the first five years after graduation, you could only discharge federal student loans by showing an “undue hardship.”) But then the lenders got ahold of the law, and the 5-year ban was extended to forever, and the federal student loan part was expanded to cover even private student loans. (The latter expansion may be defensible; the former is not.)
The worst, however, is the persistence of the “undue hardship” test. Courts began interpreting it when the ban was for a limited period of time, so of course it was difficult to establish an undue hardship that meant you should be able to discharge just-incurred student debt. The case law was strict. But now that it’s a lifetime ban on dischargeability, the undue hardship tests persists in the same form. There’s absurd case law basically saying that in order to discharge your student debt, you have to be essentially incapable of gainful employment. (And if you’re incapable of gainful employment, you likely don’t need bankruptcy protection anyway: there are no wages to garnish, so unless you have a wealth of other assets — not typical of most debtors — there’s no reason to file bankruptcy.)
Jon Connington - May 29, 2012 at 7:34 pm
It seems to me that if there is one, it’s most likely to be related to the fact that a degree is a substantial and yet wholly inalienable asset.
Bart Torvik - May 29, 2012 at 9:30 pm
I’m not a bankruptcy lawyer (yet!), but doesn’t the rule encourage lenders to make loans to students that they otherwise would not by basically eliminating the credit risk? In other words, couldn’t it be part of a pro-education policy, since the credit market for students looking to finance their education costs would be much, much tighter without it—meaning many people would be unable to go to college without it?
Gerard Magliocca - May 29, 2012 at 9:31 pm
Or it encourages reckless lending. Hard to say.
Frank - May 29, 2012 at 9:41 pm
The timeline here is really good (scroll down a bit):
http://rortybomb.wordpress.com/2011/11/07/two-steps-towards-tackling-our-current-student-loan-problems/
Rather alarming to see the 2005 development, which I think is entirely a product of capture. That’s not to defend any of the prior developments.
Shag from Brookline - May 30, 2012 at 7:41 am
I’ve been trying to get an “insider” (now retired) who was actively involved on a congressional staff (MA-Dem) back then to open up but to no avail as yet. I’ll have to feed him more than a few “Cape-Codders” to loosen his tongue. (I think the MA congressional delegation, mostly if not all Democrats, was influential in passing this.)
Consider how this may be a modern form of “debtor’s prison” via economic incarceration.
Bart Torvik - May 30, 2012 at 11:47 am
Obviously the policy encourages riskier, even reckless loans, and maybe the societal costs of those risky loans make it a stupid policy. But hey, you asked for a bona fide policy reason and you got one!
mark - May 30, 2012 at 2:38 pm
It’s an interesting question and partly one of framing. From a purist perspective as to bankruptcy, all of the exceptions are unprincipled. All debts of equal rank should be treated the same, and creditors should receive a pro rata recovery. But hosts of exceptions get made all the time. Tort victims, child support, etc.
Government claims are handled differently and student debt is by and large backstopped in a way to make it a government claim. Taxes are in the main not dischargeable for instance. Historically, the government had a priority claim against debtors, and the statute is still on the books, but it has been interpreted not to apply in bankruptcies because the bankruptcy code has a priority section of its own.
But it is always worth reminding the purists that bankruptcy is itself an exception to a general rule that contracts are intended to be honored, breaches are intended to be compensated, and debts are to be repaid. So in that sense every exception to the bankruptcy law merely brings it more in harmony with that general principle.
mark - May 30, 2012 at 3:01 pm
A further point is that to the extent you make SL debt dischargeable, you structure a perverse subsidy, whereby the more economically productive a student makes himself or herself, the more burden s/he carries. while the less economically productive student gets to leave with a light burden. Taking into account the hedonic aspects of college, there is a perverse incentive against striving to become economically productive at graduation. Which in turn means, since the proceeds of a SL are just paid over to the university, that the system would be subsidizing the university to send less economically productive graduates out into the world which I at least think is the opposite of what the society at large needs.
The real answer to the SL problem is not to step in after the borrowing but to reduce borrowing at the outset by 1) having much more disclosure about job and earnings attainment at each school by major, 2)restructuring higher education to enable much faster and cheaper matriculation and attainment of the encessary credential, and 3) creating alternatives like apprecenticeships.
p.d. - May 31, 2012 at 12:27 am
It would probably go a long way toward solving our education problems if we made loans dischargeable and let banks turn students down if their prospects of repayment are dim. Better to push unqualified students into trade schools than perpetuate the myth that college is for everyone. Subjecting bright-eyed 18 year olds to market incentives would push things in the right direction.
Shag from Brookline - May 31, 2012 at 6:44 am
But Kaplan and other for-profit schools are also involved with student loans, such that:
“Better to push unqualified students into trade schools than perpetuate the myth that college is for everyone.”
may benefit their trade schools.
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