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Discharging Student Loans in Bankruptcy

March 11, 2011

Beginning in the 1970’s, many college graduates chose to discharge their student loan debt immediately after graduation. As a result, Congress tightened the restrictions on discharging government-backed student loan debt, and by 1998 federal student loans were not dischargeable except under circumstances of undue hardship. Today the standard is whether repayment of the student loan “would impose an undue hardship on the debtor and the debtor’s dependents.”

“Undue hardship” seems like an easy hurdle to clear. If you are broke, the choice may be buying food or paying on the student loan, right? Unfortunately, courts have taken a very narrow and hard-line approach in construing the undue hardship standard. Consequently, it is very difficult to discharge student loans in bankruptcy. A good example of this is found in the recent case of Wallace v. Educational Credit Management Corp., 2010 WL 5764771 (Bky.S.D. Ohio Dec. 1, 2010).

The bankruptcy debtor in Wallace graduated with bachelor’s degree in sociology and over $30,000 in student loan debt. Wallace was able to work one year making a little over $12,000 before being forced to quit working due to complications from diabetes. Over the next few years he lost one eye, and had a kidney and pancreas removed. By 2008, he was legally blind and receiving $811 each month in social security disability. His monthly expenses were determined to be $790.

Wallace and his attorney filed an adversary case in the bankruptcy court seeking to discharge the student loan debt under the undue hardship standard. The Bankruptcy Court for the Southern District of Ohio looked at three factors (known as the Brunner test) in reaching its decision:

1. whether Wallace could maintain a “minimal” standard of living if forced to repay the student loan debt;
2. whether additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the student loan repayment period; and
3. whether Wallace made a good faith effort to repay the student loans.

The Ohio Bankruptcy Court decided that while the first prong of the Brunner test was met, Wallace “failed to demonstrate that his state of affairs is likely to persist for a significant portion of the repayment period of the Loan.” The Bankruptcy Court ordered Wallace to pay $20 per month, but stayed final judgment on the issue until 2012 and would review the case. In a bit of ironic prose, the court stated that “It remains to be seen into which group Wallace will land, whether he will find work or remain unemployed.”

As you can see from the Wallace case, student loans are very difficult to discharge. If you believe you can meet the undue hardship test, discuss your with an experienced bankruptcy attorney. While not impossible, discharging student loans is a very high bar to clear.


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