Dept. of Ed.: Undue Hardship = Certainty of Hopelessness or Total Incapacity

The federal government through the Department of Education has entered the fray over what constitutes a hardship sufficient to discharge student loans in bankruptcy.  In an amicus brief filed in support of student loan creditor, ECMC, the government argues that student loans may be discharged only when the debtor’s situation evidences a “certainty of hopelessness.”  Murphy v. U.S. Dept. of Educ., No. 14-1691 (1st Cir. filed July 29, 2015).  Citing a Fifth Circuit decision, DOE suggests that debtors “must specifically prove total incapacity in the future to repay debt for reasons not within his control.” In calling for a standard that requires total incapacity or a certainty of hopelessness, the government’s position is more extreme than that taken by some of the circuit courts of appeal.

The debtor, Mr. Murphy, seeks to discharge almost $250,000 in PLUS loans that he took out to help finance his children’s education between 2001 to 2007.  According to DOE, PLUS loans such as Mr. Murphy’s can be quite large, but are made and guaranteed by the federal government without regard to the borrower’s ability to repay the debt.  Both the bankruptcy court and district court held that Mr. Murphy’s student loan debt was non-dischargeable based on the totality of the circumstances test.

In its amicus, the government argues that the court should apply the more stringent Brunner test, first established by the Second Circuit in 1987.  That three-prong test was adopted at a time when student loans were automatically dischargeable in bankruptcy, without proving undue hardship if debtors simply waited five years after their loans first became due.  Despite significant changes in the nature of student loan debt, in student loan programs, and the Bankruptcy Code, DOE urged the First Circuit to adopt the antiquated Brunner test. The government also argued that the availability of income-based repayment plans, which allow certain borrowers to reduce their payments based on their income, precluded a finding of undue hardship.

The Department of Education’s position that only debtors whose future is “hopeless” are entitled to discharge of their student loan debt is inconsistent with Congressional intent and the purpose of the Bankruptcy Code.  Contrary to the government’s argument, there is no indication that Congress intended student loans to be a permanent financial yoke for students and their parents.  Nor did it indicate any intent to repeal the bankruptcy undue hardship provision when it enacted income-based repayment programs. The government’s claim that such a strict standard is necessary to protect the financial integrity of the student loan program also falls short because the vast majority of funds that might be discharged in bankruptcy would not be paid back even under income-based repayment programs.  Consequently, the First Circuit should adopt a standard for undue hardship under that would be satisfied “if repayment of the student loan would prevent the debtor from satisfying ordinary and necessary living expenses so that debtor could not effectively ‘make ends meet.’”

The National Consumer Law Center and the National Association of Consumer Bankruptcy Attorneys filed an amicus brief  supporting the debtor and a more reasonable standard for determining undue hardship.