When it was enacted in 2007 via the College Cost Reduction Act, the Income-Based Repayment (IBR) plan for those taking out federally backed student loans was probably not intended to serve as a protracted, bureaucratic, chapter 13 bankruptcy repayment plan for people who could not possibly repay their student loans in 25 (now 20) years.
However, given how much student loan debt the government allows people—especially law students to take on—it’s unsurprising that when student loan debtors seek bankruptcy protection, creditors try to enforce repayment by compelling debtors to sign onto IBR. Fortunately for law school debtors, a pair of bankruptcy cases that went, respectively, to the U.S. Court of Appeals for the Seventh Circuit and the U.S. Court of Appeals for the Ninth Circuit resulted in discharge of the debtors’ student loans despite the creditors’ arguments that they should have enrolled in IBR. The implication for law school debtors is that bankruptcy discharge may be an option in some cases even if IBR is available to them.
At issue in both cases was whether the debtors were able to prove that excluding their student loans from discharge would "impose an undue hardship on the debtor and the debtor’s dependents." 11 U.S.C. ß 523(a)(8) ( 2012). Congress inserted this language into the bankruptcy code in the 1970s because of unsubstantiated fears of student debtors entering high-paying jobs in law or medicine and then abusively discharging their debts nonetheless. At the time, Congress placed a five-year limit on the "undue hardship" exception, which it stretched to seven years in 1991 and eliminated altogether with the Higher Education Amendments Act of 1998.
As a result of these legislative changes, what exactly constitutes an "undue hardship" is not explicitly defined. Rising to the task, the federal courts have crafted a handful of tests for determining whether a debtor’s situation merits such a discharge, which in practice means debtors throwing themselves on the mercy of bankruptcy judges, and in these two cases, bankruptcy appellate panels, federal district court judges, and even circuit court judges. The statute’s vagueness is one reason so few people file adversary proceedings to challenge their student loans in their bankruptcies.
The most common test the federal circuits use is the three-pronged Brunner test, named for a case decided by the Second Circuit in 1987. Brunner v. N.Y. State Higher Educ. Servs., 831 F.2d 395, 396. The Seventh Circuit adopted its own version in In re Roberson, 999 F.2d 1132, 1135 (1993), and the Ninth Circuit did so as well in United Student Aids Fund v. Pena, 155 F.3d 1108, 1111–12 (1998). Under the Brunner test, a debtor must show that:
(1) He cannot maintain, based on current income and expenses, a "minimal" standard of living for himself and his dependents if required to repay the loans;
(2) Additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period; and
(3) The debtor has made good faith efforts to repay the loans.
In the two cases recently decided in debtors’ favors, the third prong—the one requiring a "good-faith" effort to repay the loan—became a sticking point for the creditor in both cases, Education Credit Management Corporation (ECMC), which argued that the debtors’ decisions to not sign on to IBR constituted an absence of good faith.
In Krieger v. ECMC, No. 12-3592 (2013), which the Seventh Circuit decided in April, the debtor involved in the case, Susan Krieger, owed ECMC $25,000 for a paralegal certificate she obtained in the early 2000s. Although Krieger won a discharge of her debt in bankruptcy court, a federal district court found that she could have looked harder for work (Brunner’s second prong) and had not acted in good faith because she could have enrolled in IBR and made loan payments of next to nothing for 25 years. In an opinion that pithily opened with "Susan Krieger is destitute," the Seventh Circuit reversed the lower court on both points. Importantly, the appeals court held that requiring a debtor to promise to repay the loan by enrolling in IBR would create a situation in which no federal student loan could be discharged under any circumstances, much less an "undue hardship."
However, in a concurring opinion, which was really more of a concurrence on the judgment than on the reasoning, one member of the three-judge panel that heard the case warned that Krieger’s circumstances were truly exceptional. Because she was not too old to work at 53, in good health, and physically able to work, this judge wrote, debtors in her position should be obligated to enroll in IBR.
A similar situation occurred in Roth v. ECMC, BAP No. AZ-11-1233-RnPaKi (2013). Debtor-appellant Janet Roth owed more than $95,000 to ECMC in the form of federally guaranteed student loans after dropping out of a communications, information technology, and education program. The bankruptcy court found that she met the first two prongs of the Brunner test, but did not satisfy the "good-faith" prong. Although the court did not believe that declining to enroll in IBR indicated a lack of good faith, a bankruptcy appellate panel took a narrower view. In the past the Ninth Circuit had found that declining to sign on to a similar hardship program did not qualify as good faith under the Brunner test, but because Roth was 64 years old, in poor health, unlikely to ever make a payment on the loans, and likely to owe a significant tax penalty when the loan would be canceled in 25 years, her decision to abstain from IBR did not signify a lack of good faith. In a concurrence, one of the judges recommended the Ninth Circuit do away with the Brunner test entirely in favor of a less rigid "totality of the circumstances" test because of the increased restrictions to discharging student loan law in bankruptcy.
So, can law school debtors forgo IBR in favor of bankruptcy discharge? Given the outcome of these two cases, it appears there’s a possibility under the right circumstances. Specifically, younger debtors are unlikely to succeed in discharging their loans, and if they suffer from some kind of disability, they’re probably better off pursuing a hardship discharge by proving they are "totally and permanently disabled" rather than using the bankruptcy courts. Otherwise, IBR looks like their easiest option despite the tax penalty that exists when the loan is canceled in the future.
For older debtors, especially nontraditional law students, and debtors who are not disabled but have little hope of working again in the future, bankruptcy may be available to them instead of IBR. It would probably be an uphill fight against the creditor, however, and as in these two cases, could involve numerous appeals. The implication for older law school debtors is that it might be easier to wait until they are in their sixties and pursue bankruptcy rather than sign on to IBR. Their situations would probably have to be as dire as Susan Krieger’s or Janet Roth’s were, but sometimes destitution is enough to persuade federal judges that discharge is warranted.
Matt Leichter is a writer and attorney licensed in Wisconsin and New York, and he holds a master’s degree in International Affairs from Marquette University. He operates The Law School Tuition Bubble, which archives, chronicles, and analyzes the deteriorating American legal education system. It is also a platform for higher education and student debt reform.