May 23, 2022

Volume XII, Number 143

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May 20, 2022

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Student Loans: Nondischargeability Questioned in Seventh Circuit and Beyond

Conventional wisdom says that it is nearly impossible to obtain a discharge of student loan debt in bankruptcy. Indeed, Section 523(a)(8) expressly excepts student loans from discharge, unless the exception of such indebtedness from discharge would impose an undue hardship upon the debtor. But two recent developments may signal that this bedrock principle is eroding – i.e., (i) the Seventh Circuit's affirmance of a bankruptcy court's ruling that an impoverished but otherwise healthy woman's student loan debts were dischargeable, and (ii) the recent introduction of a Congressional bill that would make it easier to discharge privately issued student loan debt.

Seventh Circuit's Decision Allowing Dischargeability

In Krieger v. Educ. Credit Mgmt. Corp., 2013 U.S. App. LEXIS 7202 (7th Cir. Apr. 10, 2013), the court of appeals examined the facts and circumstances related to a $25,000 student loan obligation owed by Ms. Krieger, a 53-year-old woman, and concluded that the bankruptcy court did not err when it determined that Krieger qualified for a hardship discharge of her student loan.

In arriving at its conclusion, the court of appeals explained that Ms. Krieger "is essentially out of the money economy and living a rural, subsistence life[,]" and her circumstances were unlikely to change at any point in the future.

While the majority opinion did not explicitly state that its decision should be of limited applicability because of Ms. Krieger's unusually dire straits, a concurring opinion did exactly that, suggesting that she should have instead been required to participate in the William D. Ford Income-Based Repayment Plan. Under such plan, a debtor is required to pay 15% of his or her discretionary income every month, with the debt being discharged after 25 years.

House Bill Proposes Different Treatment for Private Student Loans

A House bill introduced on February 6, 2013 proposes to amend the Bankruptcy Code to treat private student loan debt the same as any other debt, meaning it would be dischargeable in bankruptcy without the debtor having to prove undue hardship. The bill, H.R. 532, would not affect federal direct loans. Although this bill has previously failed four times, the recent increased focus on student loan debt may give it a better chance of being enacted this time around.

Conclusion

While it has traditionally been exceedingly difficult for a debtor to obtain a discharge of his or her student loan debts, the above developments could portend major shifts in the way bankruptcy courts treat student loan debt in the future. According to a report by the Consumer Financial Protection Bureau, there is approximately $1 trillion in student loan debt in the United States, $150 billion of which has been privately funded, thereby suggesting that this possible shift in the treatment of student loans may have tremendous significance for the lending community. Accordingly, we urge lenders to stay abreast of these developments and begin to factor how these developments might affect their future lending practices and existing student loan portfolios.

Copyright © 2022, Sheppard Mullin Richter & Hampton LLP.National Law Review, Volume III, Number 116
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Lenders must deal with problem credits, manufacturers must deal with insolvent customers and suppliers and businesses of all types must structure their relationships to mitigate the consequences of a bankruptcy. Financial distress also provides acquisition opportunities for those in a position to capitalize on them. Reflecting the reality of business, the Bankruptcy and Restructuring practice of Sheppard Mullin has been a key element of the firm's practice since its founding. We have the resources to respond to the time sensitivity of financial crises and the depth to...

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