As President Biden’s broad plan to cancel student debt for millions of borrowers faces mounting legal challenges, his administration took a separate step that could make it easier for the most vulnerable student borrowers to clear their debts: through bankruptcy.
Unlike credit card bills, medical bills and other consumer debts, student loans aren’t automatically wiped away in bankruptcy. Borrowers are required to file a separate lawsuit to try to do so. It’s stressful, costly and notoriously difficult to meet the strict legal tests to succeed, and most debtors don’t even try.
But, on Thursday, the Justice Department, in coordination with the Education Department, announced a new process that it said would help ensure that people in bankruptcy seeking relief on their federal student loans were treated more fairly, with clearer guidelines about what types of cases would result in a discharge.
The guidance “outlines a better, fairer, more transparent process for student loan borrowers in bankruptcy,” Associate Attorney General Vanita Gupta said in a statement. “It will allow Justice Department attorneys to more easily identify cases in which we can recommend discharge of a borrower’s student loans.” (Separately, the Biden administration asked the Supreme Court on Friday to approve its student loan debt relief program — a key component of the president’s 2020 election campaign.)
Successive administrations have often taken a hard line on the ability of borrowers to use bankruptcy to discharge their student loans, aggressively contesting their cases in court. It was partly to deter borrowers from even trying to bring a bankruptcy case without first exploring other ways to reduce debt.
As a result, the process became too burdensome for those who were most distressed.
Under the new guidelines, debtors will complete an “attestation form,” which the government will use to help determine whether to recommend a discharge. If debtors meet certain requirements — including having expenses that exceed their income — government lawyers will recommend a full or partial discharge.
In each of the five years before the pandemic, roughly a quarter-million people who had student debt filed for bankruptcy, according to a 2020 analysis by Jason Iuliano, an associate professor of law at the University of Utah.
But only a small sliver — less than 1 percent — filed the separate lawsuit, known as an adversary proceeding, to try to have that debt discharged. After reviewing the policy changes, Professor Iuliano was hopeful that the new guidance would encourage more people to try.
“At a quick glance, the process seems reasonable,” he said. “It should increase the number of student discharge requests while also making it far cheaper and easier to litigate those requests. It will be interesting to see how the reforms play out.”
The guidance comes roughly a year after officials in the Education Department said they were working with the Justice Department to review their approach. As it refined its playbook, the government also agreed to pause cases if debtors wished.
Borrower advocates, consumer bankruptcy lawyers and law professors who have been critical of the difficulties borrowers face took a cautiously optimistic stance on the policy changes.
“The new guidance has the potential to provide a meaningful avenue for relief, but its effectiveness will depend on how it is implemented by the Departments of Education and Justice,” said John Rao, staff attorney at the National Consumer Law Center.
Discharging student debt has become increasingly challenging over the past four decades — and differing standards across the country mean a debtor’s outcome can vary based on where he or she lives.
Before 1976, student loans were wiped away in bankruptcy, just like any other form of consumer debt. But some lawmakers were concerned that professionals with expensive degrees and high earning potential could game the system, so they tightened the rules: Borrowers could no longer receive a discharge within five years of when they had to start making loan payments, unless they could show that the debt posed an “undue hardship.”
The undue hardship standard isn’t defined in the bankruptcy code, so courts developed their own definition — and the code is interpreted differently between jurisdictions.
In some, judges can consider the “totality of the circumstances” in their decision. But most of the country uses a stricter interpretation, called the Brunner test.
It was named for Marie Brunner, who filed for a discharge of her debt less than a year after she had completed a master’s degree. The case created a three-prong test: Can debtors maintain a minimal standard of living based on their income and expenses while repaying the debt? Have they made a good-faith effort to repay the loans? And is their situation likely to persist for a significant part of the repayment period?
Some courts take the test a step further, and require borrowers to demonstrate a “certainty of hopelessness.”
Today, every debtor must meet some version of the undue hardship standard. In decades past, meeting the standard was required only if you tried to discharge your debt in fewer than five years. But, over time, that window was eliminated, making everyone subject to the standard.
The new policy will still track the broad outlines of the Brunner test, but the Justice Department’s attorneys will recommend a discharge under certain circumstances. For example, if a debtor’s expenses equal or exceed his or her income, a discharge may be suggested if the borrower also meets other criteria: The debtor is of retirement age; did not earn a college degree; or has a disability or chronic injury, has a protracted unemployment history or has been in repayment for at least 10 years.
The government will also consider whether the borrower has made a “good-faith effort” to earn income and pay back the loans.
Pamela Foohey, a professor at the Cardozo School of Law, said she believed the policy changes would lead the Justice and Education Departments to recommend more discharges, though the bankruptcy judge would make the ultimate decision. But she has concerns that the “good-faith” measure remains too vague and could discourage people from bringing cases.
“Nonetheless, that the guidance hopefully will provide consistency in how the D.O.J. and D.O.E. will assess each case is a significant step forward,” Professor Foohey said.
Some bankruptcy judges have spoken out through strongly worded opinions, acknowledging that the landscape has changed since Brunner was decided and that the standard that emerged was too stringent.
During his presidential campaign, Mr. Biden pledged his support for the bankruptcy proposal put forward by Senator Elizabeth Warren, Democrat of Massachusetts, which would make both federal and private student loans dischargeable, just like other consumer debt. (The changes announced on Thursday apply only to federal debts.)
“For many years, the treatment of people who borrowed money to go to school has been much harsher than for those who ran up other kinds of debts,” Ms. Warren said in a statement on Thursday. “Now, within the law, the Biden administration has begun to build meaningful change.”
A president cannot change the bankruptcy code — doing so requires congressional approval. But the Education Department is typically the main defendant in these cases, so the government can revise its approach. And that’s what has been done here.
Though there has been bipartisan support for related bills in Congress, none have gained traction. Senators Dick Durbin, Democrat of Illinois, and John Cornyn, Republican of Texas, introduced a bill in 2021 that would discharge federal student debt as part of the bankruptcy process, but only 10 years after the first payment was due.