By Justin McNeil, Senior Editor
Concerns over the total student
loan debt in the United States, which recently hit the $1 trillion mark, continue to
grow amidst projections that this is the next bubble to burst in the U.S.
economy, possibly derailing a still weak recovery from the 2008 financial
crisis. But Ben Bernanke, the U.S.
Federal Reserve Chairman, sees no such problems with
student loans. He points to the U.S. government’s ownership
of nearly 85 percent of those loans, with the remaining 15 percent belonging to
private lenders, as proof of their future stability.
Unfortunately, Bernanke may be
underestimating the dangers of having an economy with $1 trillion in student
loan debt and unable to provide opportunities to graduates for full-time
work. Tie this to ballooning tuition
costs and a U.S. legal system that makes it incredibly onerous for students to
discharge their debt, and suddenly America’s student loan system changes from one
offering a “ladder of opportunity” to one promising long-term financial dead
weight. This not only harms today’s
graduates, it also puts America’s future economic growth at risk.
Part of dealing with (or better
yet preventing) a student loan bubble burst is to have a workable and fair
approach to discharging student loans in bankruptcy. Yes, this is a large, multifaceted topic, and
this post will not delve deeply into the legal theories behind bankruptcy or
why we treat educational debt differently than others. But U.S. policy makers have an obvious
starting point: Canada’s far more balanced legal approach to addressing the
discharge of education debt in bankruptcy.
The American Approach
In the U.S., the current
bankruptcy laws are very clear when it comes to student loan debt: there is no
discharge of such debt through bankruptcy proceedings unless a showing of undue hardship can be made. (See 2005 Bankruptcy Abuse Prevention
and Consumer Protection Act). In theory, such a limitation sounds
reasonable to deter frivolous claims, but in practice the language essentially
denies relief to all but a handful of the most financially strapped
individuals. While “undue hardship” is
not defined in the statute, a definitive three-prong test was crafted in Brunner
v. New York State Higher Education Services Corp. There, the court determined that
prospective student bankrupts must establish:
(1) that the debtor cannot maintain,
based on current income and expenses, a “minimal” standard of living for
herself and her dependents if forced to repay the loans;
(2) that additional circumstances
exist indicating that this state of affairs is likely to persist for a
significant portion of the repayment period of the student loans; and
(3) that the debtor has made good
faith efforts to repay the loans.
The use of vague, qualifying
language including: minimal standard of
living, likely to persist for a
significant portion of the repayment period, and good faith efforts, has helped set an impossibly high hurdle for
any American hoping to shed student loan debt through bankruptcy. As an example, the standard was actually met
recently when a
former law student showed that her diagnosis of Asperger Syndrome prevented her
from obtaining meaningful employment to repay her $339,361 of student loan
debt. Without such extreme circumstances
though, U.S. bankruptcy courts rarely allow for a discharge. What’s more egregious is that in the rare
instance that this type of discharge is granted, the debtor immediately owes the
IRS, and
possibly others, for taxes on Cancellation of Debt Income.
The Canadian Model
In Canada, the process for gaining
relief from student loans through bankruptcy, as set forth in § 178 of the Canada Bankruptcy
and Insolvency Act,
is more forgiving to debtors. The Canadian
Student Loan Bankruptcy Blog
conveniently distills the statutory requirements north of the border and
explains how cases have normally proceeded, while also tracking proposed
legislation in this area. Essentially, a
debtor may enter bankruptcy to fully discharge student loan debt 7 years after
she was last enrolled as a student and the loans may then be automatically
discharged. The Canadian government or a
private creditor can challenge the discharge though (even if 7 years have
passed since the debtor was a student), which then requires the debtor to meet
the requirements of a two-part test consisting of: 1) whether the debtor has shown good
faith with their actions toward the student loans; and 2) whether the debtor will experience financial difficulty if forced to repay the loans.
The court in the Ontario
bankruptcy case of Giera
(Re) set
forth four factors to determine whether a debtor has acted in good faith:
[1] whether
the money was used for the purpose loaned and if the education was completed, [2]
whether the Bankrupt is deriving economic benefit from the education, [3] whether
there were any reasonable efforts to repay the loans and [4] whether there was
any effort by the Bankrupt to take advantage of interest relief or remission
options offered by the lenders
Whether a bankrupt will
experience financial difficulty in repaying the loans is determined through the
court examining the debtor’s income, assets, and expenses to gauge the
potential that the obligations can be met.
The court will also look to how much effort the debtor has put towards
finding employment, if she is unemployed or underemployed. Additionally, there is a special hardship
provision through which a former student can apply for a loan discharge after
only 5 years, but will have to immediately satisfy the same two-part test as
above.
In the last 20 years, the U.S.
has systematically toughened its laws on discharging student loan debt to
coincide with the increasing prevalence of student loans. Before 1998, dischargeability in this area was not always based on the undue
hardship standard
and the process more closely resembled Canada’s, with the possibility of
discharge available 5 years after ceasing to be a student. Similarly, even private student loans remained dischargeable according to a lesser
standard until the 2005 legislation mentioned above was passed to curb a
perceived widespread abuse of the bankruptcy process. Though student debtors have lately been subject to more restrictions in
all of the Western common law jurisdictions, Canada has on balance seemed more sympathetic to
student debtors than the U.S. Furthermore,
Canadian legislation continues to point in the more positive direction of
lessening the burden of proof for prospective bankrupts. See the recommendations in the Final Report of the Personal Insolvency Task
Force.
Aggravating Factors
The astronomical rise of college
tuition, and the
overall economic climate mean that the U.S. may be forced to reexamine its
policy toward student loan debt when it comes to bankruptcy in the near future. Traditionally at common law, the bankruptcy process
was a means through which a creditor was able to exercise his rights, with
possible results being that debtors could be imprisoned or hanged. But the modern conception of bankruptcy does
not contemplate criminal punishment and seeks to balance creditor’s rights
against debtor’s rights in a more equal fashion than was originally conceived. Western common law jurisdictions have
recognized that to better foster an entrepreneurial environment, a fresh start
must be available for debtors whose economic ventures don’t always succeed. Shouldn’t students be afforded the same
relief? And what future costs will the
American economy pay
if students don’t get relief?
As of now, college tuition
remains substantially lower in Canada than in the U.S. And though recent efforts from the Obama
administration have made the student loan repayment process more manageable, a
confluence of factors mean that this may not be enough. First, the President has made it a primary
goal to further increase the availability of student loans to ensure greater
access to higher education for Americans who may not be otherwise able to afford
the costs of a college education.
Second, the federal government has now taken over the administration of
student loans. Though it backed many of
these loans previously, it now has even more at stake when enforcing repayment
and cannot afford mass defaults.
Finally, the economic downturn has magnified the difficulties that
former students face in paying back their loans; without some further action to
mitigate current circumstances, defaults are likely to increase in short order.
Conclusion
Considering how many talking
points during the U.S. Presidential election have revolved around job creation,
small business owners, entrepreneurship, and consumer spending, the increasing
student debt should be getting more attention than it is. There have been some commendable efforts to
address this issue: the Student Loan Forgiveness Act proposed in the House of
Representatives earlier this year.
However, a comprehensive reconsideration of American bankruptcy policy
and, more specifically, easing the path to dischargeability of student loans
may be necessary very soon. A good place
to start would be with Canada’s current policy.
