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Bankruptcy Help for Students and Their Lenders?

posted by Gene Wedoff

Yesterday, the President signed into law H.R. 5715, the “Ensuring Continued Access to Student Loans Act of 2008.”  The law responds to a perceived liquidity crisis in student lending by allowing government purchases of privately-issued student loan portfolios, so that the lenders will have funds to re-lend. The law is characterized as a useful first step in the lead editorial of today's New York Times, but the Times urges a broader remedy: greater use of direct governmental student loans.

From the perspective of bankruptcy, though, the question is not how students can best get into educational loans, but how they can get out of them.  Under current U.S. bankruptcy law, all student loans are nondischargeable unless the debtor can establish “undue hardship” under a test that requires proof (among other things) that the debtor will not be able to repay the loan in the future—i.e., permanent disability—a very tough standard.  However, for at least some student debtors an easier way to get bankruptcy relief may be the suggested by In re Orawsky, a recent decision from a Philadelphia bankruptcy court.

The Orawsky approach employs a Chapter 13 plan paying substantially more on student loans than on other unsecured debts.  As Orawsky itself explains, this approach has been rejected in other decisions as a prohibited “unfair discrimination” among creditors.  But the twist in the Orawsky plan is that all unsecured creditors are given an equal share of the “disposable income” that Chapter 13 requires be paid to them.  The extra payments on student loans come from income of the debtor that is not “disposable” but is still available after payment of the debtor’s living expenses.  For example, if the disposable income standards allowed a debtor monthly food expenses of $300 but the debtor managed to spend only $200 each month for food, the $100 difference could be paid on student loans in addition to a non-discriminatory pro-rata payment of the “disposable” income.   For Chapter 13 debtors with above-median income, disposable income is calculated using the living-expense and other income deductions of the Chapter 7 means test, which can be quite generous.  So there will often be a substantial difference between means-test disposable income and what the debtor can actually make available to pay debts.

The Orawsky approach, of course, does not discharge student loans; it simply allows more money to be returned to student lenders than might otherwise be possible under a Chapter 13 plan.  In this way, it not only benefits the debtor—with less nondischargeable debt at the end of the case, but also the student lender—with a larger and quicker repayment of funds that can be re-lent.  And so Orawsky can be seen as making a bankruptcy contribution to advancing the goal of the new student loan law.


Why is it that student loans have to be classified as unsecured debts? If they are backed by the government shouldn't they be Priority debts? Like taxes? I hate the fact that a debtor cannot cure these types of debts in Chapter 13s.

Wouldn't liquidity in that area be helped if debtors were allowed to treat them in 13's possibly pay them in full with interest over 5 years? Now, chapter 13s' act as forbearance of sorts. It also has the effect of sliding the debtor further into debt due to interest over the life of a 13.

Also getting disability from the government does not guarantee that you will be granted a discharge of your student loan debts via adversary! If we are talking about people who generally do not have the means to pay debts and who live on fixed income, is it not a great injustice to require them to bring a dischargability adversary on top of all of the other fees for filing a chapter 7? Of course there are no filing fees for the debtor in an adversary, but the attorney is going to charge an arm and a leg to fight the U.S. Government.

We need to amend the BK law to give back the power of discretion to our bankruptcy judges who are uniquely situated to balance the equities. Why do people think that we are better off when we take discretion away from judges?

"If they are backed by the government shouldn't they be Priority debts? Like taxes?"

Be careful what you wish for. If student loans were priority claims, they would have to be paid in full during the Chapter 13 Plan. For many debtors, that would mean they couldn't propose a feasible Plan.

The problem with student loans is that they are set up as low interest long term notes, often paid over decades. In contrast, we are suppose to pay our taxes every year. If a debtor's tax debt is overwhelming, there is some degree of culpability there on the part of the debtor. That difference makes compressing full repayment of student loans in a Chapter 13 to 3 years or 5 years difficult, and really contrary to the intent of the loan.

Of course, whenever the government that makes the bankruptcy laws is owed money, you can be sure that they'll be putting something in there to ensure that they are going to get repaid. For student loans, it's just nondischargeability rather than priority status and nondischargeability.

True. You make a ton of sense AMC....as always!

I guess my beef is that there are some out there that could conceivably pay it back in a chapter 13 Plan if they were allowed to do so(not required to do so). ie. Student loans that are no longer differed. I think it could flood coffers with regular monthly payments.

Also, debtors could get that fresh start without the burden of student loan debt that could follow them around for the balance of their LIFE! The terms are way more affordable to pay back over decades. The problem is that it takes decades (sometimes less).

I do concede that if student loans were mandated "priority claims" the consequences would be dire.(bad really really bad) The "Option" though for some could be the thing they need to get them totally debt free in a reasonable amount of time. I don't mean filing 13 just for student loans because you could always make higher payments if you wanted to. I am talking about those who do have other debts, say high unsecured and other debts. Should the debtor have the ability to do so, that type of relief could be very helpful.

People who don't file bankruptcy have student loan debts that follow them around for a substantial portion of their lives. Paying them back involves personal sacrifices over an extended period of time.

I don't think there is going to be much support for dramatically changing that dynamic just because someone finds themselves in a bankruptcy situation.

However, you make a good point, particularly for jurisdictions with low percentage Chapter 13 Plans. The debtors are losing ground on their student loan debts, while the student loan creditor is being prevented from collecting for three to five years for either a few pennies on the dollar, or nothing.

If there is a solution better than the one we have (and at present, we don't even have one the courts agree on) I think it would involve some type of new formula that allowed limited discrimination in favor of student loan creditors.

Or, Congress could explicitely give bankruptcy judges more discretion - but that doesn't seem to be too popular with Congress based on the BAPCPA, which intentionally limited judicial discretion.

As the law stands today, I don't think Orawsky is right. As this new wave of cases that permits discrimination in favor of student loan debt (and the related "cure and maintain" cases) wend their way up to the circuit court level, I think they are going to get slapped down like the 910 car loan/surrender in full satisfaction cases did: Another bankruptcy court concept that isn't going to play well to non-bankruptcy judges.

True... so true.... man! You said it!

A background issue here is that the categories of debts that privileged in various ways in current bankruptcy law -- secured, priority, and nondischargeable -- and the nature of those privilges, are a non-systematic hodgepodge. The difficulty in dealing with student loans in Chapter 13 is a symptom f that. In better times, these issues should be rethought from scratch.

The Chronicle of Higher Education recently published an article on private student loans. Unfortunately it made the claim that they differ from Federally backed student loans because, according to the Chronicle, Federally backed student loans "can be discharged in bankruptcy" while private student loans cannot.

I hope an academic with bankruptcy expertise sends a letter to the Editor of the Chronicle and corrects this statement.

I am currently serving on a committee addressing financial aid concerns which was discussing this article, and none of the financial aid directors caught this glaring error. When I pointed it out, they had to go and ask some alleged expert in the financial aid office whether I was correct or not. Thank Heaven their alleged expert verified what I said. Apparently college financial aid directors are not generally very well versed on the issue of student loans and bankruptcy. Since these are the experts who advise students regarding incurring student debt in the first place, perhaps they should be better versed in this subject, or at least have their facts straight.

I have read on a website that if one consolidates his or her student loan debt through the Wm Ford Federal Direct Loan program that the debt is dischargeable after age 60. Is this true?

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