Bankruptcy Standards Get New Scrutiny

Education Department signals interest in revisiting rules making student loans eligible for bankruptcy -- a priority for some Democrats and consumer groups.

February 21, 2018
 
Education Secretary Betsy DeVos

The Department of Education signaled Monday that it is interested in tweaking the standards used for determining whether student loan debt can be discharged in bankruptcy.

That could point to an opening for potential bipartisan cooperation between the department and Democrats like Senator Elizabeth Warren, who have long sought to loosen bankruptcy law so student borrowers can discharge their debt.

However, what steps the department might take in that regard, including issuing new guidance or working with Congress to change the law, are unclear.

In a Federal Register notice, it requested public comments on the process for evaluating claims of “undue hardship” -- the standard student borrowers must clear to be able to discharge their loans through bankruptcy.

An Education Department spokeswoman said the notice should speak for itself. The document doesn’t indicate the steps the department may take, but consumer groups that work on student loans and bankruptcy issues said it would be hard to narrow the current standards.

Getting student loans discharged through bankruptcy is notoriously difficult. A 2005 federal law barred most student loan borrowers from that option unless they could demonstrate that they would suffer undue hardship from being forced to pay the loans.

Congress, however, has never defined what undue hardship means and didn’t delegate to the department the ability to do so. That’s left it to the courts to establish their own standards.

But debt holders and Department of Education contractors have often sought to aggressively block those undue hardship claims via litigation.

“It’s a very difficult hurdle for most consumers,” said John Rao, an attorney with the National Consumer Law Center and an expert on bankruptcy issues.

In 2014, the obstacles created by contractors prompted congressional Democrats, including Warren, to write to then education secretary Arne Duncan urging new federal guidance that would make clear specific minimum criteria for an undue hardship claim.

Among those criteria, the Democrats wrote that receiving disability benefits under the Social Security Act or being determined to be unemployable because of a service-connected disability should qualify a borrower as having an undue hardship. Contractors should accept proof of those or other criteria from a borrower without a formal litigation discovery process, the Democrats said.

The guidance released by the department the following year disappointed many Democrats and consumer advocates.

Clare McCann, deputy director of higher education policy at New America and a former Obama Education Department official, said the department’s call for comments appears to signal that it wants to broaden the definition of undue hardship. She said whatever change the department or Congress makes will have to strike the proper balance.

“You want to make sure it captures people who aren’t able to pay and won’t be able to pay over the long run, so you’re not wasting energy collecting debts you’ll never be able to collect on,” she said of the standards.

Opening up bankruptcy standards too wide, McCann said, could mean the federal student loan program becomes much more costly.

A report this month from the Department of Education’s inspector general found that the popularity of income-driven repayment plans and loan forgiveness programs could mean the federal government soon starts losing money on the student loan program.

But Rao said only a small percentage of consumer borrowers file for bankruptcy now.

“These are individuals who have some kind of hardship that is lasting, or they’re in a position where maybe they went to college and never got a degree,” he said. “In the case of some borrowers, they’re just not going to be able to repay the loan.”

Jason Delisle, a resident fellow at the American Enterprise Institute, said after the addition of multiple income-driven repayment programs for student loans since 2005, there is less of a case to be made for widening bankruptcy standards for federal student loans than for private loans.

“There are costs that go well beyond discharging loans for people who can’t pay,” he said. “There are also costs to discharge loans for people who can pay.”

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