23 Aug 2016

Discharge of Student Debt Possible During Bankruptcy

Robert Murphy, 65, is a step closer to having more than $240,000 in student loans discharged from bankruptcy.

Murphy took out several parent PLUS loans to pay for college, sending two children to Loyola University Maryland and the third to University of Connecticut and Bridgewater State University in Massachusetts. The father of three lost his job about 14 years ago and now lives on $13,200 a year that his wife earns as a teacher’s aide. After exhausting their retirement savings, the couple applied for bankruptcy in 2012.

After four years of litigation, the Department of Education and the Education Credit Management Corp., the loan servicer, is settling with Murphy to discharge his student debt.

The settlement is likely to be finalized in May, says Steven D. Pohl, the attorney at Brown Rudnick who represented Murphy as a pro bono client.

“It was probably likely that the Department of Education saw an unfavorable verdict,” says Jason Iuliano, a Ph.D. candidate at Princeton University, who is an expert on case law for student loan discharges and has written several legal publications on the topic.

Discharging federal student loans is a difficult process, but it’s not impossible, legal experts say. A student borrower must prove that not discharging the student debt would cause an “undue hardship.”

[Learn what happens when you earn too much to repay student loans based on income.]

The process of discharging a student loan is referred to as an adversarial process – it’s similar to a trial and involves litigation. The more evidence there is to prove an undue hardship, the increased likelihood of being granted a discharge by a bankruptcy judge, lawyers say.

Undue hardship is left to the courts to define, experts say.

Different court circuits use different standards of hardship. The majority of courts use what’s known as the Brunner test, which requires bankruptcy judges to look at the debtor’s future and determine whether there is a degree of “hopelessness.”

Three factors determine hardship under the Brunner test: the debtor must prove that it would be impossible to maintain a minimal standard of living while repaying the loan, the financial hardship must continue for a significant portion of the repayment period and the borrower has made a “good faith” effort to repay the debt.

A “good faith” effort might be trying to pay back the debt through an income-based repayment plan, for example.

Legal experts say that most cases with a successful student debt discharge usually involve a permanent disabilty.

“It’s usually from heath circumstances,” Pohl says. “The briefing that we did in Murphy argued to the contrary because the totality tests really never adopted that it has to be health issues.” The Murphy case in the 1st Circuit is the only court that hasn’t adopted a hardship test – all the other circuits in the U.S. have adopted one.

Since the Murphy case is in settlement, it will not be precedent-setting for other student debt discharge cases, legal experts say.

But experts say despite difficultly in discharging student debt, not enough borrowers attempt to discharge their loans after filing for bankruptcy.

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