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Student Loans in Bankruptcy

Student loans, the largest source of debt for many Americans, are almost never dischargeable in bankruptcy. Student loans will not be discharged unless the debtor can show that repayment of the loans constitutes an “undue hardship,” which is a very high bar to meet. If you are contemplating bankruptcy, and you have student loan debt, it is imperative that you understand how your student loans will be affected by the filing of a bankruptcy proceeding.

Dischargeability of Student Loans

A student loan may be discharged in bankruptcy only if the bankruptcy court finds that repayment of the loan would impose an “undue hardship” on the debtor and the debtor’s dependents. Undue hardship is not defined in the Bankruptcy Code, and it is left to the courts to make a determination in each case. Different tests have been developed by the courts, and the applicable test will usually depend on the federal appellate court circuit in which the debtor’s bankruptcy case was filed.

In New York State, the applicable standard is known as the “Brunner Test,” which was established by the Second Circuit Court of Appeals, which includes New York.  Under the Brunner Test, a student loan may be deemed an undue hardship only if all of the following conditions are met:

  • The debtor cannot maintain a minimal standard of living for himself or his dependents if forced to repay the loan;
  • Additional circumstances exist that indicate this condition will persist for a significant portion of the repayment period of the student loan; and
  • The debtor has made good faith efforts to repay the loan.

Unless discharged, student loans are generally unaffected by a Chapter 7 bankruptcy, except to the extent that collection activities must cease during the time that the automatic stay is in effect. For a simple Chapter 7 case, the stay remains in effect from the filing of the bankruptcy until the discharge is issued, which is approximately three months later.

Student Loans in Chapter 13 Bankruptcy

In a Chapter 13 bankruptcy, student loans may cause unanticipated problems. This is because, in most cases, the Chapter 13 plan treats student loans in the same manner as other unsecured, non-priority, debts. That is, unsecured debts are paid on a pro rata basis, with each creditor receiving a share of the total amount paid, based on the amount that is owed to that creditor. The problem that arises in Chapter 13, then, is that the pro rata amount to be paid for the debtor’s student loans under the Chapter 13 plan may be less than what is necessary to keep the loans current.

The bankruptcy filing places an automatic stay against collection activity during the time that the case is pending. So, while student loan creditors cannot try to collect payments from the debtor outside of the plan, the debtor will continue to fall behind on his or her student loan payments during the three to five year plan period. In addition, interest will continue to accrue on the student loan balance. Interest on student loans that accrues after the bankruptcy filing is also nondischargeable.

The result in this situation is that at the end of the Chapter 13 plan, the debtor will owe unpaid principal and interest on the student loans. Thus, the debtor may emerge from Chapter 13 owing a substantial amount on his or her student loan debt, possibly even more than was owed before the bankruptcy filing. The outcome for the debtor will depend on the pro rata percentage that is paid to unsecured creditors in the Chapter 13 plan, as well as the student loan interest rate.

Separate Classification of Student Loan Debt in Chapter 13

Can student loans be given preferential treatment in Chapter 13? The Bankruptcy Code contains conflicting provisions that, depending on a court’s determination, may allow such preferential treatment.

Under Bankruptcy Code § 1322(b)(5), a Chapter 13 plan may allow maintenance of payments for claims on which the last payment is due after the date on which the final payment under the plan is due. Since a Chapter 13 plan cannot exceed five years, the final payment on most student loans will be due after the Chapter 13 plan is completed. Thus, this section of the Bankruptcy Code would seem to allow a debtor to continue to make regular student loan payments directly to the lender, outside of the plan. The benefit of doing so is that the debtor would stay current on both the principal and interest for the student loan, while at the same time repaying other creditors through the Chapter 13 plan.

However, § 1322(b)(1) states that a Chapter 13 plan may designate separate classes of unsecured claims, but only if the plan does not discriminate unfairly against any class. What constitutes unfair discrimination is a factual matter that must be determined by the bankruptcy court on a case by case basis. The court will look at several factors to determine whether the proposed classification unfairly discriminates against unsecured creditors. These factors include:

  • Whether there is a rational basis for the classification;
  • Whether the classification is necessary to the debtor’s rehabilitation;
  • Whether the discriminatory classification is proposed in good faith;
  • Whether there is a meaningful payment to the class discriminated against; and
  • The difference between what the creditors discriminated against will receive as the plan is proposed, and the amount they would receive if there was no separate classification.

If approved by the court, classifying student loan debt separately from other unsecured debts in a Chapter 13 plan may be very advantageous to the debtor. Separate classification will allow the debtor to remain current on student loans while other, unsecured creditors are paid less through the plan. However, obtaining confirmation of such a plan will generally be difficult to do, and only when the right circumstances exist.

Long Island Bankruptcy Attorney for Student Loan Issues

If you have student loan debt and are thinking of filing for bankruptcy, there are many important factors that must be considered. You should consult with a knowledgeable and experienced bankruptcy attorney to provide you with the advice necessary to make an informed decision. Contact The Law Office of Andrew M. Doktofsky, P.C. at 631-812-7020 to schedule a free consultation.

Andrew M. Doktofsky serves all of Long Island, including Huntington, Deer Park, Babylon, Hempstead, Commack, Brentwood, and all locations in Nassau and Suffolk Counties, as well as Manhattan, Brooklyn, Queens and the Bronx.


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