Loans and the Law: The Bankruptcy Code

I’m not ashamed to admit my nerditude – I kind of love the law.  I went into lawyering for that reason.*  I DO NOT love my loans, but I’m certainly spending a lot of time thinking about them these days.  I’m going to combine those two interests into a weekly column on DebtFreeJD: “Loans and the Law!”**

Excited yet?  Well, you should be – I have bunch of posts in the hopper, including on interesting student loan-related lawsuits, pending Congressional bills, and how the modern-day student loan system came to be.

Let’s turn to our first topic: the modern bankruptcy code.   I knew vaguely that student loans weren’t dischargeable in bankruptcy, but never actually read the portion of the bankruptcy code that said that.  You can read the code yourself if you like (and it’s worth taking a gander) but here’s the highlights:

1. The bankruptcy code lists a bunch of categories of debt that can’t be discharged in bankruptcy, including debts for money obtained by fraud, “domestic support obligations,” debts caused by the debtor killing someone while driving drunk, and debts incurred to pay fines or penalties imposed under Federal election law.  So if you have student loans, for the purposes of the bankruptcy code you’ve got some things in common with drunk drivers, people who don’t pay child support, people who break election law, and fradusters.  Interesting, right?

2. Now, for the part we care about: the bankruptcy code says you can’t discharge the following:

unless excepting such debt from discharge under this paragraph would impose an undue hardship on the debtor and the debtor’s dependents, for–(A)(i) an educational benefit overpayment or loan made, insured, or guaranteed by a governmental unit, or made under any program funded in whole or in part by a governmental unit or nonprofit institution; or (ii) an obligation to repay funds received as an educational benefit, scholarship, or stipend; or (B) any other educational loan that is a qualified education loan, as defined in section 221(d)(1) of the Internal Revenue Code of 1986, incurred by a debtor who is an individual.

Have your eyes glazed over yet?  Well, as I read it, this just means that you can’t get rid of a qualified student loan debt by declaring bankruptcy unless it “would impose an undue hardship on [you] and [your] dependents” to have to pay the loan.

3. As far as I can tell, the “undue hardship” caveat is unique to student loans – it doesn’t apply to any of the other categories of non-dischargeable debt.  Also, the bankruptcy code doesn’t define “undue hardship.” I haven’t read the legislative history here, but sometimes Congress deliberately leaves room for judges to fill in gaps in laws.  Could that be going on here?  I can envision a conversation between Congressmen (or women) going something like:

Congressperson A: We need to make it so people can’t rack up a bunch of loans, and then declare bankruptcy right before they starting making $$$$.

Congressperson B: But what about people who took out student loans and then run into really tough situations and just can’t pay them back?  What do we do about them?

Congressperson A: Yeah.  But how do we draft a law that sensibly distinguishes between the two?

Congressperson B: I’ve got no idea.  Let’s let the judicial branch figure it out. They’d be best able to evaluate individual debtors as a case is on-going.

Congressperson A: Brilliant!

4. If that is what is going on here, the judiciary could in theory have a big impact on the student loan industry by defining “undue hardship” broadly – or narrowly.  If “undue hardship” is defined very broadly (i.e., I’d just rather not pay them so I can have money for a cruise next year!), the student loan industry is probably going to tighten up its standards for lending.  But if “undue hardship” is defined very narrowly (i.e., only if you are totally disabled and will never work again) the student loan industry has less to worry about, because it can pursue you for outstanding loans forever.

Is one outcome better than the other?  What do you think?

*Which is, in my opinion, the only reason to go to law school.  Incurring a bazillion dollars in loans because you couldn’t think of anything better to do after college is, in my not-so-humble-opinion, foolish.  But I digress.

***Disclaimer: THIS IS NOT LEGAL ADVICE!!!!  I’m not a bankruptcy lawyer, and I don’t litigate student loans lawsuits, or anything related.  In sum: #1 I couldn’t offer competent legal advice on this even if I wanted to and #2 I don’t want to and am not offering legal advice.  Lawyer hat is off, blogger hat is on. So don’t rely on anything I say in these columns to make decisions about your own life – but DO think of these as conversation starters on interesting topics.

One thought on “Loans and the Law: The Bankruptcy Code

  1. Cecilia@thesingledollar

    I am highly enthusiastic about this series! As a historian, I spend more and more time in the classroom picking apart legal decisions with my students — it is so fascinating (and sometimes disturbing) to see how the law and/or court decision embodies the values of the people writing/making it.

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