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Financial Services Law Insights and Observations

5th Circuit says Congress, not courts, is responsible for changing rules for discharging student loans in bankruptcy

Courts Fifth Circuit Appellate Student Lending Bankruptcy

Courts

On July 30, the U.S. Court of Appeals for the 5th Circuit affirmed decisions by a bankruptcy court and a district court to dismiss a borrower’s student loan discharge request under the Bankruptcy Code, holding that Congress, not the courts, is responsible for changing the rules for discharging student loan debt in bankruptcy.

The borrower, who became unable to make payments on her student loans and other debts, initiated an adversarial action against the Department of Education in bankruptcy court after receiving a general discharge of her debts, in an attempt to have two student loans discharged as well. While the borrower was able to prove that her monthly expenses exceed her income, the bankruptcy and district courts found that she failed the three-prong test for evaluating claims of “undue hardship” established by the 2nd Circuit in Brunner v. New York State Higher Education Services Corp. and adopted in the 5th Circuit in In re Gerhardt. Primarily, the courts stated that the borrower failed to (i) show that she was “completely incapable of employment now or in the future”; or (ii) prove that her present state of affairs was likely to persist through the bulk of the loan repayment period. The borrower appealed, arguing that the three-prong test “is inconsistent with the plain meaning of the term ‘undue hardship’” and urged the appellate court to adopt instead “a ‘totality of the circumstances’ test.”

On appeal, the 5th Circuit agreed with the lower courts, stating that when Congress amended the bankruptcy law regarding the discharge of federal student loans, the intent was to limit it to cases of “undue hardship” in order to prevent the use of bankruptcy except in the most compelling circumstances. According to the appellate court, until an en banc panel or the Supreme Court reviews the standard, the panel finds no error in the lower courts’ decision. “Policy-based arguments do not change this interpretation; the role of this court is to interpret the laws passed by Congress, not to set bankruptcy policy,” the appellate court wrote. Moreover, reducing the test to a “totality of the circumstances” standard would create an “intolerable inconsistency” in decisions on loan discharges, and expand an area of bankruptcy law that Congress has sought to constrict.

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