Most student loans are obtained from a lending institution and are ultimately guaranteed by the United States Department of Education. In many situations the loans are guaranteed by a middle entity, usually one of the forty-seven state guarantee agencies. The Pennsylvania Higher Education Assistance Agency (PHEAA) is such a guarantee agency. If a student defaults on a student loan, the original lender seeks reimbursement from the guarantee agency. Once the lender is repaid, the guarantor then holds the promissory note and commences collection action. PHEAA has state statutory authority to commence an administrative action to garnish the borrower’s wages. There is also federal authority to collect on defaulted loans through income tax refund intercepts. These collection actions often prompt clients to inquire about bankruptcy as a way of preventing or eliminating these collection practices.
As a general rule, a student loan guaranteed by the government or made by a nonprofit institution is not dischargeable under 11 U.S.C. §523(a)(8). As a result of the 2005 amendments to the Bankruptcy Code, student loans made by private entities for which repayments are tax deductible are also nondischargeable. Normally, the debtor should attempt to obtain a nonbankruptcy discharge before seeking a bankruptcy hardship discharge.
However, there is an exception to this general rule of student loan nondischargeability for student loans. If the repayment of the loan would create an undue hardship on the debtor and his/her family, the debt may be discharged. This discharge is commonly referred to as an undue hardship discharge. In order to successfully assert that a debtor is eligible for an undue hardship discharge, it is necessary to satisfy the three-pronged test for determining “undue hardship” adopted by the Third Circuit in the Court of Appeals decision on November 28, 1995 in its decision In re Faish, 72 F 3d. 298 (3d. Cir. 1995), which adopted a three part test based upon the Second Circuit’s decision in Brunner v. New York State Higher Education Services Corp., 831 F.2d 395 (2d Cir. 1987). Under this test, “undue hardship” requires a three-part showing:
- that the debtor cannot maintain, based on current income and expenses, a minimal standard of living for herself and her dependents if forced to repay the student loans;
- that additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period for student loans; and
- the debtor has made “good faith” efforts to repay the loans (which means that the debtor’s student loan default was caused by circumstances beyond the debtor’s control and not the debtor’s willful negligent conduct).
The debtor has the burden of establishing each element of this test by a preponderance of the evidence. For purposes of clarity, the preponderance of the evidence standard simply means “more probable than not.” The standard is met if the the proposition is more likely to be true than not true. Effectively, the standard is satisfied if there is greater than 50 percent chance that the proposition is true.