A BRIEF HISTORY OF BANKRUPTCY
…as it relates to student loans.
The Bankruptcy Act of 1898
Congress had two goals:
- To provide a fresh start to hardworking, honest debtors, freeing them from oppressive debt.
- The fair and equitable treatment of debtors and creditors alike.
1934: Local Loan Co. v. Hunt
A historical U.S. Supreme Court decision that set a legal precedent.
- The Court asserted that the primary goal of bankruptcy laws was to offer debtors a fresh start from financial burdens:
“[I]t gives to the honest but unfortunate debtor…a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of preexisting debt.”
1958: National Defense Student Loan (NDLS) a.k.a. Perkins Loans
- First federally funded student loan program
- Provided low-interest (5%) loans
1965: The Higher Education Act
Established the Guaranteed Student Loan Program (GSLP), later renamed the Stafford Loan Program.
- Aimed at providing higher education to the poorest students
1976: Congress Modifies the Higher Education Act of 1965
Established § 439A.
- A 5-year waiting period between the time the last student loan was used and filing for bankruptcy
- Introduced the undue hardship provision
The Bankruptcy Reform Act of 1978
Until this Act, student loans were treated like any other debt and could be discharged through bankruptcy without an adversary proceeding.
- Replaced the Bankruptcy Act of 1898
- Middle Income Student Assistance Act of 1978: Made student loans available to everyone, regardless of financial need
- Allowed debtors to file under either Chapter 7 (quick and full discharge of debt) or Chapter 13 (reorganization and repayment of some debt)
- § 439A was replaced with § 523(a)(8), which had similar nondischargeability language.
We are now all able to go to college, but the cost of that education has nearly doubled. As a result, student loan borrowing has skyrocketed, while state funding for higher education has decreased across all fifty states, leaving students with no choice but to borrow more just to attend school. This has led to an alarming increase in student loan defaults.
In some cases, high-profile individuals exploited the system, seeking to discharge their student loans through bankruptcy immediately after graduation. Imagine a doctor, with all their accumulated debt, simply wiping it away. The media latched onto these cases, adding a layer of hype that panicked Congress into reevaluating the student loan program.
1990
- The 5-year waiting period between the time the last student loan was used and filing for bankruptcy was extended to 7 years.
1998
- The waiting period between the time the last student loan was used and filing for bankruptcy was removed entirely.
- Only the undue hardship clause remained.
- The Income Contingent Repayment Plan (ICR) was implemented.
2005: The Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA)
- Introduced a means test (now you must qualify for Chapter 7)
- Introduced mandatory credit counseling and a debtor education course
- Established an 8-year waiting period between bankruptcy filings.
2007: The Income-Based Repayment (IBR) Plan Introduced
- The federal government introduced the IBR plan, which allowed borrowers to cap their monthly payments at a percentage of their discretionary income.
- IBR was intended to provide relief to borrowers struggling with large student loan balances, but it did not address the issue of bankruptcy discharge.
2008: Great Recession Exacerbates Student Loan Crisis
- The Great Recession led to a significant increase in student loan borrowing as more people sought higher education to improve job prospects in a tough economy.
- Student loan default rates increased dramatically, yet bankruptcy laws remained unchanged, preventing most borrowers from discharging student loans.
2010: Direct Lending Program
- In 2010, the federal government ended subsidies to private banks for federally backed loans and moved to a direct lending model under the Federal Direct Student Loan Program.
- This was aimed at simplifying student lending but did not change bankruptcy protections for student borrowers.
2012: Brunner Test Scrutinized
- The Brunner Test, established in 1987, became the primary standard for determining undue hardship in bankruptcy cases.
- In 2012, critics began to argue that the test was outdated and overly restrictive, especially as student debt had ballooned to unsustainable levels.
- Efforts to reform this standard grew louder in legal circles, though significant legislative change was not yet on the horizon.
2015: Obama Administration Expands Repayment Options
- The Obama administration expanded repayment options like Pay As You Earn (PAYE) and Revised Pay As You Earn (REPAYE), helping borrowers manage payments based on their income.
- However, these plans didn’t provide a direct path to bankruptcy discharge and left many borrowers struggling to pay off growing loan balances.
2018: Growing Momentum for Bankruptcy Reform
- By 2018, student loan debt exceeded $1.5 trillion, and many experts, advocates, and politicians called for changes to bankruptcy laws.
- Bipartisan support for reforming student loan bankruptcy protections began to take shape, with discussions of revisiting the “undue hardship” standard.
2019: Federal Court Cases Expand Interpretation of ‘Undue Hardship’
- Several federal court decisions began softening the strict interpretation of the “undue hardship” clause in § 523(a)(8), opening the door for more student loan discharges in bankruptcy.
- Cases like Rosenberg v. N.Y. State Higher Education Services Corp. challenged traditional interpretations, where the judge ruled in favor of the borrower, easing the path to discharge.
2020: COVID-19 Pandemic and Temporary Student Loan Relief
- The U.S. government instituted temporary relief measures during the COVID-19 pandemic, suspending federal student loan payments and interest accrual under the CARES Act.
- Although bankruptcy reform wasn’t part of the package, the pandemic’s economic toll reignited calls for student loan discharge relief.
2021: Calls for Bankruptcy Reform and Student Loan Discharge Intensify
- The Biden administration faced growing pressure from advocacy groups, legislators, and borrowers to simplify bankruptcy processes for student loan discharge.
- Senator Elizabeth Warren and others proposed legislation to allow student loans to be treated like other consumer debt in bankruptcy.
2022: Biden-Harris Administration Student Loan Forgiveness Plan
- In August 2022, the Biden administration announced a plan to forgive up to $20,000 of student debt per borrower. This was challenged in courts but set the stage for broader conversations about bankruptcy reform.
- Though forgiveness was the focus, the debate over easing bankruptcy discharge for student loans remained at the forefront of discussions.
2023: Student Loan Bankruptcy Reform Act Introduced
- In early 2023, the “Student Loan Bankruptcy Reform Act” was introduced in Congress.
- The bill aimed to revert to pre-1998 standards, removing the “undue hardship” requirement for discharging student loans in bankruptcy.
- Though the bill had bipartisan support, it was met with opposition from some members of Congress and certain financial sectors.
2024: Supreme Court Considers Jones v. Department of Education
- In 2024, the U.S. Supreme Court agreed to hear Jones v. Department of Education, a case that challenges the constitutionality of the “undue hardship” requirement in § 523(a)(8).
- This case could redefine how student loans are treated in bankruptcy, potentially leading to a more borrower-friendly interpretation of dischargeability.
This is where we currently are today, in 2024.
I’ll show you exactly how to use this information to
Vanquish Your Student Loans!
