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New rules issued for student loan discharge in bankruptcy

On July 7, the U.S. Department of Education issued a letter of guidance on its future policy toward the discharge of student loans in bankruptcy. Due to the massive build-up of defaulted student loans in Arkansas and nationwide, the Obama administration asked the Department to evaluate the possibility of discharging some student loans in bankruptcy as one solution. As a result, the new policy will recognize some expanded situations in which either part or all of a loan may be discharged in a Chapter 7 bankruptcy.

The letter also contains a kind of laundry list of factors to be considered by banks in determining whether to consent to or not oppose an undue hardship discharge. In other words, the Department's directive attempts to define undue hardship and give examples of where it would be appropriate for banks to allow a discharge or a partial discharge to go through. Presumably, in such cases the banks would get the balance from the government in accordance with the original guarantees given by the Department of Education.

Therefore, the Department's directive advises holders of student loan notes that, even where the holder determines that requiring repayment would not impose an undue hardship, the holder must nevertheless evaluate the cost of the undue hardship litigation in the bankruptcy adversary proceeding. If those costs are estimated to exceed one-third of the total amount owed on the loan, the holder may accept and/or not oppose an undue hardship claim by the borrower. Undue hardship regarding a student loan debt is asserted by a debtor by filing what is called an adversary proceeding.

It is a separate lawsuit within the bankruptcy case, which is presided over by the bankruptcy judge. After the evidence and legal arguments are presented, the court decides whether the debtor has proved a case of undue hardship. The numerous factors that are set forth by the Department in its July 7 directive will certainly provide more specific guidance to debtors and consumer bankruptcy attorneys in evaluating and deciding whether to challenge the debt. These rules will apply in Arkansas as well as nationwide. 

Source: Huffington Post, "Department of Education Reaches Decision About Student Loans and Bankruptcy", Steve Rhode, July 9, 2015

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