Student Loans in Bankruptcy and the "Undue Hardship" Exception: Who Should Foot the Bill?

I. INTRODUCTION One of the fundamental characteristics of the American dream is that anyone should have the opportunity to get an education regardless of their ability to pay the cost. The Federal Student Loan Program started as a small allocation from the Department of Education to guarantee private loans in those exceptional cases where a person wanted to attend college but lacked the means to pay and the credit to obtain financing. Today, the Federal Student Loan Program accounts for more than half of the revenue produced in many higher educational institutions, making student loans a staple of American education. In public universities, 62% of students graduated with some kind of student debt; that number was 72% at private universities, and at the increasingly popular for-profit universities - where tuition rates are among the highest in the nation - it was a whopping 96%/ Along with this rise in federal funding and student loan guarantees, default rates skyrocketed as well, forcing many to seek the protection of bankruptcy to avoid mounting debts.2 As it turns out, the winning state for the most student debt is Arizona, home to the largest for-profit educational institution, the University of Phoenix.3 It's no secret: educational loans put students, as well as lenders, in a precarious position. There is no guarantee of employment for the student after graduation and no collateral for the lender. When the federal government started guaranteeing student loans, these loans were treated like any other kind of debt that could be discharged in bankruptcy. But in 1978, Congress began to withdraw such bankruptcy protection unless repayment of the loan would present an "undue hardship."4 This Act has incurred substantial criticism over the years for apparently being at odds with the overall goal of the Bankruptcy Code to provide a "fresh start" for the unfortunate debtor.5 Lenders contend that because there is no collateral to secure the loan, they need some kind of protection in order to provide other students with lower interest rates. As a result, taxpayers would ultimately have to foot the bill when the government ends up with a large number of defaulted loans. With debtors, lenders, other students, and taxpayers playing a game of musical chairs, someone is inevitably going to end up without a chair and be unfairly forced to bear the cost. The scholarly treatment of the "undue hardship" exception has been largely negative; scholars have argued either for a more lenient reading of § 523(a)(8) or for its repeal altogether.6 This Comment argues that there are legitimate reasons in support of a strict, uniform interpretation of "undue hardship" according to its plain language and the clear intent of Congress. While one underlying purpose of bankruptcy law is to provide a "fresh start" for certain qualified debtors, Congress has chosen to diverge from that policy in dealing with student loans, and for good reason. The results may be harsh, but they are not absurd. As more debtors receive such harsh treatment in the courts, Congress may be forced to reconsider the issue. As a result, Congress could restore equal protection for student loan defaulters, just as the Bankruptcy Code does for other debtors. Alternatively, Congress could preserve the current approach but turn its attention to the universities themselves, requiring them to truthfully educate prospective students about the risks of student loans and the reality of employment prospects upon graduation. Part II provides an overview of the bankruptcy system, the development of student loans in the United States, and the policies underlying § 523(a)(8) and its approach to student loans. Part III reviews how various courts have interpreted and applied the "undue hardship" exception in the student loan context. Part IV provides an analysis of these approaches, arguing that a strict implementation of the "undue hardship" exception is the best approach. …