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Bankruptcy discharge pushed for school debt

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Statutes of limitations exist for nearly all federal criminal actions - except for espionage, treason, and since 1991, student loan default.

Delinquent borrowers may be relieved to learn that student loan default – unlike espionage and treason – is not punishable by death. But defaulting on a student loan can have disastrous effects on a borrower’s personal credit and lead to a lifetime of financial difficulties.

In February, the National Association of Consumer Bankruptcy Attorneys called on Congress to restore bankruptcy discharge for student loans in its report, “The Student Loan ‘Debt Bomb’: America’s Next Mortgage-Style Economic Crisis?” In the meantime, colleges, federal assistance programs and state governments are taking steps toward reducing loan debt before it becomes unmanageable.

Gradual changes in bankruptcy law put the squeeze on borrowers

In 2010, student borrowing for higher education surpassed $100 billion and total outstanding student loans exceeded $1 trillion for the first time in 2011.

Before 1976, federal student loans could be discharged in bankruptcy. But that year, Congress created an exception to United States Bankruptcy Code to exclude federal student loans from discharge unless they had been in repayment for five years. That exception was included in the 1978 Bankruptcy Act; then in 1990, the five-year repayment provision was changed to seven years. In 2005, Congress eliminated altogether the ability to discharge all federal and most private student loans – with one exception.

Borrowers may – in rare instances – be able to discharge student loan debt if they can prove in court evidence of undue hardship.

“Impossible – I’ve never seen it done,” said Jeff Hester, chair of the Commercial & Bankruptcy Law section of the Indiana-polis Bar Association. “I stopped reading the cases.”

David Ollis, chief counsel for the Chapter 13 trustee in Seymour, said most lawyers don’t even mention that slim chance of proving undue hardship.

“It’s such an uphill battle that most attorneys are putting in their plans: ‘The undersigned debtor will not discharge student loan obligations,’” Ollis said.

The NACBA mentions in its report the challenges in proving undue hardship.

In the case of Marie Brunner v. New York State Higher Education Services Corp., 831 F.2d 935 (2d. Cir. 1987), the 2nd Circuit Court of Appeals affirmed the finding that Marie Brunner failed to meet a three-pronged test of undue hardship: (1) 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 loans; (2) that additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period of the student loans; and (3) that the debtor has made good faith efforts to repay the loans.

In some cases – such as Denise Megan Bronsdon v. Educational Credit Management Corp., 435 B.R. 791 (BAP 1st 2010) – where borrowers attended college later in life, with no evidence to suggest that their job prospects would improve, courts have granted undue hardship. But in order to prove undue hardship discharge, borrowers would need to hire an attorney to sue their lender – an expense that struggling graduates generally cannot afford.

Dangers of default

Last September, the U.S. Department of Education released 2009 cohort default rates, which had increased across all sectors from the prior year.

The rates only consist of borrowers whose first loan repayments came due between Oct. 1, 2008, and Sept. 30, 2009, and who defaulted before Sept. 30, 2010. Among that group, public institution defaults increased from 6 to 7.2 percent, private institution defaults increased from 4 to 4.6 percent and for-profit default rates jumped from 11.6 to 15 percent.

Ollis said that once student loans enter default, people who enter bankruptcy and make good-faith efforts to repay their debt find their problems are compounded by some sections of the U.S. Bankruptcy Code. Ollis helped litigate such a case several years ago.

In Joseph M. Black, Jr., Trustee, Plaintiff-Appellant, v. Educational Credit Management Corp., and Margaret Spellings, Secretary of Education, Defendants-Appellees, 459 F.3d 796 (7th Cir. 2006), Ollis was part of the plaintiff’s counsel in a dispute about collection fees on two defaulted loans.

In that case, David Barnes received Federal Family Education Loan Program loans for $2,000 and $2,625 to attend truck driving school. He defaulted in 1989. Barnes and his wife filed for Chapter 13 bankruptcy protection in 1999, and in 2000, Educational Credit Management Corp. filed an unsecured proof of claim in the Barneses’ bankruptcy proceeding for $9,108.01, which represented $7,714.88 in principal and interest on the two defaulted student loans and $1,393.13 in collection costs. The collection costs were 18.06 percent of the $7,714.88 total of the principal and interest Barnes owed by then. ECMC arrived at this figure by using the methodology prescribed in 34 C.F.R. Section 682.410(b)(2), which allows the use of a flat “make whole” rate, in lieu of actual collection costs in the particular case.

Ollis argued that the law unfairly penalizes people who are attempting to make good on their defaulted loans. The Higher Education Act makes defaulters liable for “reasonable” collection costs, which the FFELP calculates based on the loan guarantor’s entire portfolio. That means a borrower who defaults but is trying to repay that debt is paying a pro rata share of collection costs for all other defaulted loans, regardless of whether those other borrowers in default are attempting to repay their debts.

People who enter Chapter 13 with defaulted student loans pay down their other debts so that they may be able to repay their loan debt after emerging from bankruptcy three to five years later. But during that time, their loan debts continue to grow.

“The thing that separates a credit card from a student loan debt is, they’re both unsecured debt, but in a student loan, the interest continues to accrue during bankruptcy,” he said.

Read a related story on how higher education is looking at address the student-loan economic crisis.

The call for reform

Hester said that most clients under age 40 or 45 who file for bankruptcy have student loan debt.

“What I’ve never understood is, why are they non-dischargeable? What is so special about this debt?” Hester asked. He also said that a simple fix – and one not available to student loan borrowers – would be the ability to refinance existing student loans at the prime interest rate.

Alan White, professor of law at Valparaiso University Law School and visiting professor of law at City University of New York, has written extensively about mortgage foreclosure, fair lending and other consumer law issues. He does see some parallels between what’s happening with student loan debt and the housing bubble – particularly because borrowers’ loan debt is growing faster than their ability to pay.

“It’s really the non-dischargeability of the student loan that’s the problem,” he said. “We like to think that bankruptcy is a screening device – there are rules in bankruptcy that keep people who can afford their debts from turning their backs on them.”

Among NACBA’s many recommendations for reform is that Congress re-impose a reasonable statute of limitations on student loan collections. The Higher Education Act Amendments of 1991 removed those limitations. Since then, the government has had the power to pursue for a lifetime people who have defaulted on federal student loans.

Over the years, Ollis has seen a shift in the people filing for bankruptcy.

“We’re seeing more and more student loan debt in these Chapter 13s, and the interesting thing about Chapter 13 is it has moved from people who were formerly working in factories and things like that,” he said. “It’s kind of gone middle class, so to speak.”•

Survey data from the National Association of Consumer Bankruptcy Attorneys.

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  • incroyable
    First off why should the taxpayers be subsidizing the fat salaries of academia who in many cases have been aggressively tearing away at the social fabric of the West for the past 50 years? (Deconstructionism, Marxism, you name it) Is that supposed to be a benefit to the nation? Only if the loans were for engineers and scientists and physicians. taxpayers subsidizing student loans for the erstwhile "humanities" is like the subject of a euthanasia having to pay for the poison in advance.

    Moreover, the debt ought to be nondischargeable like all others. Students are getting tricked into debt slavery and for what? A worthless diploma in many cases and a lifetime of interest-bearing debt they can never escape.

    I would like to see all the class-conflict Marxist professors who have benefitted from the postwar combine of the GI Bill and subsidized student loans to get together and out of solidarity contribute to a lobbying effort to modify student loans and make them dischargeable in bankruptcy. that is the least they can do to help the proletarian student graduates of today as they retire with their pensions and wonderful university ehalth care plans. And let the falsely named "nonprofit" universities soak up the losses. They dont pay enough in taxes to start with, anyhow. most universities could cut their managerial paper pushers by half and still do just as well.

    I compliment this newspaper on this excellent article on a timely issue of signficant public interest. I am sure that the paper will not share the sentiments of the first paragraph of my comment but nonetheless, well done.

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  1. He called our nation a nation of cowards because we didn't want to talk about race. That was a cheap shot coming from the top cop. The man who decides who gets the federal government indicts. Wow. Not a gentleman if that is the measure. More importantly, this insult delivered as we all understand, to white people-- without him or anybody needing to explain that is precisely what he meant-- but this is an insult to timid white persons who fear the government and don't want to say anything about race for fear of being accused a racist. With all the legal heat that can come down on somebody if they say something which can be construed by a prosecutor like Mr Holder as racist, is it any wonder white people-- that's who he meant obviously-- is there any surprise that white people don't want to talk about race? And as lawyers we have even less freedom lest our remarks be considered violations of the rules. Mr Holder also demonstrated his bias by publically visiting with the family of the young man who was killed by a police offering in the line of duty, which was a very strong indicator of bias agains the offer who is under investigation, and was a failure to lead properly by letting his investigators do their job without him predetermining the proper outcome. He also has potentially biased the jury pool. All in all this worsens race relations by feeding into the perception shared by whites as well as blacks that justice will not be impartial. I will say this much, I do not blame Obama for all of HOlder's missteps. Obama has done a lot of things to stay above the fray and try and be a leader for all Americans. Maybe he should have reigned Holder in some but Obama's got his hands full with other problelms. Oh did I mention HOlder is a bank crony who will probably get a job in a silkstocking law firm working for millions of bucks a year defending bankers whom he didn't have the integrity or courage to hold to account for their acts of fraud on the United States, other financial institutions, and the people. His tenure will be regarded by history as a failure of leadership at one of the most important jobs in our nation. Finally and most importantly besides him insulting the public and letting off the big financial cheats, he has been at the forefront of over-prosecuting the secrecy laws to punish whistleblowers and chill free speech. What has Holder done to vindicate the rights of privacy of the American public against the illegal snooping of the NSA? He could have charged NSA personnel with violations of law for their warrantless wiretapping which has been done millions of times and instead he did not persecute a single soul. That is a defalcation of historical proportions and it signals to the public that the government DOJ under him was not willing to do a damn thing to protect the public against the rapid growth of the illegal surveillance state. Who else could have done this? Nobody. And for that omission Obama deserves the blame too. Here were are sliding into a police state and Eric Holder made it go all the faster.

  2. JOE CLAYPOOL candidate for Superior Court in Harrison County - Indiana This candidate is misleading voters to think he is a Judge by putting Elect Judge Joe Claypool on his campaign literature. paragraphs 2 and 9 below clearly indicate this injustice to voting public to gain employment. What can we do? Indiana Code - Section 35-43-5-3: Deception (a) A person who: (1) being an officer, manager, or other person participating in the direction of a credit institution, knowingly or intentionally receives or permits the receipt of a deposit or other investment, knowing that the institution is insolvent; (2) knowingly or intentionally makes a false or misleading written statement with intent to obtain property, employment, or an educational opportunity; (3) misapplies entrusted property, property of a governmental entity, or property of a credit institution in a manner that the person knows is unlawful or that the person knows involves substantial risk of loss or detriment to either the owner of the property or to a person for whose benefit the property was entrusted; (4) knowingly or intentionally, in the regular course of business, either: (A) uses or possesses for use a false weight or measure or other device for falsely determining or recording the quality or quantity of any commodity; or (B) sells, offers, or displays for sale or delivers less than the represented quality or quantity of any commodity; (5) with intent to defraud another person furnishing electricity, gas, water, telecommunication, or any other utility service, avoids a lawful charge for that service by scheme or device or by tampering with facilities or equipment of the person furnishing the service; (6) with intent to defraud, misrepresents the identity of the person or another person or the identity or quality of property; (7) with intent to defraud an owner of a coin machine, deposits a slug in that machine; (8) with intent to enable the person or another person to deposit a slug in a coin machine, makes, possesses, or disposes of a slug; (9) disseminates to the public an advertisement that the person knows is false, misleading, or deceptive, with intent to promote the purchase or sale of property or the acceptance of employment;

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  4. I grew up on a farm and live in the county and it's interesting that the big industrial farmers like Jeff Shoaf don't live next to their industrial operations...

  5. So that none are misinformed by my posting wihtout a non de plume here, please allow me to state that I am NOT an Indiana licensed attorney, although I am an Indiana resident approved to practice law and represent clients in Indiana's fed court of Nth Dist and before the 7th circuit. I remain licensed in KS, since 1996, no discipline. This must be clarified since the IN court records will reveal that I did sit for and pass the Indiana bar last February. Yet be not confused by the fact that I was so allowed to be tested .... I am not, to be clear in the service of my duty to be absolutely candid about this, I AM NOT a member of the Indiana bar, and might never be so licensed given my unrepented from errors of thought documented in this opinion, at fn2, which likely supports Mr Smith's initial post in this thread: http://caselaw.findlaw.com/us-7th-circuit/1592921.html

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