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NYT on Student Loans in Bankruptcy

posted by Bob Lawless

At the New York Times, Ron Lieber has a story about the treatment of student loans in bankruptcy. The story does a good job of explaining the harshness and capriciousness of the current system, but it is a story that bankruptcy lawyers and judgres already know. We have been discussing these problems since the early days of Credit Slips, but it is great to see the facts get to a wider audience. Maybe that will help us get some change.

The bankruptcy rules for dealing with student loans are broken. An easy fix would be to go back to the old rules where, after a certain amount of time has passed, student loans are treated like any other unsecured debt and subject to discharge. Back in 1976, the period was five years and then it became seven years in 1990. A time period like that sounds about right. Persons seeking to discharge their student loans before the expiration of the waiting period would still need to show undue hardship. The old system struck a balance between the problems that would ensue if recent graduates could too easily walk away from their loans immediately after graduating and the harshness of the current system.

Indeed, the reason we have the current problems is largely because "undue hardship" was meant to be a rare exception to the 5- or 7-year period before a student loan became dischargeable. Congress repealed the waiting period but did not do anything to the underlying standard. Now, we just have a harsh standard.


Its hard to believe student loans are treated the same as crime victims compensation and not your mortgage or your credit card debt, there is an understanding of federal loans but to single out private student loans is an influence of private industry on congress, imagine if the same applied to companies that go through bankruptcy.

That is very said that we do not have waiting time anymore. It would have really been reasonable to return to the old system since it was very convinient. Now it is way more complicated to pay off the debt. Our standards are terrible

Ahh but it's even worse that that, student loan debit is not treated as secured debit in bankruptcy thus putting them second in line for money flowing towards creditors in the process

Bob....can't you see that this time-in-repayment stipulation, whether 5 years or 7 years, is precisely what lenders like Sallie Mae have been hoping and planning for all along? With the change to the Bankruptcy Code in 2005, discharge is now available only to debtors who pass a means test and are deemed destitute. This effectively negates the need for an additional test (the undue hardship adversary lawsuit), which discriminates against poor debtors who are the least likely to have attorney representation in the adversary lawsuit process. For this reason, the “undue hardship” requirement should be stricken from the Bankruptcy Code.

I believe that influential people like yourself and others who post on Credit Slips should help the pending private student loan legislation to move forward without any “time in repayment restrictions” as long as the debtor qualifies for bankruptcy under the strict BAPCPA formula.

Private student loans, including those that involve a non-profit entity, should be dischargeable WITHOUT time in repayment restrictions since these loans are credit based and are no different than credit card debt. The inability to discharge these loans under the current law places a disproportionate burden on poverty stricken debtors, with minorities being the hardest hit. These loans have been called the “wild west” of lending, and are the worst of the predatory loans, with interest rates exceeding those of even the highest interest rate credit cards.

Prior to 1976, all student loans were dischargeable in bankruptcy. From 1976 to 1990, government guaranteed student loans were dischargeable after 5 years in repayment, and private student loans were dischargeable without limitation. From 1990 to 1998, government guaranteed student loans were dischargeable after 7 years, and private student loans were still fully dischargeable without limitation. From 1998 to 2005, government guaranteed student loans were non-dischargeable except for undue hardship; private student loans were still dischargeable except for loans made or insured by a non-profit institution. This was a no-brainer for the lenders, since all they had to do was set up a “non-profit” entity that had even the remotest and most obscure involvement in the loan process (i.e. Sallie Mae's "USA Funds").

In 2005, Congress passed BAPCPA, making private educational loans nondischargeable, where before it had only applied to governmental loans. Ever since BAPCPA, both private (either with or without non-profit involvement) and government guaranteed student loans are nondischargeable in bankruptcy unless there is a showing of undue hardship.

Lenders are now “compromising” – oh, gee, how nice of them – saying they will be okay with allowing private student loans to be dischargeable after having been in repayment for several years. This is a losing proposition for distressed low income borrowers. You would be leaving the decision of whether or not to discharge private student loans up to bankruptcy judges who have a longstanding and deeply ingrained bias against student loan debtors. Judge Gene Wedoff, right here on Credit Slips, called the treatment of student loans in bankruptcy, “punitive…despite the absence of wrongful conduct by the debtor.” Back when student loans were dischargeable after a set number of years in repayment, lenders systematically employed a method of applying retroactive forebearances and deferments for the sole purpose of protecting the loans from discharge. Lenders cried to the Court about how they should not be penalized for "helping" borrowers. Judges mostly agreed, and sided with lenders by adding back in the time these loans had been in forebearance/deferment -- even when forebearances and deferments had not been requested by the borrower! The burden was on the debtor to cobble together five (or seven) repayment years -- An almost impossible task when records of legitimate forebearances and deferments had long ago been misplaced or lost, while the more numerous and longer imaginary forebearances and deferments which existed only in the minds and computer printouts of the lender’s were readily available to admit into the record.

If you think this can’t happen again, remember that lenders have many years’ worth of experience under the old law of manipulating time periods, dates, paperwork, and computer records. Similar shenanigans continue to this day. Consider that a former Sallie Mae employee in Indiana filed a whistleblower complaint, stating that telephone agents working for Sallie Mae on behalf of USA Funds routinely falsified borrower requests for forbearances, often just dialing a borrower’s telephone number and letting the line sit open for a few minutes while Sallie Mae’s computers record an apparent conversation. The agent then lists the borrower as having approved a forebearance, when no such approval occurred. The law requires the lender to send a written confirmation to the borrower by mail, but it doesn’t require any proof that the letter was received. Could it be that they are busy creating dummy paperwork in anticipation of a revision to the bankruptcy law?

And what of the COST to the debtor who has to prove that their loans meet all the requirements for discharge? The onus is on the debtor to file the dreaded Adversary Petition in order to determine the dischargeability of their student loans -- “dreaded” because bankruptcy lawyers dread filing them, and usually won't. “Adversary petition” sounds like a simple process, but it is actually a formal lawsuit that begins with filing a complaint, demurrers, cross complaints, discovery, depositions, interrogatories, and that’s just PRE-trial, all at a cost of tens of thousands of dollars. With the debtor’s bankruptcy attorney having exited the scene, the debtor is now left to go it alone against an army of experienced student loan industry lawyers. Distressed low income debtors do not have the money or skill to navigate this legal obstacle course, let alone ever being able to meet the time-in-repayment requirements as they will be interpreted by attorneys for the lenders. Multiply this by four or five student loans, each loan with possibly a different lender, and each loan with its own separate terms, forbearances, deferments and repayment history. This would be a daunting undertaking for even the most experienced bankruptcy attorney, who of course wouldn’t touch it with a ten foot pole anyway.
Please do not fall for the line, “It’s better than nothing”, when the edudebt industry (and even some uninformed debtor advocates who are unaware of the true history of how student loans have been adjudicated in actual practice), suggest legislation making private student loans eligible for discharge after a set number of years in repayment. Please recognize that the adversary petition process is stacked against debtors, and that it is not better than nothing -- It IS nothing. Any change in the law that puts the burden on the debtor to drag themselves through hoops that even experienced debtor bankruptcy attorneys cannot jump through, will provide no help whatsoever to these destitute borrowers.

Elizabeth Warren has said that “...Ultimately the non-dischargeability decision boils down to two simple policy questions:  Why should students who are trying to finance an education be treated more harshly than someone who negligently ran over a child or someone who racked up tens of thousands of dollars gambling? And why should a for-profit lender receive the kind of extraordinary protection that is usually reserved for domestic support recipients or the government?"

There is a very great need for the complete elimination of the undue hardship requirement, and also for private student loans to once again be dischargeable in bankruptcy....with stipulations attached that will render the legislation useless. I hope that any changes you advocate for in the future will be free of minefields for the debtor, and free of the loopholes which student loan lenders have a long history of exploiting to their full advantage.

In my second-to-last sentence, corrected to say..."WITHOUT stipulations attached that will render the legislation useless."

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