Hello and welcome to MarketWatch. Additional credit column, a look at the news through the prism of debt.
A pernicious and often ridiculed aspect of student loans is that, unlike credit card debt or a car loan, they can follow a borrower forever because they are impossible to discharge in the event of bankruptcy – at least according to the conventional wisdom.
This week, we look at evidence that suggests that’s not always the case. A new report says up to $50 billion in debt, colloquially known as private student loans and held by 2.6 million borrowers, could actually be erased by a bankruptcy court. The findings come from an analysis released Thursday by the Student Borrower Protection Center, an advocacy group.
In recent years, lawyers, jurists, and even bankruptcy judges have begun to think more creatively about whether student borrowers are eligible for bankruptcy discharge. One lawyer in particular, Austin Smith, has made a career out of challenging the idea that all student debt stays with a borrower following a personal bankruptcy filing. So far, three appeals courts have sided with Smith, indicating that his clients’ debts may be eligible for discharge in the event of bankruptcy.
“There are actually a large number of borrowers who are being denied their right to bankruptcy because the student loan industry talks out of both sides of its mouth,” said Mike Pierce, executive director of SBPC.
Analysis comes after years of research and court rulings challenging mainstream wisdom on student debt in bankruptcy
The analysis derives from this growing body of legal research and court decisions. Although federal bankruptcy court theoretically offers a clean slate of financial obligations, Congress exempted federal student loans from bankruptcy discharge decades ago and private student loans in 2005. For years, borrowers and their lawyers who tried to erase the debt generally argued that it was imposing undue hardship on the borrower – an exception in the law that made the debt dischargeable, but was a notoriously difficult standard for borrowers to meet.
Smith took a different approach, claiming instead that his clients’ debts were not student loans as defined by bankruptcy law. For a student loan to be non-dischargeable in bankruptcy court, it must fall into at least one of the following four categories: a government loan, a loan from a non-profit organization, any other type of loan for eligible educational expenses – essentially a private loan up to the cost of attending an accredited school – or the obligation to receive funds as an educational benefit, stipend or scholarship.
In his cases, Smith argued that his clients’ loans did not fall into these categories. In some cases, it was because they weren’t certified by the school as being lower than its tuition and went straight to the borrower’s bank account. In others, it was because they were used to pay for an unaccredited program, such as a coding bootcamp, culinary course, or other professional training program at a non-degree school.
a large student loan processor, was the target of many of Smith’s lawsuits. In some cases, Navient pushed back, arguing that the loans provided an educational benefit and therefore should not be eligible for bankruptcy discharge. But the Second, Fifth and Tenth Circuit Courts of Appeals ruled that the educational benefits category does not include private student loans. Business is ongoing.
“The case law is definitely improving on this question of what is a loan that qualifies for this special non-discharge status,” said John Rao, an attorney at the National Consumer Law Center, who reviewed the report for SBPC. before publication. “We now have three circuits that have clearly said and taken this view that you have to comply with specific parameters of the legislation in order to get this special protection. The big question for me is how many of these loans are actually available. This report sheds some light on that.
The estimate provides a window, but the authors would like to see more transparency around this data
To arrive at the $50 billion figure, the SBPC looked at a variety of sources, including government reports, company disclosures to investors, and registration data, to estimate the percentage of private student loans made between 2000 and 2014 that did not. are not eligible for release.
They specifically tried to assess what share of private loans were made for ineligible expenses — thus those outside the cost of attending a school — and what percentage of private loans were given to students to attend unaccredited schools. Also, for a debt to be a qualified student loan and therefore not dischargeable in bankruptcy court, it must be assigned to an eligible student, the report noted.
Eligible students are US citizens who attend college at least half-time or more. To estimate the proportion of private loans issued to ineligible students, SBPC used the number of students attending less than half-time as an approximation, but it is likely that the number of loans issued to ineligible students during this period is even more important, according to Ben Kaufman. , responsible for investigations at the SBPC. This is because they did not include loans made to non-US citizens in their estimates.
Scott Buchanan, executive director of the Student Loan Servicing Alliance, a trade group representing student loan companies, questioned the estimate given that many types of loans at issue in the report were not regularly offered to students. borrowers for several years since credit markets tightened following the Great Recession.
Pierce, the SPBC’s chief executive, said he was happy with the organization’s estimates otherwise the group would not have published them. Still, “we shouldn’t have to guess that,” he said. Instead, he said regulators and the companies themselves should take steps to make this information more transparent.
The report suggests that some of the companies that have offered these loans agree that they could be released. The authors highlight communications made to investors by Sallie Mae and Navient – who separated from Sallie Mae in 2014 – indicating that the loans they made directly to borrowers as good as job training loans carried a risk of discharge in the event of bankruptcy. Despite this warning to investors, Navient continued to collect on these loans even after the borrowers filed for bankruptcy.
Paul Hartwick, a spokesperson for Navient, wrote in an email that the company “continues to support bankruptcy reform so that federal and private education loans are dischargeable after a good faith repayment period. “.
If it’s true, as the report suggests, that lenders were telling investors these loans could be forgiven while trying to convince consumers they weren’t eligible, “that’s really offensive,” he said. Rao.
“It’s really something that [Consumer Financial Protection Bureau] and state attorneys general should review,” Rao said. “Was this an attempt to trick consumers into thinking they really had no rights?”
Buchanan of the Student Loan Servicing Alliance countered that the messages investors and consumers are getting are both true. “If you tell investors that there is a risk that some of these loans will be canceled in the event of bankruptcy, it is absolutely true,” he said. “But if you’ve told borrowers it’s hard to get your loans discharged in bankruptcy, it’s true. These are two true statements.
The report suggests that the CFPB and state regulators should step in to help borrowers affected by these loans, using their authority to monitor and sanction companies that engage in deceptive practices in the debt creation and collection process.
Rao sees another reason these regulators are stepping in. According to the bankruptcy code, creditors who collect a debt after it has been discharged can be sanctioned by the court for contempt. But one 2019 Supreme Court judgment offered an opening for creditors to object to their disregard if there was any doubt as to the debt’s eligibility for discharge in bankruptcy.
“That could be at issue in some of these cases,” Rao said. In those cases, it could be difficult for individuals to sue for a penalty or even get back the money they’ve already paid after a debt was forgiven, Rao said. “This is where government enforcement could really help.”
It may already be more difficult for companies to claim that there is uncertainty surrounding the ability to repay these loans, Rao said. “The more they lose in court on this, the more difficult it is for them to claim that they had a valid reason to doubt in order to continue collecting.”
Small fraction of total outstanding student loans
Although the debt at issue in the report represents only a small fraction of the total $1.7 trillion in outstanding student loans, addressing the issues borrowers face with these loans is important, Kaufman said. , because basically borrowers have certain rights in bankruptcy court and the evidence says “they can’t access it because some companies don’t want it.”
Moreover, even if policymakers pursue large-scale student debt cancellation, private student loan debt is unlikely to be included. “What you’re left with is the bankruptcy system for the most economically vulnerable borrowers,” Pierce said, and so it’s “really important to make it work.”
Federal student debt, most of that $1.7 trillion, is still only dischargeable in situations where borrowers face undue hardship. But in recent years, some bankruptcy judges began to consider a broader definition of undue hardship than most courts have used for decades. Yet, since so few borrowers attempt to take legal action in this situation – it can be expensive and the prevailing wisdom that student debt is not dischargeable in bankruptcy can be a deterrent – major changes in this area are more likely to exit the court system.
“If there is to be a noticeable change, it will be whether the Ministry of Education itself is more willing to consider settling these cases,” Rao said. Advice from the agency could influence subsequent court decisions, he added.
The lawyers argued that the Department should stop contesting when borrowers try to discharge their debt due to undue hardship or at least create some kind of test of when it makes sense to collect.
Last year, the agency said it was revising its policies on student loan undue hardship releases in bankruptcy.