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Rethinking Bankruptcy and Student Loans

Rethinking Bankruptcy and Student Loans
September 24, 2009

WASHINGTON -- As Congress and the White House move to alter bankruptcy code to make it more equitable to consumers, a House subcommittee began a reconsideration Wednesday of how bankruptcy law treats private student loan debt.

Rep. Steve Cohen (D-Tenn.), chair of the House Judiciary Subcommittee on Commercial and Administrative Law, held a hearing to initiate legislation reversing a 2005 change in federal bankruptcy law that, he said, gave private student loan lenders a “favorable, unusual” advantage over borrowers, as well as in comparison to the issuers of most other kinds of consumer loans. "Hopefully it’ll be bipartisan and if not, you know, we’ll just have to forge ahead and do what’s right.”

After the hearing, he formally announced plans to file legislation to “give private student loan borrowers more equitable treatment during the bankruptcy process.”

Rep. George Miller (D-Calif.), chairman of the House Education and Labor Committee, hailed the drafting of new legislation as meeting “a growing need to protect students from financially riskier private student loans and predatory lending practices,” especially with rising college costs and an unemployment rate approaching 10 percent.

The subcommittee’s senior Republican, Rep. Trent Franks of Arizona, seemed receptive to some reform of the private student loan industry, but cautioned that if the bill passed last week “isn’t the death knell of private student lending, ending the favorable treatment student loans receive under bankruptcy code certainly could be.”

Bankruptcy law bars virtually all borrowers from discharging their private student loan debt, even as most other forms of consumer debt -- including auto loans, credit card debt and mortgages -- can be discharged through bankruptcy proceedings. The only exceptions are made in cases of “undue hardship.”

Though federally guaranteed student loans usually can’t be canceled in bankruptcy cases either, they do come with fixed interest rates, flexible payment plans and other consumer protections that generally make them less onerous for borrowers, said Lauren Asher, president of the Berkeley, Calif.-based Institute for College Access and Success. “Private student loans are one of the riskiest ways to pay for college,” she said, adding that the loans “are not financial aid any more than using a credit card to pay for tuition or books is financial aid.”

Even so, students are turning to the loans to make up the gap between federal student loans (which top out at $12,500 per academic year for independent undergraduates in the last two years of study) and the ever-rising costs of tuition and fees at American colleges and universities. According to calculations by Asher’s organization, two-thirds of all graduates of four-year colleges have student loans, averaging $23,200 in federal and private loans, and a third of students who earned a bachelor’s degree in 2007-8 took out a private student loan during their time in college. Fourteen percent of all U.S. undergraduates took out a private student loan in that academic year, up from 4 percent in 2003-4.

Rep. Danny Davis (D-Ill.) testified at the hearing on behalf of the Congressional Black Caucus’s Community Reinvestment Task Force, which he co-chairs, and expressed particular concern for African-American students who, he said, “were statistically more likely to borrow private student loans,” at a rate of 17 percent.

Last year, as the House voted to reauthorize the Higher Education Act, Davis proposed an amendment that would have allowed borrowers filing for bankruptcy to discharge their private student loans as part of that process, so long as the loan had required repayment for at least five years. The measure failed in a 236 to 179 vote. Cohen’s bill will probably be modeled after Davis’s amendment.

Facing Bankruptcy

Over the course of earning a bachelor’s degree, a student at a particularly pricey institution receiving little or no grant aid could end up borrowing $100,000 or more in private loans, said Brett Weiss, a consumer bankruptcy lawyer who testified on behalf of the National Association of Consumer Bankruptcy Attorneys and the National Consumer Law Center. It’s “unfair,” he said, for other loans of that magnitude, like mortgages, to be forgiven in bankruptcy proceedings while student loans are not.

J. Douglas Cuthbertson, a lawyer who represents financial institutions in federal consumer financial litigation for the McLean, Va.-based law firm Miles & Stockbridge, warned of “debtors filing for bankruptcy almost solely on student loans,” as was sometimes the case before 1976, when Congress barred discharge of student loans within five years of college graduation. A 1990s change to bankruptcy code made the minimum seven years, and the 2005 code revision made it all but impossible to have student loan debt canceled.

Franks and Rep. Howard Coble (R-N.C.), the two only members of their party at the hearing, voiced support for Cuthbertson’s argument, the same one that has been used by Republicans whenever changes to bankruptcy law have been considered.

But Weiss cited a 1970s study by the Government Accountability Office that found that less than 1 percent of all matured student loans had been discharged in bankruptcy and dismissed Republican concerns about widespread manipulation of the bankruptcy code.

The notion that “people who view bankruptcy as an easy option … is so far from the reality, it’s just absolutely dead wrong,” he said. “Student loans are not primary factors for bankruptcy filings. Student loans are sort of in the mix.… People very, very rarely file for bankruptcy because of a student loan.”

Defining 'Undue Hardship'

The only chance borrowers have to discharge their private student loans during bankruptcy proceedings comes by being able to demonstrate “undue hardship,” a term that has not been concretely defined by Congress and is up for varied interpretations by bankruptcy judges.

Rafael I. Pardo, an associate professor at the Seattle University School of Law who has done extensive studies on student loans and their discharge in bankruptcy, called on Congress “to clarify the undue hardship standard.”

Courts generally go through long investigations to determine whether debtors have faced exceptional challenges, such as physical or mental disabilities, a lack of job skills or an absence of future earning potential. Final rulings are up to the discretion of judges, Asher of the Institute for College Access and Success said, and much more likely to happen with the benefit of “a high-priced attorney.”

All four experts who testified voiced support for Congress to create its own definition of “undue hardship,” which could be easily used to evaluate all bankruptcy cases involving student loans.

Democrats and Republicans on the subcommittee were all receptive to the formulation of a definition.

 

 

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