Loan Collections and Bankrupt Borrowers

Education Department issues new guidance on when guaranty agencies should oppose borrowers pursuing loan discharge in bankruptcy court; consumer advocates say it will provide little help.

July 8, 2015
 

The Obama administration on Tuesday issued new guidance on how aggressively loan collectors should pursue borrowers of federally backed loans who are seeking to erase their debt in bankruptcy.

Federal law allows student loans to be wiped out in bankruptcy only if the debt imposes an “undue hardship” on the borrower, which is a higher standard than other types of consumer debt like credit cards and mortgages.

Congressional Democrats have long pushed to ease the requirements, and the Obama administration earlier this year indicated that it may support such a change to the bankruptcy code. Without congressional action, though, the Education Department doesn’t have the power to tell bankruptcy courts what standard to use in deciding whether to discharge student loans.

But even without changing the standard, the department has some control over how the entities responsible for collecting federally insured loans, known as guaranty agencies, pursue borrowers for that debt.

Tuesday’s guidance recommends that guaranty agencies, in effect, more carefully consider under what circumstances they fight borrowers in court who are claiming that an undue hardship entitles them to have their debt discharged.

But the new guidance is far weaker than some consumer advocates and congressional Democrats had sought. And some said it was unlikely to change how guaranty agencies approach bankruptcy cases.

John Rao, a lawyer for the National Consumer Law Center, which represents low-income loan borrowers, said the group was “very disappointed” in the department’s guidance.

“This was a huge missed opportunity to do something constructive on the issue,” he said. “It will not be helpful. It will not change anything in terms of how these cases are handled.”

Rao said the department should require that guaranty agencies exercise the equivalent of prosecutorial discretion in the cases and promote settlements with borrowers.

“They ultimately call the shots here and they could be persuasive in encouraging settlement,” he said.

Last year, a New York Times article reported on concerns about the practices of ECMC, the most prominent guaranty agency that collects government-backed student loans. The company, the Times reported, had been reprimanded by some judges for pursuing borrowers in bankruptcy cases who obviously could not repay their loans.

In response to the article, a handful of Democrats, including Senators Dick Durbin and Elizabeth Warren, urged the Education Department to require guaranty agencies to presumptively assume that borrowers who fall into certain categories -- like disabled veterans and borrowers who have had poverty-level wages for five years in a row – qualify for bankruptcy discharges.

The National Council of Higher Education Resources, which represents guaranty agencies, said in a statement that the department's guidance was "a helpful summary of the statutory, regulatory and legal history of student loan bankruptcy."

The guidance comes as the administration is studying proposals to expand bankruptcy protection to all student borrowers and is trying to set up a new debt relief process for students who claim they were defrauded by their colleges.

Read more by

Back to Top