A key federal oversight agency is warning student loan companies not to try to collect payments from borrowers who have had their student loans discharged in bankruptcy.
The Consumer Financial Protection Bureau (CFBP), an independent federal agency charged with overseeing the financial services sector and protecting consumers from unfair business practices, sent out a bulletin this week “warning servicers of their obligation to halt unlawful conduct with respect to private student loans that have been discharged by bankruptcy courts.”
Here's what’s going on.
Background: Student loans and bankruptcy
The federal bankruptcy code treats student loans differently than it does most other consumer debts, such as credit card debt or unpaid medical bills. Under the code, in order to discharge student debt, borrowers must demonstrate that an “undue hardship” prevents them from repaying their student loans. This is a difficult standard to prove. The code does not expressly define “undue hardship,” so bankruptcy courts have created tests and tricky standards that can be near-impossible for many borrowers to meet.
Complicating things further is that in order to even try to prove undue hardship, borrowers must initiate an “adversary proceeding” — effectively a lawsuit within the bankruptcy case that the borrower must bring against their student loan lenders. In most cases, the lenders, including the federal government, will oppose the borrower. And since lenders typically have far more resources than a struggling borrower does, they may be better equipped to convince a bankruptcy judge to rule in their favor.
Bankruptcy discharge is possible for student loans
Even so, some borrowers can be successful in discharging their student debt in bankruptcy. It is a myth that it is completely impossible to discharge student loans in bankruptcy. Bankruptcy discharges do happen — it’s just not particularly common, nor is it easy.
But some private student loans can be comparatively easier to discharge. “Some private student loans can be discharged in a standard bankruptcy proceeding, just like most other unsecured consumer debts,” said the CFPB. “For this subset of private student loans, a bankruptcy discharge order eliminates the consumer’s debt.”
This can include private student loans issued to fund attendance at schools that are not eligible to receive federal student aid, such as:
- Unaccredited schools and foreign schools.
- Private student loans made in amounts in excess of the cost of attendance, which are often disbursed directly to the borrower.
- Private loans used to cover fees and living expenses incurred while studying for the bar exam or other professional exams.
In some cases, borrowers can discharge these private student loans in bankruptcy just like any other consumer debt, without having to prove undue hardship or go through an adversary proceeding.
CFPB says some private student loan companies are illegally collecting on debts discharged in bankruptcy
The CFPB has been investigating complaints that some private student loan servicers are improperly collecting on student loans that were discharged through bankruptcy.
“CFPB examiners identified student loan servicers who failed to distinguish between education loans that are discharged in a standard bankruptcy proceeding and loans that are not,” said the CFPB in a statement. “As a result, servicers improperly sought to collect on loans that had been discharged by bankruptcy courts. The CFPB found that, when faced with continued collection activities in violation of bankruptcy court orders, many borrowers continued to make payments, sometimes paying thousands of dollars on debts that they no longer owed.”
The CFPB warned that such practices are illegal and directed those servicers “to return illegally collected payments to affected consumers and immediately cease these unlawful collection tactics.” The CFPB retains enforcement powers — including the ability to impose fines or engage in litigation — for lenders and servicers who violate the law.
“When a court orders the discharge of a loan, lenders and servicers should not treat this as a suggestion,” said CFPB Director Rohit Chopra in a statement. “The CFPB has found that some servicers are ignoring bankruptcy court orders. The student loan servicing industry should ensure that their collection practices are compliant with the law.”
“After years of unfair, deceptive, and shamelessly predatory behavior by some of the largest financial companies in the world, the nation’s top consumer watchdog has finally stepped in to protect student loan borrowers,” said Amber Saddler, Counsel at the Student Borrower Protection Center (SBPC) in a statement on Thursday. “The entire student loan industry should take notice—the days of cheating borrowers out of their legal right to bankruptcy are over.”
Development follows new bankruptcy policy by the Biden administration
The CFPB’s warning to private student loan servicers comes just a few months after the Biden administration issued a sweeping new policy designed to make it easier for borrowers to discharge their federal student loan debt in bankruptcy.
Under the policy changes, the Education Department and Justice Department will have a borrower complete a detailed attestation form, where the borrower can provide information on their student loans and their overall financial circumstances. Using the information provided on the attestation form, administration officials will review the borrower’s situation to determine whether they may meet the undue hardship standard. If such a determination is made, the Justice Department would not oppose a borrower seeking a bankruptcy discharge.
While this technically does not change either the legal standard for student loan bankruptcy discharges or the need for a borrower to initiate an adversary proceeding, a bankruptcy court is far more likely to approve an unopposed bankruptcy discharge petition of federal student loan debt than a contested one. This may make it much easier for some federal student loan borrowers to discharge their debts.
Does this impact private student loans?
Importantly, however, that policy change only impacts federal student loans. It would take an act of Congress to fundamentally change the bankruptcy code to make it easier for private student loan borrowers to discharge their student loans in bankruptcy.
However, for those that are successful, this week’s CFPB bulletin may serve as a deterrent against practices that unfairly target borrowers who successfully got their private student loans eliminated through the bankruptcy process.
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