Predatory Student Loans, CFPB v ITT

Catching up on a few more stories that took a back burner during the past year.  The Consumer Financial Protection Bureau, last spring, filed a lawsuit against ITT for predatory lending practices.
CFPB alleges that the technical school chain charged tuition substantially higher than that of community colleges and even some universities, forcing many students to accept private student aid from ITT at high interest rates.  Many ITT credits are non-transferrable to other education institutions, and ITT is alleged to have used the threat of expulsion and sunk costs to force students to take private loans.

Separately classified unsecured debts in Chapter 13.

Chapter 13 of the bankruptcy code provides for, among other things, the curing of priority debts, such as taxes and child support.  This is a good thing, because most priority debts are non-dischargeable, so by having them fully paid in a Chapter 13 Plan, it helps the debtor exit bankruptcy with less surviving debt.
However, not all non-dischargeable debts are priority debts.  Student loans are a prime example.  Since interest continues to accumulate on student loans, what is a debtor to do to avoid coming out of Chapter 13 with bigger student loan problems than he or she had going into bankruptcy?
Bankruptcy courts in this district have ruled that debtors can provide for separate classification of student loans – to pay them separately, outside of the Chapter 13 Plan.  Two of those cases that we will be looking at today are In re Truss, 404 B.R. 329 (Bankr. E.D. Wis. 2009) (Judge McGarity) & In re Hanson, 310 B.R. 131 (Bankr. W.D. Wis. 2004) (Judge Kelley).
Both cases declined to allow the debtor to deduct payments to a student loan creditor on the Means Test (Form B22C).  However, the debtors were allowed to maintain payments on the student loans.  In order for the plans to be confirmable, the judges weighed two seemingly contradictory statutory provisions.  11 U.S.C. § 1322(b)(1) (which prohibits unfair discrimination amongst classes of unsecured claims) and 11 U.S.C. § 1322(b)(5) which allows the maintenance of long term debts.
To avoid scrutiny under (b)(1), the maturity date of the student loan had to be out past the term of the Chapter 13 Plan.  The debtors were also required to maintain the loan (they couldn’t propose to accelerate payments, and they couldn’t propose to make less-than-contractual payments).
Other special classifications have been allowed under what is referred to as the Crawford test.  Examples of these are creditors who may file criminal charges and creditors who can revoke occupational licenses.  In these cases – should the debtor not be allowed to pay these creditors in full and face the consequences, the result would most assuredly be that the debtor would lose his or her source of income and be unable to fund the plan – a lose-lose scenario for both the debtor and the other unsecured creditors.  In such cases, it is better to have one or two creditors paid with preference over all other creditors, rather than see all creditors get paid nothing at all.

Creditor Superpowers

Not all creditors are created equal.
Some debts are “secured” which means the lender can exercise security rights in collateral you own if you default under the terms of the note.  For example, if you stop making payments on a secured loan, a mortgage lender can foreclose your home, and an auto lender can repossess your car.
Other debts are non-dischargeable in bankruptcy.  A full list of these can be found at 11 U.S.C. § 523(a), but it includes items such as taxes, student loans, debts incurred by misrepresentation and fraud, domestic support, and certain governmental debts, among other things.
Secured debts and non-dischargeable debts are the two most common distinctive classes of debts that people going through bankruptcy are made aware of.  But there are a number of superpowers that certain creditors have over other creditors, and we’re going to go over some of the most pertinent ones here.
Utility Companies – are given special status under 11 U.S.C. § 366, and may discontinue utility services if the debtor does not provide adequate assurance of payment, such as a deposit.  In my experience, requests for deposits have been relatively rare, but they do occur from time to time.
Internal Revenue Service and State Taxing Authorities – in addition to the non-dischargeable and priority status that many tax debts enjoy, taxing authorities are also allowed to file claims in a debtor’s Chapter 13 case for tax debts that arise after the bankruptcy case is filed under 11 U.S.C. § 1305.  For example, John Doe files a Chapter 13 Bankruptcy in 2011 with a 5 year term.  In 2013, John Doe finds that he owes taxes to the IRS for the 2012 tax year.  The IRS can file a claim in John’s existing bankruptcy case and force the debt to be paid in the plan.  On the one hand, this is a good thing, because the tax won’t incur interest while it’s paid in the plan.  On the other hand, it may be difficult for John to fund his plan when it is saddled with the new debt, particularly if John is nearing the end of this plan (no plan can go longer than 60 months, so the later in the plan that this happens, the less time you have to spread the payments out).
Student Loan Creditors – filing bankruptcy can trigger higher default interest rates, which is particularly a problem for Chapter 13 debtors who are not paying off their student loans in full during the Chapter 13 Plan.  Since student loans are currently non-dischargeable (there has been a lot of buzz in Washington lately about possibly amending the bankruptcy code to allow certain types of student loans to be discharged under certain conditions), those post-petition rates continue to be incurred throughout the life of the bankruptcy plan.  Bruning v. United States, 376 U.S. 358 (U.S. 1964).

A side-by-side comparison of Chapter 7 and Chapter 13 Bankruptcy.


Chapter 7
Chapter 13
Generally
Liquidation of non-exempt assets, discharge of general unsecured debts.
Reorganization and repayment plan.  Debts split into categories. Some paid in full, others paid a percentage based on income and other factors.
Duration
Time between filing and discharge is approximately 4 months.
Time between filing and discharge is approximately 3-5 years.
Cost
Cheaper
More Expensive
Income
Must be below median or be able to “beat” the Means Test.
Surplus disposable income on either the Means Test or the budget.
Prior Bankruptcy
Ineligible to file if filed a prior Chapter 7 in the last 8 years or a prior Chapter 13 in the last 6 years.
Eligible to file even if not eligible for a discharge. Eligible for discharge 4 years after prior Chapter 7 or 2 years after prior Chapter 13.
Assets
If equity exceeds allowable exemptions, trustee can sell for benefit of unsecured creditors.
Assets are not liquidated, but repayment plan may require a minimum threshold paid to unsecured creditors to make them as whole as they would have been under Chapter 7.
Stay Protections
Both chapters stop collection efforts, lawsuits, wage garnishments, and utility disconnection.
Repossession & Foreclosure
Automatic stay suspends pending actions temporarily, but no adequate protection for arrears.
Arrears are cured. Foreclosure and repossession fully stayed pending successful completion of repayment plan.
Codebtor Stay
No
Yes
Other Issues
Preference payments, insider payments, transfers of assets, excessive gambling losses, and fraudulently incurred debt all pose the risk of adversary proceedings or denials of discharge.
Chapter 13 is sort of a fix-all remedy to anything that might be a problem in Chapter 7. Many issues become non-issues, or are mitigated with a floor amount paid to unsecured creditors spread out over the life of the repayment plan.
Discharge
Non-dischargeable debts simply survive the bankruptcy.
Certain non-dischargeable debts (priority debts, such as taxes and child support) are paid in full.  Other non-dischargeable debts (such as student loans) can be paid down concurrently with unsecured creditors.
Credit
Most people have improved credit scores about 12 months after bankruptcy is filed, assuming they have made payments on surviving debts (e.g. mortgages, car loans, or student loans).
Credit rebuilds a little faster in Chapter 13 than in Chapter 7.

  

Student Loans in Bankruptcy

Recently, Anton Nikolai gave an informative presentation regarding student loans to bankruptcy attorneys at the Lou Jones Breakfast Club.  You can read the full text of the presentation, but I wanted to share some bullet points.
Most people are aware that student loans are non-dischargeable in bankruptcy under 11 U.S.C. § 523(a)(8), which can be broadly interpreted to any sort of debt incurred for an educational purpose or benefit.  I’ve even seen arguments in the past that credit card debt incurred to pay off a student loan could be held non-dischargeable – similar to the reasoning for making credit card debt for payment of taxes non-dischargeable (which is expressly provided for by statute at § 523(a)(14) and (14A).  The non-dischargeability of educational benefits applies to both governmental and private student loans.
There is an exception carved out by statute – undue hardship.  But this is more than your ordinary hardship standard.  In fact, the 7th Circuit has adopted one of the most stringent tests for undue hardship in these circumstances, called the Brunner test (from Brunner v. New York State Higher Educ. Serv. Corp., 831 F.2d 395 (2d Cir. 1987)).  The test requires:
  1. Debtor cannot afford to maintain a minimal standard of living if forced to repay student loans.  (This is a tough burden, but not impossible to prove.)
  2. Circumstances exist indicating that this inability is likely to persist for the majority of the repayment period – a certainty of hopelessness.  (This is almost impossible to prove.)
  3. Debtor has made good faith efforts to repay the loan.

The automatic stay does stop student loan collection practices, but those collection practices may resume after discharge once the case is terminated and the automatic stay is lifted.
Federal student loans have powers that private student loans do not.  They do not need a state court judgment to garnish wages.  They may do so automatically through an “administrative garnishment”.  But this garnishment, too, would terminate while a bankruptcy case is pending.
In Chapter 13 Bankruptcy, student loans are considered general, non-priority, unsecured debt.  Meaning they get paid at the same rate as your other general unsecured debts (e.g. credit cards and medical bills).
Unless your Chapter 13 plan proposes to pay such creditors in full, you will have an unpaid balance on your student loans.  Upon exiting bankruptcy, your student loan account may be in default, and subject to default interest rates.
There have been some instances of debtors in bankruptcy proposing to pay their student loan creditors separately, outside of their Chapter 13 repayment plan.  To do so requires that the student loans be treated as a special class of creditor.  This can only happen if the last contractual due date of the loan is after your last scheduled Chapter 13 plan payment.  While the bankruptcy code does permit for special classes of creditors to be created, it also prohibits debtors from creating special classes that discriminate unfairly.  At this time, there is no judicial consensus that student loans can be a special class.  Some judges allow it.  Others do not.
If your plan does not provide for payment in full of your student loans, you will want to make sure that your student loan creditors file proofs of claim in your Chapter 13 bankruptcy.  Although they are stayed from collecting while you are in bankruptcy – whether they file a claim or not – if they don’t file a claim, it means that they will not get paid and your other creditors who do get paid will be paid more money.  Since student loans are non-dischargeable, it is in your interest that they get paid during your bankruptcy plan.Don’t rely on your attorney to determine if your student loan creditors filed claims.  First of all, your attorney is probably handling dozens or hundreds of cases at a time, each with dozens or hundreds of creditors.  It’s tough to verify a negative under these conditions.  Also – particularly with private student loans – it’s not always simple for your attorney to distinguish a student loan creditor amongst your list of other creditors.  Creditors have 90 days from the date of your first meeting of creditors to file a proof of claim.  If they don’t, your attorney has another 30 days to file claims on their behalf under Rule 3004 of the Federal Rules of Bankruptcy Procedure.  If there is anyone you want to get paid, you’ll want to make sure your attorney is aware.There are four types of federal student loans: Stafford, Parent Plus, Graduate Plus, and Perkins.  To determine which of your student loans are federal, check out http://www.nslds.ed.gov/.
There are a few ways to have a student loan administratively discharged (outside of bankruptcy), but these are rare: school closure, disability, unpaid tuition refund, and false certification.Student loans are in one of five repayment statuses: in-school deferment, repayment, other deferment, delinquency, and default.In a default, a federal student loan can intercept tax refunds, wages without a court order, and social security benefits.In a loan is in default, you can rehabilitate the loan to exit default status – but this is a once in a lifetime event.  You must make 9 out of 10 payments to do this.There are various repayment plans you can explore to pay your student loans in a manner that is more affordable.
  1. Standard Repayment (fixed payments for 10 years)
  2. Graduated Repayment (10 years, starts out small, then increases every 2 years)
  3. Extended Repayment (25 year term, fixed or graduated, must have more than $60k in student loan debt)
  4. Income Contingent Repayment (25 year term, based on income AND student loan balance, balance at end is forgiven)
  5. Income Based Repayment (25 year term, based solely on income, $0 payments are possible, unpaid balance is forgiven, pay 15% of calculated discretionary income (income beyond 150% of poverty guidelines), payments adjust each year based on prior year’s taxes)

Note: any forgiven balances in ICR or IBR are taxable income.