The Education Department is routinely contesting requests for bankruptcy discharges from people deep in debt and short on resources, according to court documents. Consumer advocates say the practice runs counter to the Biden administration’s interest in helping distressed borrowers and undermines the department’s effort to reform its restrictive bankruptcy policy.
What’s more, advocates say the department has been making unreasonable demands on borrowers in the middle of the public health and economic crisis.
One single mother of three was told her 15-year-old son could get a job and she could fight harder for child support to free up money to pay her loans. A grandmother working two jobs to care for her disabled grandson was encouraged to find higher-paying work, while the department pressed another borrower to take on a second job at a time when millions of Americans were facing unemployment.
The Washington Post reviewed dozens of bankruptcy cases from New York to Arizona involving federal student loans and found a similar pattern of demands.
“Why is the government continuing to take such harsh stances against these struggling borrowers at this moment,” questioned Dan Zibel, chief counsel at the National Student Legal Defense Network, a nonprofit organization. “The department should take a hard look at what it’s doing, what message it’s sending to borrowers.”
The barriers to discharging education debt through bankruptcy are high, but not insurmountable. People must bring a separate lawsuit within their bankruptcy case – known as an adversary proceeding – to have their student loans discharged. They have to convince the court the debt would impose an “undue hardship” and fend off the lender from thwarting their effort.
As the creditor for $1.6 trillion in federal student loans, the Education Department has the right to contest a bankruptcy discharge to maintain the fiscal integrity of the lending program. But consumer groups argue the department also has an obligation to help struggling borrowers.
Zibel, who worked in the Education Department during President Barack Obama’s administration, co-wrote a paper exploring reforms to the department’s bankruptcy policy. He argues that the federal agency relies on a rigid interpretation of case law to determine undue hardship.
People must prove a “certainty of hopelessness” to meet the department’s standard, a position that a growing number of bankruptcy judges say is flawed or absurd.
Even the department has given a second thought to its policy, asking the public in 2018 for feedback on whether updates were needed. At the time, the agency questioned whether borrowers are being discouraged from seeking help because its standard is too prohibitive.
The Education Department said it is still committed to reviewing its policy on bankruptcy discharges to assess the types of changes that could better protect borrowers.
“While that review work continues, the department also recognizes the added challenges, including risks to personal health, that comes from the ongoing pandemic,” an agency spokesperson said in an email.
As a result, the department has agreed “to any stay of proceedings requested by the plaintiff in bankruptcy actions at least through the end of the pause on student loan payments.” The payment freeze, which has been in effect since March 2020, is slated to end in September.
But for some borrowers looking for a fresh start, there is no point in delaying their bid for full debt relief.
Sarah Bannister, 63, has spent the past 12 years struggling to pay the private and federal loans she took out to send her daughter and son to college. She had negotiate lower payments only to fall behind, enroll in payment plans based on her income but be asked to pay more than her rent.
Even with a steady job working for New York City, Bannister said there was no way she could keep pace with the payments. Interest continued to accrue. Collection fees mounted. And what started as roughly $200,000 in student loans ballooned to three times as much.
This month, Bannister learned the department is contesting her bankruptcy discharge request.
“There is no way I can get from under all of this debt,” Bannister said. “I’ve tried to get new jobs, higher-paying positions and I get small promotions, but it’s not enough to make a difference.”
The moratorium on federal student loan payments has been a reprieve, but Bannister fears she will default and ultimately have her wages garnished when it ends. Her children have tried to help, but they are contending with their own education loans and living expenses.
“I don’t want to be homeless,” said Bannister, who lives in subsidized housing in New York. “If [the department] insists that I pay these loans and garnish my check, that is a real possibility.”
Aaron Ament, former chief of the department’s office of the general counsel under Obama, argues it is “unconscionable” that the Education Department is still spending resources to fight borrowers seeking a second chance.
“Secretary [Miguel] Cardona should reverse course and do everything in his power to protect student borrowers most in need, especially those in bankruptcy during the pandemic,” said Ament, who co-wrote the bankruptcy article and is now president of the National Student Legal Defense Network.
Advocates worry the ongoing economic fallout of the pandemic could drive an increase in personal bankruptcy filings once government interventions end. About 20% of outstanding student loan debt was delinquent before the pandemic and that number could skyrocket when the payment pause ends in the fall.
Ament, Zibel and Pamela Foohey, a professor at Yeshiva University’s Benjamin N. Cardozo School of Law, estimated in their paper that most people who file bankruptcy owe $20,000 or less in student loans. A borrower could spend as much as $10,000 seeking a discharge, while the department could spend more than it will ever collect fighting the case.
The department could set practical thresholds for a bankruptcy discharge, Foohey said. It could forgo contesting a request if more than half of a person’s income is derived from Social Security or disability payments. Or if their household earnings have been far below federal poverty guidelines for several years.
While there are steps the Education Department could take to better define undue hardship, Congress would ultimately need to rewrite the rules it put in place for a monumental shift in the treatment of student loans in bankruptcy.
There have been bills introduced in recent years to overhaul the system. While those attempts have failed, there is renewed interest from lawmakers and the administration. President Biden, who helped impose tougher consumer bankruptcy laws as a senator, said he now supports letting people who enter bankruptcy discharge their student debt.
Still, reforms will be challenging. Policymakers must consider whether relaxing standards will result in congressional cutbacks in the federal loan program, or heightened creditworthiness standards from private lenders, said Stanley A. Freeman, a partner in the education practice at the law firm Eversheds Sutherland.
There is also the issue of moral hazard, the risk of incentivizing borrowers to take on debt and evade repayment through bankruptcy. Foohey said that argument falls flat because of the cost, complexity and moral stigma associated with filing for bankruptcy.
“Filing for bankruptcy is not a decision that is taken lightly,” Foohey said. “There are lots of internal checks within the bankruptcy system to ensure people are not using it inappropriately.”