Even in Bankruptcy, College Debt Stands

Even in Bankruptcy, College Debt Stands
Tim Tarvin

Alice Wallace wasn’t your typical college student.

The North Little Rock woman attended Pulaski Technical College when she was in her late 50s, after she was laid off from her job at the Arkansas Municipal League in 2008. By 2014, Wallace left the community college with two business-related associate’s degrees and about $40,000 in debt.

The degrees didn’t help Wallace find permanent work, and in 2015, she filed for Chapter 7 bankruptcy liquidation. Nearly all of her debt was because of the student loans.

What sets Wallace, now 64, apart, however, is that she sued the U.S. Department of Education in U.S. Bankruptcy Court to discharge her student debt — and won.

“A very tiny, tiny fraction of people in bankruptcy who have student loan debt actually seek to get it discharged,” said Geoff Walsh, a staff attorney for the National Consumer Law Center in Boston, where one of his practice areas is consumer bankruptcy. “It’s a very discouraging, very expensive and very difficult process to go through.”

Generally, student loans aren’t discharged in bankruptcy, leaving borrowers with the debt after they’ve gone through the process. That could be a problem for the growing number of borrowers.

At the end of 2015, 44.2 million people in the United States had student loan debts, more than double the number of borrowers in 2004, according to the latest figures from the Federal Reserve Bank of New York. At the end of 2015, more than 4.7 million borrowers had defaulted on their loans.

The outstanding student loan debt is $1.3 trillion, about 30 percent more than total auto loan debt.

“Some people think this could be the new credit bubble that might burst,” said Tim Tarvin, associate professor of law at the University of Arkansas School of Law. “By nature, it’s all unsecured debt.”

And that’s cause for alarm because the average balance is getting bigger. The Federal Reserve Bank of New York reports that the number of borrowers who owe less than $10,000 fell slightly between 2014 and 2015, while the number of student loan borrowers who owe more than $100,000 increased 11.7 percent to 2 million.

In most cases, the loans are “backed by the full faith and credit of the U.S. government,” Tarvin said. “To my knowledge there has been no appropriation. It’s like Social Security. It’s just the pledge of the government to cover it.”

To shed the student loan debt in bankruptcy, the borrower has to show that the debt will cause an “undue hardship” for the debtor, Walsh said. And to prove that, the debtor has to show that the debt can’t be paid now, nor is it likely to be paid in the future.

“It’s a vague standard and it gives courts a lot of discretion,” Walsh said.

12 Student Loans
Even before Alice Wallace was laid off from her $25,000-a-year job in 2008, she struggled to make ends meet.

A lack of discretionary money meant she brought her lunch to work and didn’t go to the movies, according to her testimony in January 2016 in U.S. Bankruptcy Court. A transcript of the proceeding to have her student loan debt discharged was filed with the court. Arkansas Business couldn’t reach her for comment.

Wallace told U.S. Bankruptcy Judge Phyllis Jones, of the Eastern District of Arkansas, that she decided to return to school in January 2010 to start working on two degrees, one in accounting and the other in office technology.

She took out her first of 12 student loans beginning in September 2010. Without the loans, she said, she wouldn’t have been able to afford the classes.

Graduating didn’t seem to help her find permanent work. In May 2015, she filed for Chapter 7 bankruptcy, listing $45,000 in assets and $49,000 in debts.

To discharge the student loan debt, the borrower has to file a lawsuit in the bankruptcy case.

Wallace was represented by attorney Steven Davis of North Little Rock. But other debtors attempt to represent themselves, making it even more difficult to dismiss the student loan debt.

“Even if they might meet all the criteria, they would not know how to proceed and take care of this,” said Tarvin, the University of Arkansas professor.

Wallace asked that her student loan debts be discharged because she was in her 60s, continued to take medication after she survived cancer and couldn’t find a job.

Wallace also said she had squeezed all the money she could from her living expenses, leaving nothing to repay the loans.

Forgiveness Programs
During Wallace’s trial in January 2016, assistant U.S. Attorney Stacey McCord, who represented the U.S. Department of Education, said that Wallace didn’t take advantage of the income-based repayment options offered by the Department of Education.

In Wallace’s case, the payment would have been zero, and if her financial situation didn’t improve, in 25 years the loan would have been forgiven.

Walsh, of the National Consumer Law Center, said that option gives borrowers an affordable payment, but “it also means that you’re carrying around this very large debt burden pretty much for your whole life.”

Meanwhile, the interest on the loan is accruing.

“So you can get to be in your 50s and have this enormous loan,” Walsh said. “It’s way bigger than you started out with when you were 25-30.”

McCord, the assistant U.S. attorney, told Arkansas Business last week that the Department of Education’s position is the income repayment plan gives debtors the ability to handle their debt if they are struggling to make ends meet.

“Based on your income and the size of your family, your payments can be zero and over a number of years,” she said. The zero payments could remain in place until a borrower’s financial health improved.

Judge Jones, however, was troubled by the income-based repayment program in Wallace’s case. Wallace would be 88 when the loan was forgiven after 25 years, and the amount might be considered taxable income by the Internal Revenue Service. That would be “swapping the student loan debt for a tax debt,” Jones wrote in her opinion.

Jones also didn’t see the point of Wallace going through the repayment program.

“Adding any payment for the student loan, no matter how small, to Ms. Wallace’s monthly expenses would be futile,” Jones wrote. “Her income is and will more likely than not continue to be insufficient to pay any amount.”

On Sept. 15, Jones ruled that Wallace proved she had an undue hardship and the student loan debt, which at the time was $45,200, would be discharged.

Most Don’t Try
Walsh, of the National Consumer Law Center, said most people in bankruptcy don’t bother to get their student loan debt discharged because it’s expensive to litigate, and the debtors usually don’t have the money to pay the extra expense of filing a lawsuit against the Department of Education.

While the borrower’s other debts will be discharged in bankruptcy, the student loan debt will remain as an enforceable debt.

That means the student loan creditor could collect on the debt by garnishing wages (garnishment is usually capped at 25 percent of the debtor’s net take home pay), seizing the amount from the debtor’s bank account or taking property, Tarvin said.

Attorney Greg Niblock of Niblock & Associates of Stuttgart said that of the number of bankruptcies his firm handles, about 40 to 45 percent have student loan debt.

He said that most people know that student loan debts aren’t dischargeable.

Niblock said he tells his clients: “You shook the hands of the devil and he took your soul for collateral, and you aren’t getting it back until you pay him.”

Distribution of Student Loan Borrowers by Balance

Balance No. of Borrowers
4th-Quarter 2015
% of All
% Change
$1-$10,000 16,700,900 37.80% -0.67%
$10,000-$25,000 12,434,400 28.15% 0.70%
$25,000-$50,000 8,319,600 18.83% 4.03%
$50,000-$75,000 3,341,100 7.56% 6.85%
$75,000-$100,000 1,350,800 3.06% 9.10%
$100,000-$150,000 1,116,500 2.53% 8.81%
$150,000-$200,000 500,400 1.13% 12.65%
$200,000.00 415,400 0.94% 19.16%
Total 44,179,100   1.93%

Source: Federal Reserve Bank of New York Consumer Credit Panel/Equifax