COLUMN-Bankrupt? How to get student loan debt erased

Reuters

By Liz Weston

LOS ANGELES, March 3 (Reuters) - Getting student loan debt erased in bankruptcy court isn't easy, but it's possible. Unfortunately, most borrowers can't afford the fight that might give them some relief.

"You'd need to spend at least $5,000," said Henry Sommer, supervising attorney at Consumer Bankruptcy Assistance Project in Philadelphia and a former president of the National Association of Consumer Bankruptcy Attorneys. The catch is that "if you had $5,000, you would not be eligible for a student loan discharge," Sommer added.

Several recent court decisions have challenged the notion that only the worst-off borrowers, typically those who are permanently disabled, can get education debt erased. The borrowers who won these discharges had low costs, either receiving free legal help or representing themselves.

In most cases, borrowers in bankruptcy don't even ask for help because they figure a discharge of debt is so rare. In one study of 170,000 student loan debtors who filed for bankruptcy protection in 2007, only 51 won full discharges of their debt and 30 received partial discharges.

The author of the study, which was published in the American Bankruptcy Law Journal, found that only 213 of the student loan debtors studied even tried to have their education debt discharged by filing what's known as an "adversary proceeding." Since bankruptcy law doesn't allow student loans to be erased in a regular filing, this extra step is necessary before education debt can be discharged.

Of those who tried to get their student debt wiped out, in other words, two out of five got at least some relief. Based on the characteristics of those who were able to get discharges, researcher Jason Iuliano calculated that an additional 69,000 people who filed bankruptcy that year would have had a "good chance" of erasing their student loans had they filed adversary proceedings.

Iuliano speculated that one reason so few student loan borrowers seek relief is that they've been convinced it's hopeless. He cited academic journals and numerous popular press articles indicating such discharges are almost impossible. Debtors are sometimes told that absent a total and permanent disability, they can't get their loans discharged.

There may be another reason. People who file for bankruptcy are, not surprisingly, usually broke. Paying attorneys' fees can be a stretch, and attorneys may be loathe to make the extra effort required knowing they might not be paid for it.

"Most [bankruptcy attorneys] don't attempt an undue hardship discharge because it requires an adversarial proceeding, which is a lot more work," said Mark Kantrowitz, a student aid expert and publisher of Edvisors Network Inc.

Iuliano's research showed that those who represented themselves were about as likely as those who had lawyers to win their cases. Bankruptcy attorney Sommer said few borrowers are prepared to argue their cases in court against skilled and often aggressive lawyers representing their creditors.

"Most people are not capable of doing that," Sommer said. "This is full-scale litigation."

The bar is certainly high. A borrower has to prove that repaying his or her student loans would be an "undue hardship." Typically, that means meeting three tests: a current inability to pay the loans, because doing so wouldn't allow you to maintain a minimal standard of living given your current income and expenses; a future inability to repay the money, because your financial situation is likely to continue; and a good-faith effort to repay what you owe.

In two recent decisions, though, courts granted relief to borrowers who hadn't made voluntary payments on their debt and who refused to enroll in income-based repayment plans. The appeals court judges in both cases said enrolling would have been pointless given the women's tiny incomes.

In a third case, the borrower was both employed and healthy, but wage garnishments by his student lenders left him unable to support his wife and two children.

Michael Hedlund was twice granted relief in bankruptcy court, but his lenders challenged the decisions both times, said Derek Foran, a partner with San Francisco-based Morrison & Foerster Foran, who along with attorney Yonatan Braude represented Hedlund for free in those appeals. The court battles ultimately resulted in a decision by the U.S. 9th Circuit Court of Appeals that upheld Hedlund's bankruptcy relief. That will make it harder for lenders to undermine bankruptcy court decisions in Western states in the future, Foran said.

"The problem is that the creditors have vast resources they don't see any downside to trying to get the decisions reversed on appeal," Foran said. "We like to feel we made the system a little fairer for debtors in the 9th district."

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