Academic journal article Journal of the International Academy for Case Studies

Discharging Student Loans in Bankruptcy: Good Luck with That

Academic journal article Journal of the International Academy for Case Studies

Discharging Student Loans in Bankruptcy: Good Luck with That

Article excerpt

RECOMMENDATIONS FOR TEACHING APPROACHES

This case should be introduced with a basic introduction into how federal bankruptcy operates to liquidate debt, albeit not all types of debt. The case examines the specific category of student loan debt and the limited remedies available for its discharge under bankruptcy. First, students should understand the goals of bankruptcy, who benefits from the process, and why certain categories of debt, such as student loans, receive less favorable treatment for the debtor. Turning from the general to specific, students can explore news accounts and/or primary court opinions in the matter of Tetzlaff v. Education Credit Management Corporation, a case that inspired the creation of this case study. Tetzlaff was litigated in the federal courts at the trial and appellate levels, with published opinions in 2014 and 2015, respectfully. The United States Supreme Court, in January 2016, denied review of the issue of whether student loans can be discharged in bankruptcy, leaving some uncertainty in the law because different intermediate courts have provided varied approaches in assessing student debtors' financial hardships. As with most legal issues, the legal test applied to the facts determines the outcome. What is the predictable legal consequence from the application of each of the three tests? Should the United States Supreme Court, if presented with this issue in the future, settle the split in the circuits and bring more certainty to the issues of discharging student loan debt in bankruptcy?

BACKGROUND OF THE LAW

Bankruptcy Law 101: Providing a Fresh Start for the Debtor

"The law of bankruptcy provides possible solutions to problems that arise when a person . . . is unable, or finds it difficult, to satisfy obligations to creditors" (Morgan, 2015, p. 820). Put plainly, bankruptcy gives a debtor the chance to start over, either by restructuring debt or liquidating it. The two federal laws controlling the process are the Bankruptcy Reform Act of 1978 and the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. These statutes set up three avenues to dispose of debt. Under Chapter 13 of the Bankruptcy code, the debtor works under the supervision of a trustee to create a payment plan that reduces the amount of debt to a feasible amount that can be paid off under a payment plan extended over three to five years (Morgan, 2015, p. 828). Typical Chapter 13 plans apply to debtors with unanticipated large medical bills, out of control credit card balances, and other consumer debt.

Chapter 11 bankruptcy provides for a reorganization of debt such that creditors are paid over an extended period, based on a plan formulated in consultation with a committee of one's creditor (Morgan, 2015, p. 825). Rather than addressing consumer debt, Chapter 11 is usually applicable to businesses and rich people wanting to restructure their obligations to creditors.

Chapter 7 bankruptcy liquidates the debtor's obligations to creditors (Morgan, 2015, p. 825). Debts that are included in a Chapter 7 proceeding are satisfied in whole or part by a trustee who takes control of the debtor's assets, such as houses, cars, bank accounts, and personal possessions. The trustee then sets aside for the debtor certain items "exempt" from bankruptcy, such as the house with a homestead exemption, one car per driver in the family, furniture, clothing, and tools of one's trade. The remaining assets are divided among the creditors, with the class of secured creditors (those who took collateral in the loan) paid first, and the class of unsecured creditors (such as credit card companies) paid last. If the assets are not sufficient to satisfy all of the obligations of the class, the creditors take a pro rata share of the assets. In practice, this could leave the class of secured creditors receiving pennies on the dollar for the credit they extended, and the class of unsecured creditors with no satisfaction. …

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