STUDENT BANKRUPTCY AND THE PERMISSIBILITY OF TRADITIONAL CAMPUS COLLECTION MEASURES

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1 TOPIC: STUDENT BANKRUPTCY AND THE PERMISSIBILITY OF TRADITIONAL CAMPUS COLLECTION MEASURES INTRODUCTION: While some economic indicators signal the end of the recession, the fact remains that consumer bankruptcy [1] filings are on the rise. [2] Many of these bankruptcies involve current or former students who are unable to pay back their educational debt to college or university lenders. In this environment, understanding the basic principles of bankruptcy and how student bankruptcy affects traditional campus debt collection techniques, such as withholding of transcripts and denial of registration, is more important than ever for administrators. This NACUANOTE will address those principles and provide practice pointers for college and university officials dealing with students in bankruptcy. DISCUSSION: Bankruptcy in General [3] The twofold objective of the Bankruptcy Code is to: (1) relieve the honest debtor from the burden of oppressive debt, thereby granting him a fresh start; and (2) provide for equitable treatment of creditors through a systematic distribution of the debtor s nonexempt property. [4] Colleges and universities, of course, have an equally important objective to collect amounts owed for educational and other services rendered to student borrowers. To achieve this, many campuses institute and enforce policies of withholding official transcripts and barring registration for students who fail to fulfill their financial obligations to the institution. [5] Outside of bankruptcy, such actions are considered reasonable and are not unfair collection practices prohibited by 15 U.S.C. 1692(f). [6] However, the extent to which an institution may enforce these policies against a student who is, or has been, a debtor under the Bankruptcy Code is determined by a number of factors including: (1) the operation of the automatic stay provisions; (2) the discharge injunction; and (3) the antidiscrimination provisions of the Bankruptcy Code. Understanding these concepts is essential to ensuring that an institution does not violate the Bankruptcy Code when enforcing its collection policies and procedures.

2 Restrictions on Collection Procedures During the Pendency of a Bankruptcy Case - The Automatic Stay The automatic stay is one of the fundamental debtor protections provided by the Bankruptcy Code. [7] It is designed to (1) protect the debtor by giving him a breathing spell from the collection efforts of creditors; and (2) maintain the status quo between the debtor and his creditors. To achieve these results, the stay temporarily prohibits a broad range of creditor conduct, including any act to collect, assess, or recover a claim against the debtor that arose before the commencement of the case. [8] The stay arises the moment a debtor files a petition for relief in the bankruptcy court, and remains in effect until the case is closed or dismissed, or a discharge is granted or denied. [9] Although an institution will typically receive formal notice of a student s bankruptcy petition by mail, creditors are subject to both actual and inquiry notice for purposes of the automatic stay. [10] Consequently, an institution has a duty to investigate any notice of a bankruptcy filing by one of its student debtors, regardless of how the institution learns of it. Once on notice, the institution and its agents must immediately suspend any collection efforts outside the bankruptcy process. If an institution willfully violates the automatic stay, the student debtor may be entitled to monetary damages, including costs, attorney s fees and in appropriate circumstances punitive damages. [11] Withholding Official Transcripts Does withholding a debtor s official transcript while the debtor is under the protection of the bankruptcy court violate the automatic stay? The majority of courts that have addressed this issue have concluded that it does. [12] In other words, the majority of bankruptcy courts consider withholding a transcript to be an act to collect in violation of 362(a)(6). [13] A minority of courts particularly in the Third Circuit have held that when the educational debt is concededly nondischargeable, the institution does not violate the automatic stay by withholding the official transcript from a debtor who previously defaulted. [14] This line of cases focuses on the contractual relationship between the institution and the debtor. For example, one court analogized the withholding of a transcript to a bank s placing an administrative freeze on an account. [15] The court reasoned that similar to a bank s refusal to honor its promise to pay, a university s withholding of a transcript is a refusal to perform a promise to create and deliver a record of the debtor s academic performance. This rationale, some argue, is consistent with the purpose of the automatic stay, i.e., to maintain the status quo. However, this minority view has been heavily criticized. [16] Denying Class Registration. Limited case law suggests that refusing to allow a debtor to register for classes is also an act to compel payment of a pre-petition debt and likewise violates the automatic stay. [17] While only a few courts have considered this issue, they agree that barring a debtor from registering for class is analogous to withholding a transcript in the bankruptcy context; both institutional prohibitions are acts to collect, which are prohibited by the automatic stay. [18] As such, courts may award damages, costs and attorney s fees to the debtor if they find that the institution willfully violated the automatic stay by refusing to allow a student to register for classes. [19] The argument that the pre-petition debt was nondischargeable has been rejected in this context as well. [20] That said, while an institution cannot deny registration to a student who is under the protection of the Bankruptcy Court in order to compel the payment of old debts, it need not permit a student to accrue new educational debt going forward. Thus, college and university officials can take certain steps to protect their institutions without running afoul of bankruptcy laws. Some of these steps may include requiring advance payment of tuition or administratively withdrawing a student who incurs a tuition charge but

3 fails to pay in accordance with institutional policy. During the pendency of the automatic stay, best practice therefore suggests that an institution refrain from withholding transcripts or denying registration without permission of the court. Such permission may be requested by filing a motion for relief from stay. [21] However, the institution should first review the filing to determine if reasonable grounds exist to justify such relief. For example, if the debt is predominately nondischargeable student loan debt [22] or if the debtor is abusing the privileges of the stay, the institution may be able to successfully argue that the bankruptcy filing is not in good faith. [23] But under ordinary circumstances, courts are unlikely to grant an institution relief from the stay. Indeed, at least one court has reasoned that withholding a debtor s transcript is counterproductive to the creditor s desire to be paid, since the debtor needs the additional training or employment for which the transcript is a prerequisite in order to increase his income and, in turn, repay the nondischargeable debt. [24] Arguments that the institution has a security interest in an academic transcript as a basis for relief have likewise been unsuccessful. [25] Restrictions on Collection Procedures Post-Discharge: The Discharge Injunction From a debtor s perspective, the paramount goal of filing for bankruptcy is to obtain an order of discharge, which releases the debtor from personal liability for the payment of certain dischargeable debts. [26] The discharge operates as a permanent order directed to the debtor s creditors, stipulating that they refrain from taking any action against the debtor or his property to recover discharged debts. [27] This includes legal action, as well as communications with the debtor, such as telephone calls, letters, and any other personal contact. From a creditor s standpoint, the final disposition of a bankruptcy case signals the expiration of the automatic stay and determines whether or not a creditor can proceed to collect a debt that arose prior to the date of the bankruptcy petition. The crucial inquiry then, is what debt was discharged, and what debt remains collectable? Discharged vs. Nondischargeable Debt Certain debts are nondischargeable by statute, and thus can be collected after bankruptcy. [28] These include certain educational loans, as well as debts related to taxes, child support, and alimony. [29] These exceptions represent determinations by Congress that some debts should be repaid for public policy reasons regardless of their burden on the debtor. [30] Most educational loans can only be discharged through a special process within the bankruptcy called an adversary proceeding, after a finding of undue hardship. [31] The exception to discharge for educational debt is self-executing, meaning the bankruptcy court must make an undue hardship finding before discharging that debt, even if the creditor does not request one. [32] Importantly though, not all extensions of credit to a student will be excluded from discharge. For example, debt for unpaid tuition accounts and bills (as opposed to student loan debt) may be included in the general order of discharge, and therefore will be uncollectable. [33] Thus, colleges and universities that seek to enforce their collection policies should be mindful of how they classify debt, and endeavor to ensure that it is classified as nondischargeable educational loan debt under section 523(a)(8). [34]

4 Withholding Transcripts and Denying Class Registration After Discharge Congress intended the Bankruptcy Code to ensure that the debtor will not be pressured in any way to repay discharged debts. [35] Accordingly, bankruptcy courts have held that denying a student access to his official transcript after the discharge of all debts owed to the institution violates the discharge injunction. [36] Thus, institutions that continue to withhold transcripts in contravention of the discharge order could face monetary or other sanctions. [37] The argument that refusing to release transcripts is not an action but rather is a failure to act has also been rejected. [38] Of course, if the debtor emerges from bankruptcy with non-discharged educational debt, the institution is free to pursue traditional collection methods including transcript withholding with respect to that debt. [39] Courts take a similar view with respect to an institution s preventing a student from registering for classes. Engaging in such a tactic where the student s debt has been discharged will likely be seen as a violation of the discharge injunction and may be sanctioned by the courts. [40] But denying a student s request to reenroll based upon the student s outstanding nondischargeable debts would likely be permissible. [41] The Anti-Discrimination Provisions Public Institutions Public schools also have to contend with the anti-discrimination section of the Bankruptcy Code. Section 525(a) of the Bankruptcy Code provides that governmental units may not deny, revoke, suspend, or refuse to renew a license, permit, charter, franchise, or similar grant to... or discriminate with respect to employment against someone solely because he or she has filed for bankruptcy or received bankruptcy relief. These provisions apply any time after the filing of a bankruptcy action, as well as after entry of a discharge order, and they prevent withholding of transcripts by public institutions during the pendency of a case and after the debt has been discharged. [42] The fact that the anti-discrimination provision does not explicitly apply to private institutions has no real practical consequences, as the automatic stay and discharge injunctions accomplish the same purpose. Practice Pointers In light of the above, institutions would be well served by implementing some or all of the following practice pointers: 1. Be proactive before the debtor files for bankruptcy. Consider adopting policies to: o Identify delinquent accounts early and distinguish dischargeable from nondischargeable debt; o Structure unpaid tuition and fees as an educational loan, thus insuring that the debt o is nondischargeable; [43] and Prohibit students with certain types or levels of debt from enrolling in additional classes, completing classes, or graduating under certain circumstances. 2. During the pendency of a bankruptcy proceeding, make sure that all appropriate parties know and understand that the debtor is immediately protected by the Bankruptcy Code s automatic stay and that the institution must cease all collection activities. 3. Do not assume that nondischargeable debt is exempt from the automatic stay, and seek the Bankruptcy Court s permission (via motion for relief from the automatic stay) before taking any action to collect student debt. 4. Provide students under automatic stay protection with their transcripts, and permit them to register for classes. Remember that the institution will be able to resume collection activities

5 after the close of bankruptcy proceedings for any portion of the student s debt that is nondischargeable. 5. After the close of the bankruptcy proceeding, carefully review the discharge order to determine what, if any, debt survived the case. Educate staff responsible for post-discharge collection activities on the scope of the educational debt exception to discharge to make sure that your institution only attempts to collect debt that was not included in the general order of discharge. 6. Remember that even a passive act such as withholding transcript and refusing to allow a debtor to register for classes will likely be interpreted by the bankruptcy courts as an attempt to collect on outstanding debts. 7. Encourage your institution to train its staff in the principles of bankruptcy law, to monitor legal developments, and to periodically review and update its policies and procedures to confirm that they comply with the Bankruptcy Code and any new developments in the law. CONCLUSION: Understanding the fundamental principles of bankruptcy law is vital for an institution s effective financial administration. Compliance with the automatic stay and discharge injunctions, as well as the anti-discrimination provisions, is imperative. An institution that incorporates the concepts explained in this Note into its business practices both enhances its ability to protect its creditor rights and minimizes the risk of violating the Bankruptcy Code. FOOTNOTES: FN1. Consumer bankruptcy generally refers to a bankruptcy proceeding filed by an individual whose debts were incurred primarily for a personal, family or household purpose. Educational debt is consumer debt. See 101(8). Except as otherwise indicated, references to sections herein are to the Bankruptcy Reform Act of 1978, as amended, codified in Title 11 of the United States Code. FN2. See U.S. Courts Press Release: Bankruptcy Filings up Nearly 14 Percent over Last Fiscal Year (November 8, 2010). FN3. This Note focuses on the two types of consumer bankruptcy cases that are most frequently encountered by campus administrators and their counsel: voluntary Chapter 7, also known as liquidation or straight bankruptcy; and Chapter 13, commonly referred to as rehabilitation bankruptcy. Chapter 7 bankruptcy provides for the immediate sale and distribution of a debtor's nonexempt property to his creditors. Chapter 13 bankruptcy enables debtors with regular income to repay all or part of their debts to creditors over three to five years. FN U.S.C.C.A.N , FN5. See e.g. University of North Carolina at Chapel Hill, Procedures for Requesting a Transcript, ; Wake Forest University, Transcript Request.

6 FN6. See, e.g., Juras v. Aman Collection Service, Inc., 829 F.2d 739 (9th Cir. 1987), cert. denied, 488 U.S. 875 (1988). FN7. H & H Beverage Distributors v. Dep't of Revenue, 850 F.2d 165, 166 (3d Cir. 1988) (quoting H.R. Rep. No. 595 at 340 (1977), reprinted in 1978 U.S.C.C.A.N. 5787, 6296). FN8. 362(a)(6). FN9. See Mu min, 374 B.R. 149, 155 (Bankr. E.D. Pa. 2007). FN10. See Thomas J. Yerbich, Consumer Bankruptcy: Fundamentals of Chapter 7 and Chapter 13 of the U.S. Bankruptcy Code, at (2003). FN (k); Mu min, 374 B.R. 149, 167 (Bankr. E.D. Pa. 2007). FN12. See In re Kuehn, 563 F. 3d 289, 294 (7th Cir. 2009); Mu min, 374 B. R. 149, 161 (Bankr. E.D. Pa 2007); In re Parker, 334 B.R. 529, 536 (Bankr. D. Mass. 2005); In re Walker, 336 B.R. 534, 538 (Bankr. M.D. Fla. 2005); In re Hernandez, 2005 Bankr. LEXIS 789 (Bankr. S.D. Tex. 2005); In re Scroggins, 209 B.R. 727, 730 (Bankr. D. Ariz. 1997); In re Merchant, 958 F.2d 738, 741 (6th Cir. 1992); In re Gustafson, 111 B.R. 282, 288 (9th Cir. BAP 1990), rev'd. on other grounds, 934 F.2d 216 (9th Cir. 1991); In re Parham, 56 B.R. 531, 534 (Bankr. E.D. Va.1986). FN13. Mu min, 374 B.R. 149, 160 (Bankr. E.D. Pa. 2007); Hernandez, 2005 Bankr. LEXIS 789 at 4 (Bankr. S.D. Tex. 2005). FN14. See Johnson v. Edinboro State College, 728 F.2d 163 (3d Cir. 1984); In re Billingsley, 276 B.R. 48 (Bankr. D. N.J. 2002); Najafi v. Cabrini College (In re Najafi), 154 B.R. 185 (Bankr. E.D. Pa. 1993). However, even where the official transcript could lawfully be withheld, institutions may still be obligated to release unofficial transcripts under FERPA. See, e.g., Withholding Academic Transcripts and Diplomas. FN15. See Billingsley, 276 B.R. 48, 54 (Bankr. D. N.J. 2002) (citing Maryland v. Strumpf, 516 U.S. 16 (1995)). FN16. See Mu min, 374 B.R. 149, 156 (Bankr. E.D. Pa. 2007); In re Parker, 334 B.R. 529, (Bankr. D. Mass. 2005); Walker, 336 B.R. 534, 537 (Bankr. M.D. Fla. 2005); Hernandez, 2005 Bankr. LEXIS 789 at 4 (Bankr. S.D. Tex. 2005). FN17. Parker, 334 B.R. 529, 536; In re Lynch, 415 B.R. 712, FN18. Id.

7 FN19. Id. FN20. Parker, 334 B.R. at 536. FN21. To request relief from the stay, a creditor must file a motion with the clerk of the bankruptcy court along with the applicable filing fee. Motions for relief from stay are heard by the court on an expedited basis, usually through a preliminary hearing within 30 days of the date the motion is filed. See 362(e). FN22. Certain debt, including student loan debt, is considered nondischargeable, meaning that the debtor will be obligated to pay it back, even after filing for bankruptcy. For additional discussion about the distinction between dischargeable and nondischargeable debt, see section below titled Discharged vs. Nondischargeable Debt. FN23. See Mu min, 374 B.R. 149, (Bankr. E.D. Pa. 2007); Hernandez, 2005 Bankr. LEXIS 789 at 9-12 (Bankr. S.D. Tex. 2005). FN24. Gustafson, 111 B.R. 282, 286 (9th Cir. BAP 1990), rev'd. on other grounds, 934 F.2d 216 (9th Cir. 1991); see also Hernandez, 2005 Bankr. LEXIS 789 at (Bankr. S.D. Tex. 2005) (Likelihood of debtor s completion of graduate school and increased earning potential thereby enhancing ability to pay nondischargeable debt is a factor to consider in granting relief from automatic stay.) FN25. See, e.g. In re Heath, 3 B.R. 351, 353 (Bankr. N.D. Ill. 1980) (rejecting concept that educational institution has a protected property interest in an academic transcript); In re Howren, 10 B.R. 303 (Bankr. D. Kan. 1980) (academic transcript, unlike collateral in which a creditor ordinarily takes a security interest, has no intrinsic value to the institution). FN26. See 727 for Chapter 7 cases and 1328 for Chapter 13 cases. FN27. In re Moore, 407 B. R. 855, 858 (Bankr. E.D. Va. 2009). FN28. See 523(a); Boston University v. Mehta, 310 F.3d 308, (3d Cir. 2002). FN29. See 523: A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt--... (8) unless excepting such debt from discharge under this paragraph would impose an undue hardship on the debtor and the debtor's dependents, for (A) (i) an educational benefit overpayment or loan made, insured, or guaranteed by a governmental unit, or made under any program funded in whole or in part by a

8 governmental unit or nonprofit institution; or (ii) an obligation to repay funds received as an educational benefit, scholarship, or stipend; or (B) any other educational loan that is a qualified education loan, as defined in section 221(d)(1) of the Internal Revenue Code of 1986 [26 USCS 221(d)(1)], incurred by a debtor who is an individual. FN30. Congress enacted 523(a)(8) regarding educational debt, because there was evidence of increasing abuse of the bankruptcy process that threatened the viability of educational loan programs and harm to future students and taxpayers. Congress recognized that this is an instance where a creditor's interest in receiving full payment of the debt outweighed the debtor's interest in a fresh start. See In re Renshaw, 222 F.3d 82, 87 (2nd Cir. 2000). FN31. See Fed. R. Bankr. Proc. 7001(6). FN32. See United Student Aid Funds, Inc. v. Espinosa, 130 S. Ct (2010) (Finding that a Bankruptcy Court s confirmation of a repayment plan for educational loans, which also included a provision discharging the educational loans without an undue hardship finding, was legal error, but it was not void under Federal Rule of Civil Procedure 60(b)(4)). FN33. See, e.g., In re Moore, 407 B.R. 855, 859 (Bankr. E.D. Va. 2009) (distinguishing between a nondischargeable loan, which requires that funds be advanced or transferred, or an agreement between the school and the student whereby the school extends credit and the student promises to pay at a later date; versus a debt for an outstanding tuition bill, which, without more, is not a loan and may therefore be discharged in bankruptcy); see also In re Renshaw, 222 F.3d 82, (2d Cir. 2000) (discussing when the nonpayment of tuition qualifies as a loan under 523 of the Bankruptcy Code). FN34. For a detailed discussion of this issue see Matthew C. Welnicki, Dischargeability of Students Financial Obligations: Student Loans Versus Student Tuition Account Debts, 31 J. COLLEGE AND UNIV. LAW 665 (2005). FN U.S.C.C.A.N. at A debtor may choose to repay a discharged debt after bankruptcy. See 362(f). While an institution may accept voluntary payments on a discharged debt, it may not subsequently withhold a transcript when a debtor discontinues those voluntary payments. Withholding a transcript or denying registration under such circumstances would violate the discharge injunction. Cf. Johnson v. Edinboro State College, 728 F.2d 163, 165 (3d Cir.1984) (enforcing a nondischargeable debt post-discharge is permissible). FN36. In re Moore, 407 B. R. 855, 861 (Bankr. E.D. Va. 2009); In re Kuehn, 563 F 3d 289, 294 (7th Cir. 2009), Gustafson, 111 B.R. 282, 288 (9th Cir. BAP 1990), rev'd. on other grounds, 934 F.2d 216 (9th Cir. 1991); In re Parham, 56 B.R. 531, 534 (Bankr. E.D. Va. 1986). FN37. See Welnicki, supra, Note 35, at 672 (citing Sesset v. Avco Financial Serv., Inc., 230 F.3d 439, (1st Cir. 2000); Cox v. Zale Del., Inc., 239 F.3d 910, (7th Cir. 2001)). In an action against

9 a state institution, a debtor s remedy may be limited to injunctive relief. FN38. Lanford v. Macalester College, 10 B.R. 132 (Bankr. D. Minn. 1981). FN39. See, e.g., Johnson v. Edinboro State College, 728 F.2d 163 (3d Cir. 1984). FN40. In re Parker, 334 B.R. 529, 536 (Bankr. D. Mass. 2005); In re Moore, 407 B. R. 855, 861 (Bankr. E.D. Va. 2009). FN41. See, e.g., Juras v. Aman Collection Service, Inc., 829 F.2d 739, 742 (9th Cir. 1987) ( [T]he university s refusal to provide the transcript is akin to a refusal to enroll him for another term, a service it could presumably decline to provide if he failed to repay loans ). FN42. See In re Reese, 38 B.R. 681, 683 (Bankr. N.D. Ga. 1984); Heath, 3 B.R. 351 (Bankr. N.D. Ill. 1980); In re Howren, 10 B.R. 303 (Bankr. D. Kan. 1980). FN43. For example, the institution could reach an agreement with the student for future payment of the amounts presently due, in exchange for the institution s continuing to provide educational services. See Welnicki, supra, Note 34, at , for additional discussion regarding the treatment of unpaid student accounts as nondischargeable loans. AUTHORS: Julia R. Hoke, Director for Legal Affairs and General Counsel of the State Education Assistance Authority, State of North Carolina Diane G. Miller, Associate General Counsel for the State Education Assistance Authority, State of North Carolina RESOURCES: NACUA Resources: NACUA Bankruptcy and Student Debts Resource Page Additional Resources: Federal Bankruptcy Code (Title 11 U.S.C.) Federal Rules of Bankruptcy Procedure

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