By Diane Davis
Lawsuits claiming Wells Fargo, Navient, and others unlawfully tried to get borrowers to repay private student loans even though the obligation was wiped out in bankruptcy are moving through the courts with key arguments and rulings expected in coming months.
There are four proposed class action cases in all with attorneys, banks, judges, and other stakeholders keeping an especially close eye on the U.S. Court of Appeals for the Fifth Circuit in Texas.
That’s where a panel of three judges will hear arguments this fall in a case against Navient, the lending and servicing giant, for allegedly misleading four borrowers who took out loans to attend an unaccredited trade school. The obligations were discharged, or wiped out, in bankruptcy, but they were still pressed for repayment, the suit says.
The bankruptcy court in Texas denied Navient’s dismissal motion, setting up Fifth Circuit review. An appeals court decision could come by the end of the year or early next year, and a finding against the company could upend parts of the private education lending business.
Navient has stopped collection activities, pending the outcome of the case.
Other similar cases are percolating in New York, where a ruling on a dismissal motion by Navient and National Collegiate Trust could come as early as July.
A Wells Fargo unit is named in one of the suits, Navient in two. Wells Fargo and Navient told Bloomberg Law that they wouldn’t comment on pending litigation.
A Navient spokeswoman said a “vast majority of private education loan borrowers are managing their loans successfully.” A Wells Fargo spokesman said the company is “committed to providing financing that helps students and families pursue their higher education goals.”
Lenders and servicers argue that bankruptcy judges misapply bankruptcy law when they discharge their loans like they would routine credit card, auto, or personal debt to give debtors their “fresh start.”
But the plaintiff debtors argue that these are unsecured consumer loans and are automatically wiped out by a discharge injunction in bankruptcy.
“A lot of people have been misled about what student loans the Bankruptcy Code will allow to be discharged, and we’re trying to restore some accuracy into the process,” Austin C. Smith of Smith Law Group in New York, told Bloomberg Law.
Smith, who said borrowers have been “harassed,” is one of the attorneys representing the plaintiffs/debtors in the cases against Educational Financial Services, a Division of Wells Fargo, Navient, and National Collegiate Trust, and other loan servicers.
A crucial part of these cases is how bankruptcy courts treat student debt.
Federal student loans underwritten by taxpayers represent the overwhelming majority of the nation’s $1.5 trillion student debt load, according to U.S. figures. But total student loans outstanding from private sources, like banks and other financial institutions as reported by MeasureOne in December 2016, was $102.3 billion. Only certain types of private loans are being disputed in these cases.
Discharging student debt in court is very difficult to do, and there’s no dispute that repayment obligations are extinguished if federally backed loans are wiped out in bankruptcy.
But some private debts aren’t recognized by the U.S. Department of Education under Title IV of the Higher Education Act as “qualified education loans,” which means they aren’t protected under Bankruptcy Code Section 523(a)(8), Smith said.
Many courts have interpreted an “obligation to repay funds received as an educational benefit” in the statute to mean that any loan that furthers a debtor’s education can’t be wiped out in bankruptcy. This interpretation is wrong, Smith said.
Bankruptcy law refers to Section 221(d)(1) of the Internal Revenue Code to define “qualified education loans.” That requires a student to attend an accredited school, be an eligible student, and the loan only cover the “cost of attendance.”
The loans in question here might cover medical residency programs, for-profit flight schools, unaccredited trade schools, and secondary schools.
Stephanie Henry, who filed a bankruptcy class action suit in June against Wells Fargo in Texas, obtained a loan to attend an unaccredited trade school.
Henry paid Wells Fargo through her Chapter 13 plan and the court entered a discharge order, but the company kept collecting on her “debts,” the suit says.
Henry says that the discharge order in her case “extinguished all education-related debt that was not excepted from discharge.”
Evan Brian Crocker obtained a bar exam student loan, and Michael Shabazi got a career training loan for an unaccredited trade school. Judge David R. Jones of the U.S. Bankruptcy Court for the Southern District of Texas denied Navient’s motion for summary judgment in March and certified their case for direct appeal to the Fifth Circuit. Navient argued that because the loans “conferred educational benefits,” they were nondischargeable.
The court rejected Navient’s argument.
“To be excepted from discharge, a debtor must have taken on an obligation to repay funds that were given in the form of an educational benefit, a scholarship or a stipend,” Jones said.
Otherwise, a loan for a car used by a commuter student to travel to and from school every day would be nondischargeable, the court said.
Two class action cases in New York involve students attending accredited schools with loans “above the cost of attendance.”
Hilal Homaidan obtained a “direct to consumer” tuition loan from Sallie Mae and Navient and Tashanna Golden obtained private loans from National Collegiate Trust, both in excess of the cost of attendance so they weren’t qualified education expenses.
Both cases are pending on “parallel tracks” before Judge Elizabeth S. Stong of the U.S. Bankruptcy Court for the Eastern District of New York. Stong will hear Navient and National Collegiate Trust’s motions to dismiss together in late July because the cases raise similar issues.
According to Navient and National Collegiate Trust, a majority of courts have concluded that a private student loan qualifies as an “obligation to repay funds received as an educational benefit.”
This interpretation of the law is “at odds with both the legislative history and the plain meaning of the text,” and is used by creditors to expand the scope of the statute to cover a wide variety of student loans, Jason Iuliano, a research fellow at the University of Pennsylvania Law School told Bloomberg Law.
Bankruptcy courts have misinterpreted the statutory criteria for determining which educational debts are nondischargeable, Iuliano said.
As a result, billions of student loan debt has been “misclassified” and it prevents many borrowers from obtaining the bankruptcy relief to which they are entitled.
Most debtors have been unable to challenge their creditor’s arguments because they lack the funds “to mount competent legal defenses,” Iuliano said.
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