Sixth Circuit Rules Consolidated Student Loans Still Subject to Undue Hardship Test - Alfes v. Educational Credit Management Corp.

March 22, 2013

Vincent Howard and our Moreno Valley personal bankruptcy lawyers have written here several times about the difficulties clients face with getting student loans discharged in bankruptcy. A law change in the 1970s gave special status to student loans made by the government, permitting them to be discharged in bankruptcy only after a showing of "undue hardship" to the debtor. Unfortunately, more recent legal changes extended that requirement to all student loans. Since then, student loan debt has become a major issue for younger people, and calls for reform of the undue hardship rule have gotten more common. In Alfes v. Educational Credit Management Corp., Thomas Alfes of Michigan argued that he shouldn't be subject to the rule because his loans had been consolidated under a loan that was not an "educational loan" under the law. The Sixth U.S. Circuit Court of Appeals disagreed.

Alfes took out his student loans, funded in whole or part by a federal program, between 1982 and 1997. He consolidated, ending up with SunTrust Bank as lender and obligee and the Pennsylvania Higher Education Assistance Agency as guarantor. He filed for Chapter 7 bankruptcy in 2005 and received a discharge the same year. However, he later filed an adversary proceeding seeking a declaration that his consolidated student loan was not an educational loan under the bankruptcy code, and thus had been discharged with the other debt. SunTrust and the PHEAA failed to answer, and the bankruptcy court entered a default judgment, finding the debt dischargeable.

But in the meantime, Educational Credit Management Services agreed to assume the loan from PHEAA. The bankruptcy court initially declined to substitute or reopen the case, but changed its mind six weeks later, substituted ECMC for PHEAA, and granted ECMC's motion to dismiss Alfes's case, saying the consolidated loan is a student loan. Alfes later refused to pay the loan, saying ECMC's servicer was bound by the default judgment. He reopened the bankruptcy again and moved for an order prohibiting future collections and sanctions against the servicers. The parties eventually settled with a deadline of May 17 for any further claims; ECMC brought a case that day. The bankruptcy court found for ECMC, relying on the dismissal of Alfes's case and that the default judgment didn't bind ECMC as a non-party. The district court upheld.

The Sixth Circuit upheld again. ECMC argued that its interest as a guarantor (successor to the PHEAA) was not touched by the default judgment, because SunTrust was lender, not guarantor. The Sixth found that guarantors have separate rights from lenders under bankruptcy law, because guarantors become creditors. Thus, res judicata does not bar ECMC from pursuing its case as guarantor (though it cannot pursue the case as assignee for SunTrust). Alfes also alleged that ECMC's guarantor argument, introduced in an amended complaint one day after the settlement's deadline, should have been dismissed as an unfair surprise and untimely. The Sixth disagreed, finding the claims substantively identical because they both identify ECMC/PHEAA as guarantor, and noted that ECMC had asserted separate and distinct guarantor rights before. It also permitted the late amended complaint because it related back to the original, timely complaint.

Vincent Howard and our Seal Beach consumer bankruptcy attorneys are disappointed by both the outcome and the reasoning of this decision. This would be a good opportunity for courts to scrutinize the reasoning behind student loans' special protected status in bankruptcy, to see if student loans are substantially similar to consolidated loans. The court relied on a 1996 case to come to some of its conclusions, but 17 years later, the way student loans are treated in bankruptcy and society is different. In general, courts require a showing of "undue hardship" to discharge student loans, which is both difficult and, to some extent, a judgment call for the court. Vincent Howard and our Highland individual bankruptcy lawyers help clients make that case when we feel we can--but we don't blame debtors like Alfes for attempting to make what appears to be a solid argument that it's not necessary.

If you feel overwhelmed by student loan debt or any other kind of consumer debt you can't reasonably repay, you should talk to Howard Law, P.C., about whether bankruptcy is right for you. For a free, confidential case evaluation, send us an email or call 1-800-872-5925.

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