Student loans are a way of life in America, and the federal government guarantees most of those loans. The question now before the Supreme Court is what the obligations of the lender and the borrower are when a student can't pay.
More than a third of students enrolled in post-high school classes borrow money to advance their education. The federal government guarantees most student loans to the tune of $618 billion. To prevent people from just walking away from their obligation, federal law makes it hard to discharge a student loan debt (that is, not pay for it). The bankruptcy code allows discharge only in cases of undue hardship, but the code does permit restructuring of a debt to make it repayable.
Enter today's test case and its protagonist, Francisco Espinosa. In 1988, he was a baggage handler for America West Airlines. He enrolled in a technical school to learn computer drafting and design, but after graduating, he couldn't find a job.
Meanwhile, America West was in trouble. It froze wages and then cut them so that by 1992, Espinosa, still in his old job, was earning just over $6 an hour. He was single, lived frugally, drove a car worth $1,200 and had no debt, aside from his $13,000 student loan, which he was in arrears on.
Espinosa says he was humiliated and scared. The lender not only called him demanding that he repay the loan, but also called his mother, suggesting she borrow from her pension.
Then he fell in love and wanted to marry.
"I needed to get my finances squared away," he says. "I just can't come into a relationship and have people calling me, bill collectors."
Repayment Plan Established
Turning to the phone book, he called a lawyer. The lawyer filed what is known as Chapter 13 bankruptcy, which calls for the restructuring of a loan. "I did want to pay what I owed," Espinosa says. "I didn't want to get out of it."
A bankruptcy trustee working with Espinosa's lawyer worked out a plan for Espinosa to pay $274 a month, which would pay off the loan plus the bankruptcy fees. But it would not pay off the $4,000 accrued interest. The lender, United Student Aid Funds Inc., was notified in writing of the proposed repayment plan. It filed no objections, and six months later, a federal bankruptcy judge approved the plan. The company did not appeal, despite being notified a second time that the plan, if fulfilled, would discharge the debt in full, without the remaining interest payments.
Espinosa lived up to the plan's requirements, paying off the debt in installments over the maximum five-year period permitted under law. In 1997, the bankruptcy court declared the debt paid in full.
"I got my stamped release letter," Espinosa says. "I thought it was over and done with at the time."
Two years later, though, United started dunning Espinosa for the interest, among other things, and put a lien on his tax refunds. It continued to try to collect the money until Espinosa's lawyer asked the bankruptcy court to hold United in contempt.
Undue Hardship Requirement
Then, 11 years after the bankruptcy court had confirmed the original repayment plan, United claimed that the plan was illegal and void.
The lender noted that the federal bankruptcy code allows discharge of an unpaid student loan only if the borrower can show undue hardship. United said that to do that, the bankruptcy court should have conducted an adversary hearing with a formal summons ordering the company to appear in court.
Espinosa's lawyer countered that the company was repeatedly notified that the plan called for nonpayment of the $4,000 in interest, that the company in essence had waived its right to an undue hardship hearing, and that in any event, the bankruptcy court's judgment was final and could not be reopened long after the deadline for appeal had passed.
A federal appeals court ruled against United, declaring that "it makes a mockery of the English language and common sense" for United to claim that it "was somehow ambushed or taken advantage of." Backed by the U.S. government, 24 states and the entire student loan industry, United appealed to the U.S. Supreme Court.
United argues that without a finding of undue hardship, a plan discharging any part of a student loan debt is illegal and void under the law. If student loans could be more easily discharged, they say, lenders would be reluctant to make such loans.
Espinosa says that's nonsense; only a small part of the debt here was discharged — too small a part to require an adversary hearing if the company didn't object. Backed by the National Association of Bankruptcy Trustees, he says that courts, particularly bankruptcy courts, would be thrown into chaos if judgments had no finality and one side could appeal long after the fact.
Now the Supreme Court will decide.