Bar News - July 16, 2014
Federal Practice & Bankruptcy: Using Chapter 13 Claim Objection Procedures to Resolve Student Loan Disputes
By: Richard Gaudreau
With student loan debt going back years, if not decades, having to disprove a billing error can be a daunting task.
Old payments on older student loans can become important only after assignment to a new servicer when a problem first comes to light. Even if a borrower finds old canceled checks, how those payments were applied to a particular loan when a servicer is handling more than one is far from transparent. The new servicer rarely has a payment history, making it difficult to resolve disputes.
Trying to extricate oneself from this morass can become a Kafkaesque task.
The Problem with Private Collectors
The US Department of Education’s (ED) business model for student loan collection now relies on private debt collectors paid by commission. One collector at the Educational Credit Management Corporation (ECMC) earned $454,000 in commissions in one year, more than double the salary of the commissioner of the department of education, according to May 2012 article in Businessweek.
Bloomberg News has reported that ED awarded almost $1 billion in commissions in 2011. ED also offers cash prizes to its top collectors. A recent National Consumer Law Center (NCLC) study found private collectors to be abysmal at resolving consumer complaints. An audit by the Department of Education acknowledged collectors were ignoring verbal complaints, failing to pass them on to ED for action.
With commissions as incentive and fiduciary obligations lacking, this is hardly surprising. In May 2014, NCLC filed a federal lawsuit against ED under the Freedom of Information Act alleging ED refused to disclose incentives it provides to private student loan collectors.
Resolving Disputes through Chapter 13
One alternative to resolving a student loan dispute is through Chapter 13. Besides the obvious advantage of the automatic stay stopping a collection lawsuit, it can also provide access to more favorable burden-of-proof rules. When an old student loan makes it difficult for both parties to find relevant documents, determining which side has the burden of proof can be dispositive.
Most state courts require a debtor defending a collection lawsuit by alleging payment to prove all those payments as an affirmative defense. See Jenkins v. Sallie Mae, 649 S.E.2d 802 (Ga. 2007). The burden of proof rules in Bankruptcy Court can be more flexible.
By filing a proof claim, a student lender submits to the jurisdiction of the bankruptcy court. When bankruptcy is filed under Chapter 13, the bankruptcy court sends creditors a notice informing them of the right to file a proof of claim – the means by which a creditor alleges how much it believes is owed on the date of the bankruptcy filing.
A claim is allowed unless a party in interest objects. A valid proof of claim is prima facie evidence of the validity and amount of the claim.
Once a prima facie case is established, the burden of proof shifts to the debtor to produce substantial evidence to rebut the claim. If a debtor produces substantial evidence to rebut the claim, the burden then shifts back to the student lender to establish its claim by a preponderance of the evidence.
This shifting burden of proof is an advantage for debtors in Bankruptcy Court because it requires a response from a student lender, as long as the evidence offered is significant enough. One ground for disallowing a claim is where it is “unenforceable against the debtor... under any agreement or applicable law.” 11 USC 502(b)(1). That a claim has already been paid is a valid ground for objection and disallowance.
That US Bankruptcy Court judges may issue orders affecting student loan debt is hardly a radical notion. An order on a proof of claim – even on non-dischargeable debt – can have res judicata effect. Whether an order will have preclusive effect depends on whether the claims objection is well documented or not. A claims objection raising procedural issues without more will not have res judicata effect.
Student loan servicers like ECMC have argued a “claims order” can never discharge student loan debt and, therefore, the servicer may continue to collect the full amount it believes is owed after the bankruptcy closes. Outside the 11th Circuit, most courts have rejected this position as a “red herring,” finding that if there is no student loan debt owed, there is nothing left to discharge.
Case in Point
One recent case I litigated in New Hampshire Bankruptcy Court provides a good example of how the claims objection procedure can resolve a student loan dispute.
In Kempton v. Discover Bank and Kempton v. Sallie Mae, the debtor believed his ex-wife forged his name to $100,000 of private student loans when she moved back into the marital home after a long separation. Her return did not signal a reconciliation, but occurred as a result of a bail order on charges against her for embezzling $1.3 million from her employer.
There was a startling similarity between some of the charges and how she accessed private information to forge the student loans. Although she admitted to a police officer that she affixed her ex-husband’s electronic signature to a Sallie Mae note, she claimed he authorized it, which resulted in the police regarding it as a civil matter and refusing to prosecute.
Sallie Mae and Discover closed their files without any substantive investigation, even though the debtor submitted documentation showing that he was in the hospital at the time of the forgery, without access to a computer.
The debtor used this information to document a claims objection after Sallie Mae and Discover filed proof of claims in his Chapter 13 bankruptcy. When both failed to meet their burden of proof by filing a response, the court issued orders finding that the debtor owed nothing to Sallie Mae and Discover.
The Ninth Circuit Court of Appeals has held that the: “[a]llowance or disallowance of a ‘claim in bankruptcy is binding and conclusive on all parties or their privies, and being in the nature of a final judgment, furnishes a basis for a plea of res judicata.’” Siegel v. Fed. Home Loan Mortgage Corp.
A North Carolina bankruptcy court in 2003 upheld an order on a proof of claim, which found a student loan to be $0. In that case, In re Goldberg, the court found ECMC’s claim to be fraudulent and precluded ECMC from collecting on it. In disallowing ECMC’s proof of claim, the court stated: “There is nothing more basic to the role of the bankruptcy court than to determine the validity of a claim... There is a failure of consideration and therefore no obligation of the debtor to ECMC.”
Richard Gaudreau is a solo practitioner in Salem, focusing on bankruptcy and student loan issues. He is certified in consumer bankruptcy law by the American Board of Certification, and NH chair of NACBA.