Student Loan Zombie Debt

Was that student loan discharged in bankruptcy, or wasn’t it? Two recent decisions leave the answer to that question in doubt. Hoxie v. Educational Credit Management Corporation (US Dist. SD California, November 13, 2006) and Mersmann v Educational Management Credit Corporation (US App 10th Circuit, September 24, 2007) threaten the financial security of many people who have been relying on older discharges in bankruptcy to give them a fresh start.

Educational Credit Management Corporation , discussed in a prior article ,  is now bringing all of its government-sanctioned debt-collection machinery into play to collect on loans going back to the 1970’s, which were explicitly included in Chapter 7 or Chapter 13 cases during the 1990’s, and met the then-applicable statutory requirements for discharge.

The issue in Mersmann is discharge by declaration. Prior to 1998, Chapter 13 debtors could obtain a hardship discharge of student loans by including the documentation in a Chapter 13 plan, subject to challenge by the trustee or the creditor. As long as the seven year rule remained in effect, creditors did not routinely scrutinize or challenge such plans.

When undue hardship became the only grounds for discharge in 1998, creditor challenges became more common. At first, courts sustained existing discharges while ruling that a formal adversary proceeding would be required in the future. Later rulings voided such discharges on the grounds that creditor’s right to due process was violated. The Tenth Circuit, relying on a 1999 decision. Andersen v. UNIPAC-NEBHELP, continued to recognize old discharges by declaration until Mersmann .

As things now stand, all such discharges nationwide may be subject to renewed collection efforts, with the creditor entitled to interest and penalties which may have accrued in the interim. Furthermore, the bar of undue hardship is now set much higher than it was in the 1990’s.

Hoxie is even more troubling, as it involved a Chapter 7 discharge under the seven year rule in effect in 1993. In its opinion, the California District Court relied on a 2004 Supreme Court Ruling which used the present requirement for an adversary action to discharge student loans on grounds of hardship as justification for denying the State of Tennessee’s claim to immunity to such a suit under the 11th amendment. Morphing that reasoning into a retroactive requirement for an adversary action concerning matters which would not normally have been litigated at the time requires extremely convoluted arguments involving major breaches of elementary logic.

The few bankruptcy and circuit court adversary cases dealing with the seven year rule all involved disputes about whether the seven year requirement had been met, which was not in question in Ronald Hoxie’s 1993 bankruptcy.

This is Zombie debt with a vengeance. Given ECMC’s track record, it is easy to envision their systematically tracking down every debtor whose student loan was discharged under the seven year rule, and using the Hoxie decision as a dagger to carve out as many pounds of flesh as can be extracted without killing too many unfortunate debtors in the process.