The Supreme Court of New York County recently decided the unfortunate case of Educap, Inc v. Tsekas. This case, implicating student loan debt, contractual liability, and bankruptcy is very relevant to what is happening in the United States today. The student loan debt bubble, in a manner similar to the 2008 subprime mortgage bubble, is imploding, creating a financial crisis. History bears out the assertion that college tuitions, since 1980, have increased at a pace significantly higher than inflation. College tuition prices in 2013 are at an all time high, with many universities charging over $50,000 per academic year. At the same time, the job market for recent college graduates is quite poor, markedly affecting their ability to pay off student loan debt. The millennial era proverb of “education is an investment that will always pay off” is being severely challenged by these circumstances. The basic fact pattern seen in this case is being repeated all over the country, and most likely with the same outcome. If you are considering bankruptcy as a way out of your student loan debt, please read this cautionary tale carefully!
Background of the Case
In March 2006 defendant Tsekas signed a promissory note (a legally enforceable promise to pay) to HSBC bank for about $30,000 in student loans. The note was essentially a contract, containing certain terms and conditions.
Plaintiff Educap subsequently bought the promissory note from HSBC, and defendant was now obligated to pay the plaintiff. Defendant however could not make the payments and in August 2010 the plaintiff filed suit to recover under the note.
Defendant raises an affirmative defense: that the student loan debt was discharged in bankruptcy when he declared chapter 7 bankruptcy and the Bankruptcy Court of the Southern District of New York issued an order releasing him from “all dischargeable debts” under chapter 7.
The first problem the court identified was that student loan debt is a specific exception to debts that are dischargeable in bankruptcy! Since the Federal Government and large banking institutions provide the vast majority of student loans, and because college students have negligible political clout in comparison, a cynical commentator might observe that the government and large banks would not allow the creation of a bankruptcy mechanism that might potentially cost them tens of billions of dollars per year in discharged debt. Student loan debt, then, is then a potential anchor around the neck of every borrower.
The court noted one, rather limited, exception to the above rule. IF the borrower can show, via an adversarial proceeding, that post-bankruptcy the student loan debt would be an undue financial hardship or burden, then the debt itself may be discharged if the bankruptcy court agrees. In this case, very, very unfortunately, the borrower did not file this type of proceeding, and thus, loses on the issue.
The plaintiff also sued based on specific language in the note. Such notes almost always include similar language, to the effect that the borrower, in any dispute, will pay the lenders reasonable collection costs and attorney’s fees. Sadly, such notes are a form of ‘take it or leave it’ contract, the borrower has zero power to negotiate, and often, borrowers fail to even read the notes carefully. Such language potentially opens the door for a far harsher verdict than simple repayment of the loan.
In this case, the court enforced the contract, making the defendant liable for an additional $13,000 in interest and late fees. Plaintiff sought $10,000 in attorney’s fees, however the court focused on the word “reasonable” in the contract and stated that plaintiff had made no showing whatsoever that its attorney’s fees were reasonable, and thus denied the award of fees.
Student loan debt thus poses two problems for the borrower. It is not, absent the special showing, dischargeable in bankruptcy. Further, the language of the note or agreement favors the lender and imposes harsh yet enforceable consequences for default, because a default is also a breach of contract, that also may not be dischargeable via bankruptcy.
Student loan debt and the legal language of the contracts and notes that govern it can prove very problematic. There are many traps for the unwary, including family members of the student who may agree to guarantee the loan. It is imperative to retain experienced counsel to address these matters - please do not hesitate to contact our office for a consultation.