Q & A: Student Loan Bankruptcy (Basic)
by Jeannine Mitchell
For this Q & A, Debt 101 Publisher Jeannine Mitchell consulted Douglas Hoyes, an Ontario-based bankruptcy trustee known for his interest in student loan bankruptcy policies. Relevant legal transcripts supplied by Mr. Hoyes are attached.
Douglas Hoyes (BA, CA, CIRP, CBV,Trustee) is co-founder, Hoyes, Michalos & Associates Inc.
THE 7-YEAR ‘WAIT’
Debt 101: Douglas Hoyes, are government-guaranteed student loans only discharged in a bankruptcy if the student has “ceased to be a student” for more than seven years (or more than five years, if they prove economic hardship)?
Douglas Hoyes: Yes. Section 178 1(g) of the Bankruptcy & Insolvency Act states that the following debts are NOT discharged when you declare bankruptcy in Canada:
(g) any debt or obligation in respect of a loan made under the Canada Student Loans Act, the Canada Student Financial Assistance Act or any enactment of a province that provides for loans or guarantees of loans to students where the date of bankruptcy of the bankrupt occurred:
(i) before the date on which the bankrupt ceased to be a full- or part-time student, as the case may be, under the applicable Act or enactment, or
(ii) within seven years after the date on which the bankrupt ceased to be a full- or part-time student.
Debt 101: But there’s a five-year possibility too?
Douglas Hoyes: Yes. The Act goes on to state: (1.1) At any time after five years after a bankrupt who has a debt referred to in paragraph (1)(g) ceases to be a full- or part-time student, as the case may be, under the applicable Act or enactment, the court may, on application, order that subsection (1) does not apply to the debt if the court is satisfied that:
(a) the bankrupt has acted in good faith in connection with the bankrupt’s liabilities under the debt; and
(b) the bankrupt has and will continue to experience financial difficulty to such an extent that the bankrupt will be unable to pay the debt.
Debt 101: So if they meet those tests of good faith and financial difficulty, the loans could be discharged after five years.
Douglas Hoyes: Correct, but government-guaranteed student loans are only automatically discharged if you have “ceased to be a student” for more than seven years prior to when you declare bankruptcy.
THE 5-YEAR HARDSHIP OPTION
Debt 101: Some people are in such a financial crisis with other debts as well as their student loans that they might want to try that 5-year hardship option.
Rather than waiting 2 more years for that ‘7-year clock’ to pass, could they make a standard application for bankruptcy, just citing their extreme hardship?
Douglas Hoyes: There really is no “standard” application. You are correct that the applicant must prove good faith and financial difficulty, so in that sense the burden of proof is the same in all cases. However, since the facts in each case will be different, the material the applicant, or the applicant’s lawyer will present to court will be different in each case.
Debt 101: But since judgements vary, they’d be taking the chance of having to pay for another bankruptcy application later if their hardship application fails. We discuss this in our second Q & A: Student Loan Bankruptcy (Complex Cases).
Given that risk, I guess they should have a strong case for meeting the good faith and financial difficulty tests the Act requires for a 5-year ‘hardship’ discharge. They’d have to demonstrate that they acted in “good faith” with respect to their student loans and they’d have to show that they’d experience so much financial difficulty that they couldn’t – even in the future - repay the student loan.
So next, we should talk about those ‘tests.’
GOOD FAITH + OTHER BANKRUPTCY ‘TESTS’
Debt 101: To discharge student loans through bankruptcy, you must show the court good faith. But how does the court measure good faith? We’ve heard of ‘attempts to pay’, ‘maintains updated contact information’ and ‘demonstrates student loan money was properly spent.’ Assuming these are all correct, is there anything else involved in demonstrating your ‘good faith’?
Douglas Hoyes: If the student loans are more than seven years “old “ (as defined in section 178(1)(g)) and if there are no objections to the bankrupt’s discharge, the student loans are automatically discharged.
Debt 101: If there were no objections by the lenders of those student loans, you mean?
Douglas Hoyes: Correct. However, there is no automatic discharge if a former student applies under the 5-year “hardship” rule for student loans (section 178 (1.1)), or if a creditor opposes the discharge of a bankrupt - even when the loans have gone beyond 7 years. In these cases, the former student must satisfy the court of those two conditions:
1. they acted in “good faith” with respect to their student loans.
2. they would experience financial difficulty if they were to try to repay the student loan.
Debt 101: How would that look in an actual case?
Douglas Hoyes: In the case of Giera, Re, heard by Deputy Registrar Mills in 2008, there are four elements to “good faith”. The Court is to examine whether:
1. the money was used for the purpose loaned and if the education was completed,
2. whether the Bankrupt is deriving economic benefit from the education,
3. whether there were any reasonable efforts to repay the loans and
4. whether there was any effort by the Bankrupt to take advantage of interest relief or remission options offered by the lenders.
I’d add two comments:
First, if a student left school, perhaps for medical reasons, before graduating, it’s more likely that the court will discharge the student loan than if they graduated and are getting the benefit of the loan.
Second, if a student went to school to be a doctor, and they are now working as a doctor, it’s unlikely the court will discharge their loan. However, if they went to school to be a computer programmer, and they can’t find a job as a computer programmer, it’s more likely that the court will discharge their loan, since they are not deriving economic benefit from their education.
Debt 101: Not benefiting economically from their education – that’s an important point. Because one argument for the tough rules around student loan bankruptcies is that education is a benefit borrowers keep, unlike a repossessed car.
Douglas Hoyes: Economic benefit was considered in the Giera, Re case. The bankrupt had a student loan that was more than seven years old, but the government (the Attorney General) opposed her discharge.
The bankrupt graduated from a dental technology programme. Upon graduation, she obtained employment in an orthodontic office, building orthodontic appliances. During this time, the bankrupt developed a severe allergic skin reaction to the materials used such that she required medical treatment. Once she ceased this employment, her skin problems disappeared. The bankrupt concluded that she was allergic to the products used in the dental/orthodontic appliances.
After graduation she did apply to defer her payments, and she did make numerous payments on her student loan until she filed her bankruptcy.
The Court concluded that the “Bankrupt lives modestly and within her financial means.” The court accepted “that she has struggled to live within her budget and she is to be commended for not turning to consumer credit to make ends meet. Although her employment appears to be stable, the Bankrupt does not earn an income commensurate with her education and is not likely to do so in the foreseeable future.”
However, despite all of this, the court concluded that the bankrupt has the ability to repay the principal amount of the student loan of $8,000, so her bankruptcy will not end until she makes full payment.
Debt 101: Still, the Court decided that she only had to pay a sum the court estimated as the principal. On the down side, she had bankruptcy costs and her credit rating will suffer for years. But $8,000 is much lower than the payment she was originally faced with.
Douglas Hoyes: It’s still a large number in that case.
Debt 101: Agreed. How about a case that illustrates the other 'test' - economic difficulty in repaying the loan?
Douglas Hoyes: The case of Kelly, Re, from 2000, is now used as a precedent in most cases, including the Giera case above.
The court concluded that the bankrupt did not try hard enough to find a job, and to reduce her expenses to free up cash to make larger payments on her student loan. So the loan was not discharged.
OPPOSITION TO BANKRUPTCIES
Debt 101: In these cases, bankruptcy applicants were opposed when they attempted to have their student loans discharged. And in the case of Kelly, Re, the bankruptcy applicant represented herself against lawyers from both the Ontario and the federal governments.
We can’t know if the precedent from Kelly, Re would be different if she’d had legal representation. But it does raise another question. Do governments often oppose the discharge of student loans? And do any governments stand out as successfully blocking student loan discharges?
Douglas Hoyes: It’s quite common. I was in court a few weeks ago in Toronto and the government objected to the discharge of a single mother with 15-year old student loans. It was clear that the Registrar was upset by the application, so he told both parties to “go outside” and work it out. When they returned, the bankrupt agreed to pay $150 per month for four years as a condition of her discharge.
The Registrar approved the settlement, but he did ask the lawyer for the government “Why are you here today on this case, when last week there was a doctor here with $200,000 in student loans and you didn’t object in that case?” The government lawyer said that she “just deals with the cases that are delegated to her”.
In my experience, it is generally the single mothers whose discharges are opposed, as opposed to a bankrupt who may be in a better position to defend themselves.
Debt 101: So single mothers and other vulnerable bankruptcy applicants are the people the government tends to go after? That seems shocking, but thank you for pointing it out. People need to prepare for reality.
STUDENT LOANS VS. OTHER DEBT
Debt 101: Do you think that eligible student loans have a similar discharge rate to other forms of debt?
Douglas Hoyes: Other forms of debt, like credit cards and bank loans, are almost always discharged in a bankruptcy. It is very unusual for a creditor like a bank to oppose someone’s [consumer debt] discharge. It is much more common for the government to oppose where a student loan is involved.
PRIVATE (BANK-ONLY) STUDENT LOANS
Debt 101: With all these questions about student loans and bankruptcy, we’ve been talking about ‘public’ student loans. Meaning, loans issued under Canada’s federal or provincial student aid statutes.
We hear that ‘private’ student loans (provided directly by banks) tend to be co-signed lines of credit, which makes bankruptcy less likely. In other words, co-signers are responsible for payment if the students don’t repay. And for banks to allow a private student loan (or line of credit), co-signers generally must be able to back up their signature with financial assets.
So here’s the question. If former students did apply for bankruptcy discharge of these private student loans, must they wait until 7 years after school, just like they would have to with government-backed student loans? If not, how old do private student loans need to be?
Douglas Hoyes: Section 178 1(g) of the Bankruptcy & Insolvency Act only refers to student loans “ made under the Canada Student Loans Act, the Canada Student Financial Assistance Act or any enactment of a province that provides for loans or guarantees of loans to students.”
So, a private loan (ie. a loan from a bank that is not government guaranteed) is not subject to the same rules.
However, there have been cases where a Big Bank, who shall remain nameless, has opposed discharges for their student lines of credit.
Debt 101: Banks were known to oppose discharge of those old risk-shared government student loans from the 1990s. Is it possible that banks may become as active as government in opposing discharges of the private student loans they’re marketing?
Douglas Hoyes: Yes, it’s possible that banks will be more aggressive in the future. In general, if a creditor takes the time to appear in court to oppose a discharge, it’s likely that the court will grant the creditor something, such as making the bankrupt pay at least a small portion of the debt back.
So yes, if there are “private” student loans, it is possible that the banks could get aggressive in the future, if they perceive there is a good chance that they will get something for their effort. However, presumably they, like most creditors, realize that spending a lot of money on lawyers for minimal return doesn’t generally make good business sense.
Debt 101: Douglas Hoyes, thank you very much for walking us through some of the issues involving student loan bankruptcies. There are other issues, including costs and the ‘timing’ rules if you've returned to school, and we’ll cover those in our follow-up Q & A: Student Loans and Bankruptcy (Complex Cases).
Douglas Hoyes: In the meantime, people can read my detailed post on “Seven Years”.