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TOPIC:
STUDENT BANKRUPTCY AND THE PERMISSIBILITY OF TRADITIONAL
CAMPUS COLLECTION MEASURES
INTRODUCTION:
While some economic indicators signal the end of the recession, the fact remains that consumer
bankruptcy [1] filings are on the rise. [2] Many of these bankruptcies involve current or former
students who are unable to pay back their educational debt to college or university lenders. In this
environment, understanding the basic principles of bankruptcy and how student bankruptcy affects
traditional campus debt collection techniques, such as withholding of transcripts and denial of
registration, is more important than ever for administrators. This NACUANOTE will address those
principles and provide practice pointers for college and university officials dealing with students in
bankruptcy.
DISCUSSION:
Bankruptcy in General [3]
The twofold objective of the Bankruptcy Code is to: (1) relieve the honest debtor from the burden of
oppressive debt, thereby granting him a “fresh start;” and (2) provide for equitable treatment of
creditors through a systematic distribution of the debtor’s nonexempt property. [4]
Colleges and universities, of course, have an equally important objective – to collect amounts owed
for educational and other services rendered to student borrowers. To achieve this, many campuses
institute and enforce policies of withholding official transcripts and barring registration for students
who fail to fulfill their financial obligations to the institution. [5] Outside of bankruptcy, such actions
are considered reasonable and are not unfair collection practices prohibited by 15 U.S.C. § 1692(f).
[6] However, the extent to which an institution may enforce these policies against a student who is,
or has been, a debtor under the Bankruptcy Code is determined by a number of factors including: (1)
the operation of the automatic stay provisions; (2) the discharge injunction; and (3) the
anti-discrimination provisions of the Bankruptcy Code. Understanding these concepts is essential to
ensuring that an institution does not violate the Bankruptcy Code when enforcing its collection
policies and procedures.
Restrictions on Collection Procedures During the Pendency of a Bankruptcy
Case - The Automatic Stay
The automatic stay is one of the fundamental debtor protections provided by the Bankruptcy Code.
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[7] It is designed to (1) protect the debtor by giving him a “breathing spell” from the collection efforts
of creditors; and (2) maintain the status quo between the debtor and his creditors. To achieve these
results, the stay temporarily prohibits a broad range of creditor conduct, including “any act to collect,
assess, or recover a claim against the debtor that arose before the commencement of the case.” [8]
The stay arises the moment a debtor files a petition for relief in the bankruptcy court, and remains in
effect until the case is closed or dismissed, or a discharge is granted or denied. [9]
Although an institution will typically receive formal notice of a student’s bankruptcy petition by mail,
creditors are subject to both actual and inquiry notice for purposes of the automatic stay. [10]
Consequently, an institution has a duty to investigate any notice of a bankruptcy filing by one of its
student debtors, regardless of how the institution learns of it. Once on notice, the institution and its
agents must immediately suspend any collection efforts outside the bankruptcy process. If an
institution willfully violates the automatic stay, the student debtor may be entitled to monetary
damages, including costs, attorney’s fees and – in appropriate circumstances – punitive damages.
[11]
Withholding Official Transcripts
Does withholding a debtor’s official transcript while the debtor is under the protection of the
bankruptcy court violate the automatic stay? The majority of courts that have addressed this issue
have concluded that it does. [12] In other words, the majority of bankruptcy courts consider
withholding a transcript to be an “act to collect” in violation of §362(a)(6). [13] A minority of courts –
particularly in the Third Circuit – have held that when the educational debt is concededly
nondischargeable, the institution does not violate the automatic stay by withholding the official
transcript from a debtor who previously defaulted. [14] This line of cases focuses on the contractual
relationship between the institution and the debtor. For example, one court analogized the
withholding of a transcript to a bank’s placing an administrative freeze on an account. [15] The court
reasoned that similar to a bank’s refusal to honor its promise to pay, a university’s withholding of a
transcript is a refusal to perform a promise to create and deliver a record of the debtor’s academic
performance. This rationale, some argue, is consistent with the purpose of the automatic stay, i.e., to
maintain the status quo. However, this minority view has been heavily criticized. [16]
Denying Class Registration.
Limited case law suggests that refusing to allow a debtor to register for classes is also an act to
compel payment of a pre-petition debt and likewise violates the automatic stay. [17] While only a few
courts have considered this issue, they agree that barring a debtor from registering for class is
analogous to withholding a transcript in the bankruptcy context; both institutional prohibitions are
acts to collect, which are prohibited by the automatic stay. [18] As such, courts may award damages,
costs and attorney’s fees to the debtor if they find that the institution willfully violated the automatic
stay by refusing to allow a student to register for classes. [19] The argument that the pre-petition
debt was nondischargeable has been rejected in this context as well. [20] That said, while an
institution cannot deny registration to a student who is under the protection of the Bankruptcy Court
in order to compel the payment of old debts, it need not permit a student to accrue new educational
debt going forward. Thus, college and university officials can take certain steps to protect their
institutions without running afoul of bankruptcy laws. Some of these steps may include requiring
advance payment of tuition or administratively withdrawing a student who incurs a tuition charge but
fails to pay in accordance with institutional policy.
During the pendency of the automatic stay, best practice therefore suggests that an institution refrain
from withholding transcripts or denying registration without permission of the court. Such permission
may be requested by filing a motion for relief from stay. [21] However, the institution should first
review the filing to determine if reasonable grounds exist to justify such relief. For example, if the
debt is predominately nondischargeable student loan debt [22] or if the debtor is abusing the
privileges of the stay, the institution may be able to successfully argue that the bankruptcy filing is
not in good faith. [23] But under ordinary circumstances, courts are unlikely to grant an institution
relief from the stay. Indeed, at least one court has reasoned that withholding a debtor’s transcript is
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counterproductive to the creditor’s desire to be paid, since the debtor needs the additional training or
employment for which the transcript is a prerequisite in order to increase his income and, in turn,
repay the nondischargeable debt. [24] Arguments that the institution has a security interest in an
academic transcript as a basis for relief have likewise been unsuccessful. [25]
Restrictions on Collection Procedures Post-Discharge: The Discharge
Injunction
From a debtor’s perspective, the paramount goal of filing for bankruptcy is to obtain an order of
discharge, which releases the debtor from personal liability for the payment of certain dischargeable
debts. [26] The discharge operates as a permanent order directed to the debtor’s creditors,
stipulating that they refrain from taking any action against the debtor or his property to recover
discharged debts. [27] This includes legal action, as well as communications with the debtor, such as
telephone calls, letters, and any other personal contact.
From a creditor’s standpoint, the final disposition of a bankruptcy case signals the expiration of the
automatic stay and determines whether or not a creditor can proceed to collect a debt that arose
prior to the date of the bankruptcy petition. The crucial inquiry then, is what debt was discharged,
and what debt remains collectable?
Discharged vs. Nondischargeable Debt
Certain debts are nondischargeable by statute, and thus can be collected after bankruptcy. [28]
These include certain educational loans, as well as debts related to taxes, child support, and
alimony. [29] These exceptions represent determinations by Congress that some debts should be
repaid for public policy reasons regardless of their burden on the debtor. [30]
Most educational loans can only be discharged through a special process within the bankruptcy
called an “adversary proceeding,” after a finding of undue hardship. [31] The exception to discharge
for educational debt is self-executing, meaning the bankruptcy court must make an undue hardship
finding before discharging that debt, even if the creditor does not request one. [32]
Importantly though, not all extensions of credit to a student will be excluded from discharge. For
example, debt for unpaid tuition accounts and bills (as opposed to student loan debt) may be
included in the general order of discharge, and therefore will be uncollectable. [33] Thus, colleges
and universities that seek to enforce their collection policies should be mindful of how they classify
debt, and endeavor to ensure that it is classified as nondischargeable educational “loan” debt under
section 523(a)(8). [34]
Withholding Transcripts and Denying Class Registration After Discharge
Congress intended the Bankruptcy Code to ensure that the debtor “will not be pressured in any way”
to repay discharged debts. [35] Accordingly, bankruptcy courts have held that denying a student
access to his official transcript after the discharge of all debts owed to the institution violates the
discharge injunction. [36] Thus, institutions that continue to withhold transcripts in contravention of
the discharge order could face monetary or other sanctions. [37] The argument that refusing to
release transcripts is not an action but rather is a failure to act has also been rejected. [38] Of
course, if the debtor emerges from bankruptcy with non-discharged educational debt, the institution
is free to pursue traditional collection methods – including transcript withholding – with respect to
that debt. [39]
Courts take a similar view with respect to an institution’s preventing a student from registering for
classes. Engaging in such a tactic where the student’s debt has been discharged will likely be seen
as a violation of the discharge injunction and may be sanctioned by the courts. [40] But denying a
student’s request to reenroll based upon the student’s outstanding nondischargeable debts would
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likely be permissible. [41]
The Anti-Discrimination Provisions – Public Institutions
Public schools also have to contend with the anti-discrimination section of the Bankruptcy Code.
Section 525(a) of the Bankruptcy Code provides that governmental units may not “deny, revoke,
suspend, or refuse to renew a license, permit, charter, franchise, or similar grant to . . . or
discriminate with respect to employment against” someone solely because he or she has filed for
bankruptcy or received bankruptcy relief. These provisions apply any time after the filing of a
bankruptcy action, as well as after entry of a discharge order, and they prevent withholding of
transcripts by public institutions during the pendency of a case and after the debt has been
discharged. [42] The fact that the anti-discrimination provision does not explicitly apply to private
institutions has no real practical consequences, as the automatic stay and discharge injunctions
accomplish the same purpose.
Practice Pointers
In light of the above, institutions would be well served by implementing some or all of the following
practice pointers:
1. Be proactive before the debtor files for bankruptcy. Consider adopting policies to:
Identify delinquent accounts early and distinguish dischargeable from
nondischargeable debt;
Structure unpaid tuition and fees as an educational loan, thus insuring that the debt is
nondischargeable; [43] and
Prohibit students with certain types or levels of debt from enrolling in additional
classes, completing classes, or graduating under certain circumstances.
2. During the pendency of a bankruptcy proceeding, make sure that all appropriate parties know
and understand that the debtor is immediately protected by the Bankruptcy Code’s automatic
stay and that the institution must cease all collection activities.
3. Do not assume that nondischargeable debt is exempt from the automatic stay, and seek the
Bankruptcy Court’s permission (via motion for relief from the automatic stay) before taking any
action to collect student debt.
4. Provide students under automatic stay protection with their transcripts, and permit them to
register for classes. Remember that the institution will be able to resume collection activities
after the close of bankruptcy proceedings for any portion of the student’s debt that is
nondischargeable.
5. After the close of the bankruptcy proceeding, carefully review the discharge order to
determine what, if any, debt survived the case. Educate staff responsible for post-discharge
collection activities on the scope of the educational debt exception to discharge to make sure
that your institution only attempts to collect debt that was not included in the general order of
discharge.
6. Remember that even a passive act such as withholding transcript and refusing to allow a
debtor to register for classes will likely be interpreted by the bankruptcy courts as an attempt
to collect on outstanding debts.
7. Encourage your institution to train its staff in the principles of bankruptcy law, to monitor legal
developments, and to periodically review and update its policies and procedures to confirm
that they comply with the Bankruptcy Code and any new developments in the law.
CONCLUSION:
Understanding the fundamental principles of bankruptcy law is vital for an institution’s effective
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financial administration. Compliance with the automatic stay and discharge injunctions, as well as
the anti-discrimination provisions, is imperative. An institution that incorporates the concepts
explained in this Note into its business practices both enhances its ability to protect its creditor rights
and minimizes the risk of violating the Bankruptcy Code.
FOOTNOTES
AUTHORS:
Julia R. Hoke, Director for Legal Affairs and General Counsel of the State Education Assistance
Authority, State of North Carolina
Diane G. Miller, Associate General Counsel for the State Education Assistance Authority, State of
North Carolina
RESOURCES:
NACUA Resources:
NACUA Bankruptcy and Student Debts Resource Page
Additional Resources:
Federal Bankruptcy Code (Title 11 U.S.C.)
Federal Rules of Bankruptcy Procedure
U.S. Courts Website on “Bankruptcy Basics”
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