STUDENT LOAN BANKRUPTCY Question and Answer

1. STUDENT LOAN BANKRUPTCYQuestion and Answer David E. Stocker General Counsel Account Control Technology, Inc. 6918 Owensmouth Avenue Canoga Park, CA 91303

2. Some interesting facts to demonstrate the recent swings in bankruptcy filings. • Prior to effective date of the reform act record setting numbers of bankruptcies were filed. In 2005 over 2 million individuals filed bankruptcy. This was ½ million more persons than had ever filed under prior law. • Post reform bankruptcy filings fell 73% in 2006. • In 2007, there was a 48% increase in number of individual bankruptcies filed. Many related to the mortgage crisis as the FDIC predicted 1.5 million failures.

3. What is Bankruptcy? A. A legislatively created process to allow individuals and businesses to discharge certain of their debts by paying amounts, including zero, as set by the Bankruptcy Code and Rules.

4. Q. What are the common types of Bankruptcy? Chapter 7-a process of liquidation where the debtor assigns all non-exempt assets to the court to be divided among their creditors in a priority as set by the bankruptcy law and code. Chapter 13-a process where the debtor identifies their debts and presents a plan, for creditor and court approval, to repay debts based upon type of debt owed and the bankruptcy law and code. The debtor’s disposable income, after reasonable expenses, must be paid into the court trustee for monthly distribution.

5. Chapter 11-this is a bankruptcy which is only available to businesses, although some courts have allowed student loans, a personal debt, to be included in these proceedings. A Chapter 11 operates much like a Chapter 13. The debts are paid through a court managed plan. Chapter 12-this is a proceeding which is only available for agribusiness or “family farm” debts. As with the use of a Chapter 11-some courts have permitted individual debts to be included.

6. How is Bankruptcy started? The debtor files a petition with the bankruptcy court to have their debts discharged. How will I know if my accounts are involved? The debtor provides a matrix of all their creditors and the court sends a notice of the petition filing to each of them. If you are not on the matrix and/or are not given notice, your debt is not impacted by the bankruptcy filing.

7. When I receive notice of a bankruptcy filing which involves one of my accounts, am I required to take any action? You should immediately cease all collection activity and notify your collectors, internal or external. You should then review the effected loans and determine their potential discharge status. A proof of claim, this is a form which states the amount owed and the basis of the debt, should be filed with the court to preserve your rights in the proceeding. You can prepare and file the proof of claim, you do not need to hire an attorney.

8. Can the debtor refuse to pay my claim? The debtor may file an objection to any claim filed, but you have the right to oppose that objection. In some situations, other creditors have the right to object to your being paid. You may oppose that action as well. You will need an attorney to conduct these proceedings. What is the “automatic stay”? This is an order of the court which becomes effective upon the filing of the debtor’s petition. It prohibits any actions or communication involving the debtor which could be construed as a collection effort. It is sometimes possible to get permission of the court to lift this stay, but you need an attorney to file a request with the court.

9. Will I be required to go to court? A. Typically, you will not be involved in the court process directly. However, if there are objections to your claim, or the debtor files for a determination of “undue hardship” your institution will need to send a witness. If the bankruptcy is filed in a court near your institution, you may choose to attend the “Meeting of Creditors”. You will not need to have an attorney with you to participate. At that meeting, also called the 341 meeting, you may interview the debtor and review their financial records.

10. How will I know the bankruptcy is over so I may resume collections? The court will either issue a “Discharge Order” or a “Dismissal Order”. Either one ends the automatic stay and closes the proceedings. For all bankruptcies filed after October 17, 2005, unless there has been a specific determination and order for “Undue Hardship” as part of the bankruptcy, you should consider any student aid debts not discharged. For older bankruptcies filed prior to that, you will need to review the discharge rules in place at the time the petition was filed.

11. Section 523(a)(8) – Post bankruptcy reform… • With passage of the “Bankruptcy Abuse Prevention and Consumer Protection Act of 2005” (BAPCA), section 523(A)(8) has been revised to read as follows: • “(8) unless excepting such debt from discharge under this paragraph would impose an undue hardship on the debtor and the debtor’s dependents, for • (A)(I) an educational benefit overpayment or loan made, insured, or guaranteed by a governmental unit, or made under any program funded in whole or in part by a governmental unit or a nonprofit institution; or

12. Section 523(a)(8) – Post bankruptcy reform… • (A)(II) an obligation to repay funds received as an educational benefit, scholarship, or stipend; or • (B) any other education loan that is a qualified education loan, as defined in section 221 (D)(1) of the internal revenue code of 1986, incurred by a debtor who is an individual.” • This change to section 523(A)(8) was effective beginning on October 17, 2005.

13. I have had debtors in the past say they believe their student account was discharged in their bankruptcy. How should I respond? You need to make a review of rules in place at the time the petition was filed and determine if the accounts are discharged as you understand the rules. If the account did not meet the requirements for a discharge, you should inform the debtor why you believe their account is still valid and continue collections.

14. What changes were made to the discharge rules for student aid in the 2005 Bankruptcy Reform Act?? The most important change was the expansion of the types of student aid now protected from discharge. The reform provisions added “qualified education loans” to the protected class and incorporated the Internal Revenue Code definition of “qualified education loan” to describe the loans now added to the not discharged in bankruptcy group.

15. Bankruptcy Reform • Section 221 (D)(2) of the internal revenue code defines a “qualified education loan”, as: • “The term “qualified education loan” means any indebtedness incurred by the taxpayer solely to pay qualified higher education expenses— • Which are incurred on behalf of the taxpayer, the taxpayer’s spouse, or any dependent of the taxpayer as of the time the indebtedness was incurred, • Which are paid or incurred within a reasonable period of time before or after the indebtedness is incurred, and Which are attributable to education furnished during a period during which the recipient was an eligible student.

16. Bankruptcy Reform • Such term includes indebtedness used to refinance indebtedness which qualifies as a qualified education loan. The term “qualified education loan” shall not include any indebtedness owed to a person who is related (within the meaning of 26 U.S.C. §§ 267(B) or 707(B)(1)]) To the taxpayer or to any person by reason of a loan under any qualified employer plan or under any contract referred to IN 26 U.S.C. § 72(P)5)] (2) qualified higher education expenses. The term “qualified higher education expenses” means the cost of attendance (as defined in section 472 of the higher education act of 1965, 20 U.S.C. § 1087, as in effect on the day before the date of the enactment of this act [enacted June 7, 2001]) at an eligible educational institution,…

17. Bankruptcy Reform • For purposes of the preceding sentence the term “eligible educational institution” has the same meaning given such term by section 26 U.S.C. § 25a(F)(2), except that such term shall also include an institution conducting an internship or residency program leading to a degree or certificate awarded by an institution of higher education, a hospital, or a health care facility which offers postgraduate training.

18. Are my institutional and tuition accounts included in this new class of protected debts? It will take time for the courts to sort out the issues around the institutional receivables discharge question. The big question is whether there is a “loan”. Most institutional receivables debt is not reduced to a contract or promissory note. Therefore, challenges to the discharge protection will revolve around that issue. A second issue which will likely be offered as a challenge is that the IRS provisions focus on interest tracking of the student “loans”. With no contract, it is problematic that institutions can or are charging interest. It will likely be argued that if there is no interest being charged, it is not a “loan” and not protected from discharge.