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There are few things more tenacious that an unpaid student loan. The U.S. Department of Education pulls out all the stops to collect from borrowers who default on loans that it guarantees. People who file for bankruptcy often discover those loans are still hanging around when a collection agency comes knocking on the door. Discharging a student loan debt through bankruptcy is very difficult but not impossible. One collection agency told debtors it couldn’t be done. The Second U.S. Circuit Court of Appeals says that’s not true, and will allow a lawsuit against the collection agency to stand.

Collectco, Inc., the agency involved, told debtors in writing that student loans cannot be resolved in bankruptcy and the balances must be paid off. The case began when a woman in Buffalo, New York tried to discharge her $2,460 student loan debt in a bankruptcy proceeding. She did not claim undue hardship at the time. Seven years later, she received a letter from Collectco telling her the student loan was still on the books and must be paid. The woman sued on behalf of herself and 181 others who got the same letter. The Appellate Court ruled that the letter was misleading, and allowed the lawsuit against Collectco to proceed.

Actually, the law does allow forgiveness of the debt but the process is not easy. The borrower must prove that paying the amount owed would impose “an undue hardship on the debtor,” meaning the inability to meet a minimum standard of living. One component of that test is convincing a judge that the petitioner’s financial circumstances indicate a “certainty of hopelessness” for a long time to come. Fewer than 1,000 borrowers try to run this legal gauntlet every year.

Before 1975, it was easy to discharge student loan debt as part of an ordinary bankruptcy. Then Congress got word about newly-graduated doctors and other professionals filing for bankruptcy immediately after finishing school, thus ridding themselves of huge debts. Lawmakers, annoyed at what they saw and eager to protect taxpayer dollars, changed the law in 1976. The law was tuned up with tougher provisions in 1990 and 1998, and in 2005 protection for private lenders was added. One thing lawmakers did not do is define “undue” financial hardship. Judges across the country have been trying to figure it out since. So despite blustery warnings from lenders that student loans are forever, a skilled bankruptcy attorney can help borrowers get relief from those debts and start rebuilding their financial lives.

Source: The New York Times, “Debt collector mislead borrowers, court says,” Andrew Martin, Aug. 31, 2012