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NYC Consumer Debt Defense Project

Debt Collector Misled Borrowers, Court Says

Friday, August 31, 2012

For borrowers struggling to pay off their student loans, getting rid of the debt in bankruptcy is difficult because they need to convince a judge that it constitutes an “undue hardship.”

But it is not impossible. And on Thursday, the United States Court of Appeals for the Second Circuit, based in Manhattan, ruled that a debt collection agency working to collect loans backed by the Education Department misled borrowers by telling them their debt was not dischargeable in bankruptcy.

In doing so, the appellate court reversed a lower-court ruling and allowed a lawsuit brought against Collecto, the collection agency, to proceed in Federal District Court.

“They were giving incorrect legal advice in an attempt to coerce money out of these people,” said Brian L. Bromberg, appellate lawyer for the plaintiff, a Buffalo woman. He said that while debt collectors often told borrowers that they could not discharge their students loans in bankruptcy, Collecto “was foolish enough to put it in writing.”

Collecto officials declined to comment Friday afternoon, as did the Education Department.

There is a common misperception that student loans cannot be discharged in bankruptcy, in part because it is so difficult to do so. Debtors must demonstrate that repaying the loan “would impose an undue hardship on the debtor,” showing that they cannot maintain a minimal living standard, that their dismal state of affairs is likely to continue and that they have made a good-faith effort to repay.

Though hard numbers are difficult to come by, it appears that fewer than 1,000 borrowers each year even try to make the “undue hardship” case. There are 37 million borrowers with federal student loans.

The appellate case dates back to 2001, when the Buffalo woman, Berlincia Easterling, filed a bankruptcy petition. At that time, she owed the Education Department $2,460 for a student loan. Mr. Bromberg did not know where Ms. Easterling attended college, and she could not be reached for comment.

In her bankruptcy petition, Ms. Easterling did not try to pursue an undue hardship claim and listed her student loan debt as “not dischargeable.”

Seven years later, she received a letter from Collecto about her student loan balance, which had grown to $3,359.76 with accrued interest. “Account ineligible for bankruptcy discharge,” the letter said. “Your account is NOT eligible for bankruptcy discharge and must be resolved.”

According to the appellate opinion, when Collecto learned that a debtor had filed for bankruptcy, it stopped collection activity until it could determine if the student debt was discharged. In the unlikely event that it was, Collecto would send the debt back to the Education Department as uncollectable.

If the debt was not discharged, Collecto would resume trying to collect it by sending a letter like the one Ms. Easterling received. Ms. Easterling brought the lawsuit on behalf of herself and 181 other debtors in New York State who received the same collection letter.

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