How a Small Credit Union Fought For - And Won - It's Right To Collect On Student Debt

Quote by Larry Plavnick, attorney for the credit union in this case.

By Laura Schreier, Special to Banker & Tradesman

When a borrower of theirs filed for bankruptcy, Boston-based Liberty Bay Credit Union did something unusual – it went to court and asked for some of its money back. And it won, on the strength of a handwritten note the borrower had scrawled out five years ago.

The case stands out for two reasons, according to legal experts: First, that Liberty Bay's victory strengthens guidance for recovering funds in a bankruptcy filing – in this case, on educational lending, which is a growing trend in the credit union industry. And second, it shows how a savvy credit union can successfully fight back in the courtroom.

"I had a gut feeling, but I didn't know how it would play out," Liberty Bay Collections Manager Victor Simas said of the case. Still, the institution – which operates locations in Boston, Braintree and Stoneham – pursued the matter because Simas was experienced in bankruptcy law and knew Liberty Bay had a shot.

"I'm kind of stubborn," he told Banker & Tradesman. The legal costs were higher than the amount of money the institution won back, but Simas said once the credit union started the process of arguing this case, it decided to pursue it all the way.

Running Lean

In the case, the borrower opened a general $10,000 line of credit in 2001. But in 2007, she wrote the credit union, requesting that it increase her credit to $14,000 so she could pay for books and tuition for her children.

Under bankruptcy law, educational loans are non-dischargeable – meaning even if the borrower files for bankruptcy, educational loans still stick, even when all others would be wiped away.

Usually this applies to loans specifically made through a designated loan program. But Liberty Bay maintained that, with the note, the extra $4,469 it ended up extending to the borrower was indeed educational, and therefore not dischargeable when she later ended up in bankruptcy.

Judge Joan N. Feeney agreed, in an opinion that strengthens private lenders' positions.

The stated purpose of the loan is the deciding factor here, Feeney wrote, never mind that the credit union never followed up with the borrower to ensure that the money was actually spent on her children's education.

"The Debtor expressly set forth the purpose of the loan in her handwritten note... and it is immaterial that there were no controls on the use of funds," the decision reads.

"What this really means is, credit unions and banks now better understand their remedies," said Lawrence R. Plavnick, attorney with Woburn-based McLane, Graf, Raulerson and Middleton Professional Association, which represented the credit union in this case.

But it also sends the message that lenders absolutely need to document the purposes for their loans, he added, and have the proper training to identify where they have rights under bankruptcy filings like this one.

Too many credit unions receive bankruptcy notices and don't bother to examine the details, he said, so money disappears without a second thought. Simas agreed.

"Credit unions, like all financial institutions, are probably running very lean these days," he said, with few in-house collections experts to spot areas where the institution can maintain its rights to a loan.

Simas said he dealt with collections in his previous job at Ohio-based KeyBank, where he frequently saw doctorate or medical graduates try to walk away from their student loan obligations after declaring bankruptcy. This was prior to 2005, before bankruptcy law was reformed to include private lenders in its educational loan exemptions. Back then, some courts were sympathetic to the lender, he said; others were firmly on the side of the borrower every time.

Hats Off

But when the law changed in 2005, private lenders got the same protections that government or nonprofit educational lenders had always gotten. That's important, said Mike Mullowney, managing partner of Newton-based Silver Sword Capital Partners, because student loans are very high-risk loans for the lenders.

Silver Sword connects national student lenders like Sallie Mae with community banks and credit unions that can sell co-branded products. In those cases, the institution gets a fee for providing the storefront that sells the loans, but it doesn't use its own money.

"Our credit union business is booming," he said. But more and more credit unions, sitting on a lot of cash and with a mandate to lend, want to transition into making the loans themselves.

And with that in mind, a court opinion like this is good news. But Mullowney noted that the law, while offering protections now, might not always be so strong.

Public sympathy is on the side of students struggling to repay enormous loans – and for good reason, he added, although those giant bills are more the fault of universities' astronomical tuition increases, not lenders' terms. If the law takes away lenders' ability to recoup that money after a bankruptcy filing, "that'd be a game-changer."

"I'm not sure that lenders would be as excited about the opportunity [to make student loans if the law were changed]," he said.

For now, legal experts urge lenders to improve their knowledge of bankruptcy law. David Reed, a partner at Virginia-based Reed & Jolly, authored a "Bankruptcy Guide for Credit Unions," that institutions can buy and use as a tutoring device. It doesn't substitute for legal help, Reed said, but the important first step is to have employees in-house who are well-versed enough to see red flags and know whether they can pursue them.

Reed acknowledged that the legal costs usually were enough to scare credit unions away from arguing cases like this, but he urged institutions to share their struggles with their professional organizations and get as much help, financial or otherwise, as possible. Institutions will only get better guidance and protections if they decide to fight back.

"Unless you litigate it, nothing changes," he said, adding, "My hat's off - kudoes to this credit union."

Originally published October 2012

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