Thursday, October 15, 2015

Kelly v. Sallie Mae & Educational Credit Management Corporation: Fees, Interest and Penalties Are Dragging Down Student-Loan Debtors

Some policy experts argue that there is no crisis in the student loan program. Most students borrow only modest amounts of money, they say. The people who owe more than $100,000 are just a tiny fraction of the 41 million student-loan borrowers.

But this argument fails to take into account interest, penalties, and fees that borrowers accumulate if they run into financial trouble and can't make their loan payments.  Some distressed borrowers obtain economic-hardship deferments or forbearances that excuse them from making payments. But the fees and interest that accrue over time can double, triple, or even quadruple the size of their loan balance. When that happens, they are doomed.

And here's a case that illustrates my point: Kelly v. Sallie Mae, Inc. (2015). Laura Kelly borrowed about $24,000 to pay for her undergraduate degree in political science at Seattle University. She made payments for eight years, but she ran into financial trouble and filed for bankruptcy in 2008.

By the time Kelly entered bankruptcy, her debt had more than QUADRUPLED to $105,000 due to collection fees and accumulated interest. She filed an adversary proceeding to clear this debt, and a bankruptcy court gave her a partial discharge. The court concluded that Kelly was unable to pay off her loans, that her financial situation was not likely to improve soon, and that she had acted in good faith in the way she had handled her indebtedness.

Sallie Mae and Educational Credit Management Corporation, perhaps the most ruthless of the federal government's debt collectors, appealed the bankruptcy court's decision; and a federal district court reversed. The district court upheld the lower court's conclusion that Kelly could not pay back the hundred grand and still maintain a minimal standard of living. And it upheld the conclusion that Kelly's financial situation would not improve soon.

But the district court reversed the bankruptcy court's conclusion that Kelly had acted in good faith. The district court thought Kelly should have explored alternative payment plans, including a Public Service loan-payment program. And it also believed she could cut her expenses and make some sort of loan payment.  "In short," the district court ruled, "Ms. Kelly made no effort, much less good faith effort, to repay her loans."

Proceeding without a lawyer, Kelly appealed the district court's opinion to the next level: the Ninth Circuit Court of Appeals. The Ninth Circuit, considerably more compassionate than the district court, reversed the district court's decision and reinstated the bankruptcy court's partial discharge. This is what the Ninth Circuit said:
The bankruptcy court justified its conclusion that Kelly had acted in good faith with reference to its findings that, among other things, Kelly had maximized her income, had incurred only marginally excessive expenses, paid thousands of dollars toward her student debt over an eight year period before filing for bankruptcy, and at least minimally investigated payment alternatives such as debt consolidation, deferment, and a federal loan repayment program. . . . Moreover, though Kelly did not pursue loan repayment options, the bankruptcy court did not clearly err in its conclusion that Kelly had a good-faith belief that she was ineligible for the program, and that applying for the program would have been futile since she could not afford the payments after consolidation. 
The Ninth Circuit's Kelly decision is significant for three reasons:

1) First, Kelly successfully fought Sallie Mae and Educational Credit Management Corporation, two of the federal government's most sophisticated and relentless  debt collectors, without a lawyer all the way to the Ninth Circuit.  But look how long the process took. Kelly filed for bankruptcy in 2008, and the Ninth Circuit didn't issue its opinion until 2015. Most debtors wouldn't have the stamina for a seven-year court fight, which is what ECMC and Sallie Mae are counting on. Thus, Kelly should be saluted as a hero for fighting ECMC and Sallie Mae for so long.

2) Second, the Kelly decision is one of a string of recent federal appellate court decisions that ruled in favor of student-loan debtors. Kelly is not as significant as the Ninth Circuit BAP Court's Roth decision or the Seventh Circuit's Krieger decision. Nevertheless, by upholding the bankruptcy court's decision to grant Kelly some relief, the Ninth Circuit has signaled that it will support compassionate bankruptcy courts that rule in favor of student-loan debtors if those rulings are grounded in solid fact findings.

3) Third, and most importantly, Kellv v. Sallie Mae & ECMC dramatically demonstrates how penalties, accumulated interest, and collection fees can turn a manageable debt into a nightmare.  Kelly only borrowed $24,000 to pay for her college education. By the time she arrived in bankruptcy court, the debt had quadrupled in spite of the fact that she had made loan payments for eight years.

Kelly's case is not unusual. I know a student-loan debtor who borrowed around $80,000 to attend graduate school and made payments totally approximately $40,000. The Department of Education now says he owes $315,000!

Our government has designed a student-loan program that is totally insane. For many students, it is the fees, penalties and accumulated interest that are sinking them--not the amount of the original debt.


Educational Credit Management Corporation v. Kelly, 2012 U.S. Dist. LEXIS 56052 (Bankr. W. D. Wash. 2012), reversed, Kelly v. Educational Credit Management Corporation, 594 Fed. App. 413 (9th Cir. 2015).

Kelly v.Sallie Mae, Inc. & Educational Credit Management Corporation, 594 Fed. App. 413 (9th Cir. 2015).

Natalie Kitroeff. Loan Monitor Is Accused of Ruthless Tactics On Student Debt. New York Times, January 1, 2014. Accessible at:

Krieger v. Educational Credit Management Corporation, 713 F.3d 882 (9th Cir. 2013).

Roth v. Educational Credit Management Corporation, 409 B.R. 908 9th Cir. BAP 2013).  

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