Federal Student Aid - IFAP
   
STATUTORY CHANGE

Section 313 of the Bankruptcy Reform Act of 1994 (Pub. L. 103-
394) added the following paragraph (c) to 11 U.S.C. 525:

(c)(1) A governmental unit that operates a student
grant or loan program and a person engaged in a
business that includes the making of loans guaranteed or
insured under a student loan program may not deny a
grant, loan, loan guarantee, or loan insurance to a person
that is or has been a debtor under this title or a bankrupt
or debtor under the Bankruptcy Act, or another person
with whom the debtor or bankrupt has been associated,
because the debtor or bankrupt is or has been a debtor
under this title or a bankrupt or debtor under the
Bankruptcy Act, has been insolvent before the
commencement of a case under this title or during the
pendency of the case but before the debtor is granted or
denied a discharge, or has not paid a debt that is
dischargeable in the case under this title or that was
discharged under the Bankruptcy Act.
(2) In this section, `student loan program' means the
program operated under part B, D, or E of title IV of the
Higher Education Act of 1965 (20 U.S.C. 1070 et seq.)
or a similar program operated under State or local law.

[This change was effective on the date of enactment (October 22,
1994) and will apply to all applications for Title IV assistance
received by schools, lenders, guaranty agencies, or the Department
on or after that date.]


QUESTIONS AND ANSWERS

1. Is there a general rule that can summarize this statutory change?

Yes. A school, lender, guaranty agency, or the Department of
Education, cannot consider a person ineligible for a Title IV loan,
grant, or work study award *1* SOLELY because the person, or
someone associated with that person, has filed for bankruptcy, owes
a debt that is dischargeable in that bankruptcy proceeding, or has
had a debt discharged in bankruptcy. However, as discussed in
response to question #3, an applicant for Title IV assistance who has
included a defaulted Title IV loan or grant overpayment that is
NON-dischargeable in his or her bankruptcy schedules, will be
considered ineligible for additional Title IV aid until he or she
resolves the default or overpayment status.

When determining a Title IV applicant's eligibility for student
financial assistance, if the applicant has filed a bankruptcy petition
that lists a Title IV debt, the following sequence of questions may be
helpful:

a. IS THE TITLE IV DEBT A DEFAULTED LOAN OF A
GRANT OVERPAYMENT?
If YES, go to b. If NO, the applicant is eligible for all Title IV
aid.

b. HAS THE DEBT BEEN DISCHARGED OR IS IT
DISCHARGEABLE?
If YES, except for a parent applying for a PLUS loan (see
question #7), the applicant is eligible for all Title IV aid. If NO,
the applicant must make satisfactory payment arrangements with
the holder of the debt before being considered eligible for further
aid.

Where an applicant seeks additional Title IV aid and has
listed a non-dischargeable, defaulted Title IV loan or grant
overpayment in a Chapter 7 bankruptcy filing, the holder of
the Title IV debt can negotiate a satisfactory repayment
arrangement at the request of the individual. Although
bankruptcy law prohibits the holder of the defaulted loan or
grant overpayment from taking collection action against a
debtor, that individual remains ineligible for new aid under
section 484(a)(3) of the Higher Education Act. Advising
the applicant of that ineligibility and assisting an individual
who wishes to cure that default status is not engaging in
collection action prohibited by the Bankruptcy Code during
a bankruptcy proceeding. The holder of the debt can
determine what constitutes a satisfactory repayment
arrangement for such an individual, as it would for any
other person who owes a defaulted Title IV loan or grant
overpayment.

An individual who lists a non-dischargeable, defaulted
Title IV loan or grant overpayment in a bankruptcy filing
under Chapter 11, 12, or 13 of the Bankruptcy Code would
ordinarily cure his or her default status by providing for
repayment of the debt under the plan proposed in the
bankruptcy proceeding. The holder of the loan or grant
obligation in these instances has limited ability to negotiate
repayment terms, by objecting in the bankruptcy proceeding
to the classification given the debt or to the amount of the
debtor's disposable income to be devoted to payments under
the plan. Regulations in the FFEL and Perkins Loan
Programs describe the responsibilities of schools and
guarantors to scrutinize and, under some circumstances,
contest these issues. Subject to those requirements,
however, the school or guarantor holding the loan must
treat the repayment term and amount provided for in the
debtor's plan as constituting satisfactory terms for a
repayment agreement for purposes of requalifying the
applicant for new Title IV aid.

2. What is meant by the term "a debt dischargeable in bankruptcy?"

This means subject to discharge under the Bankruptcy Code.
Generally, a Title IV student loan or grant overpayment is NOT
dischargeable unless the loan has been in repayment or the
overpayment has been outstanding for at least 7 years, excluding any
periods during which repayment has been suspended (for example,
periods of forbearance or deferment), or the bankruptcy court
determines that repayment of the debt would constitute an undue
hardship to the debtor and his or her dependents.

Except when determining eligibility for a PLUS loan (see
question #7), the dischargeability status of a non-Title IV debt
included in a Title IV applicant's bankruptcy petition is ordinarily
not of concern to a Title IV school, lender, or guaranty agency.
However, the dischargeability of a Title IV debt, if it is a defaulted
loan or a grant overpayment, is very important when determining
the applicant's eligibility for additional Title IV aid (see
question #1).

An individual seeking additional Title IV assistance who
lists a defaulted Title IV loan or grant overpayment on his
or her bankruptcy schedule, must obtain a written statement
from the holder of the debt that states that the specific debt
is dischargeable in bankruptcy because the debt has been in
repayment for at least 7 years (excluding any periods
during which repayment has been suspended) or, in cases
where the debt has not been in repayment for at least
7 years, that the applicant's hardship petition has been
approved by the bankruptcy court. Title IV participants
should rely upon information from the holder of the loan or
grant overpayment claim, because the holder of the loan or
grant overpayment claim is the party most likely to have
reliable, authoritative records concerning either the
duration of the repayment period or the possibility that a
ruling was issued on undue hardship.

3. May a school, lender, or guaranty agency consider an applicant
ineligible for a Title IV loan or grant because of an unpaid grant
overpayment or a loan default status that existed prior to the
applicant's bankruptcy filing with respect to a debt that was
discharged or is dischargeable in that bankruptcy proceeding? Is
the result different if the debt is non-dischargeable?

As explained in the general rule in question #1, except for a
parent applying for a PLUS loan, the Bankruptcy Reform
Act removed prohibitions against the receipt of Title IV aid
that were based on an applicant's filing for relief in
bankruptcy, obtaining a DISCHARGE, or failing to pay a
DISCHARGEABLE or discharged debt. Therefore, the new
bankruptcy law now prohibits a Title IV participant from
refusing to consider an applicant eligible for a Title IV loan
or grant because of a failure to repay a grant overpayment
or a default on a loan that occurred prior to the applicant's
bankruptcy filing on a debt that was DISCHARGED or is
DISCHARGEABLE in bankruptcy.

If an applicant owes a defaulted Title IV loan or grant that
is NON-dischargeable, and the applicant has not made
satisfactory repayment arrangements with the holder of the
debt, the applicant continues to be ineligible under section
484(a)(3) of the Higher Education Act for new Title IV aid.
The new bankruptcy law does not exempt or excuse such
an applicant, who must be treated the same as any other
applicant for Title IV aid who owes a defaulted Title IV
loan or grant overpayment.

4. Is reaffirmation of a Title IV loan previously discharged in
bankruptcy still required as a prerequisite for an additional Title
IV loan?

No. As of October 22, 1994, an applicant for a Title IV loan will
not be required to reaffirm any previous Title IV debt that had been
discharged in bankruptcy.

5. What is meant by the reference in the law to "another person
with whom the debtor or bankrupt has been associated"?

This term includes any person with whom the Title IV
applicant has (or had) a family, business, or personal
relationship. Examples of such persons are endorsers on
the promissory note and references on a loan application, or
persons whose information is used on a student's need
analysis form. However, as explained in question #7, a
prospective endorser of a Federal PLUS or Federal Direct
PLUS loan may be considered as being insufficiently
creditworthy because of a previous or pending bankruptcy.

6. What action should the maker of a loan take if it learns that a
borrower's bankruptcy schedules include a Title IV loan for which
some (or all) of the loan disbursements are to be made after the
date of filing?

A borrower who lists a loan not in repayment status in his
or her bankruptcy filing, presumably is attempting to have
the entire loan discharged in that bankruptcy proceeding.
A borrower is obligated to repay only those loan funds that
have been received. When loan disbursements are received
by the borrower after the filing of the petition, those
disbursements are, with very limited exceptions, not subject
to discharge. However, that does not ensure that a
borrower who lists such a loan may not attempt, and even
succeed, in obtaining a discharge. Furthermore, by seeking
such a discharge, the borrower causes the filing of a
guarantee claim by the lender and thus, a reinsurance
payment by the Department to the guarantor.

To eliminate the possibility that a borrower would obtain a
discharge or cause a guarantee claim to be filed by seeking
a discharge of a loan disbursed after the borrower's
bankruptcy filing, the Department urges lenders to take
reasonable steps to ensure adequate identification of such
loans. To do so, the Department strongly encourages
lenders to make no disbursements on any loan applied for
and approved before the borrower's bankruptcy filing, and
to recall any disbursements not yet delivered to the
borrower, if the lender agrees to make a new loan for the
same amount that was not disbursed or was recalled on the
cancelled loan, and so advises the borrower. In these cases,
the lender will not be refusing to lend to the borrower on
account of the bankruptcy, as prohibited by the new
bankruptcy law, but is merely making the requested loan in
a manner that documents the character of that loan as a
loan made after the date of the borrower's bankruptcy
filing, and therefore not dischargeable in that proceeding.

7. Will bankruptcy still be a factor in determining if an applicant
for a Federal PLUS or Federal Direct PLUS loan has an adverse
credit history?

Yes. An applicant for a PLUS loan under either loan program who
has been the subject of a bankruptcy discharge during the 5 years
preceding the date of the applicant's credit report, continues to be
considered to have an adverse credit history,*2* and thereby
ordinarily not eligible for the loan. However, like any other PLUS
loan applicant with an adverse credit history, such an applicant
could still qualify for a loan if the applicant persuades the maker of
the loan (and the maker documents its determination) that
extenuating circumstances mitigated the adverse credit inference
suggested by that filing or, in the absence of such circumstances, it
agreed to make the loan on the condition that the applicant obtain a
creditworthy endorser.

Taking into account the fact of a prior bankruptcy discharge in this
manner does not violate bankruptcy law, because in so doing, the
maker of the loan does not reject the loan applicant solely on
account of the prior discharge, but remains willing to make the
requested loan on the condition that the applicant satisfactorily
rebuts the negative inference suggested by that prior discharge. The
applicant can do so by demonstrating either that the loan, if not paid
by the applicant, will be repaid by another individual who is
creditworthy, or that the inference of lack of creditworthiness should
not be drawn with respect to this particular applicant.


*1* Although work study is not specifically mentioned in the
statutory language, the Department believes that the
amendment was intended to apply to all of the Title IV programs.

*2* Pursuant to 34 CFR 682.201(b)(7) and §685.200(b)(7).