BANKRUPTCY: EFFECT ON STUDENT LOANS AND GRANTS

PELL GRANT MONEY –

Student debtors often question whether the bankruptcy Trustee can seize Pell Grant money upon filing for bankruptcy.  The good news is federal benefits (including tuition grants) are exempt in bankruptcy and do not have to be turned over to the Trustee for liquidation.  Pell grants are most often provided to undergraduate students who are in the process of earning a bachelor’s or professional degree.  Unlike federal student loans, these grants, although funded by the federal government, do not require repayment.
When a voluntary petition in bankruptcy is filed, a bankruptcy estate is created.  The primary duty of the bankruptcy trustee is to liquidate non-exempt assets in order to repay unsecured creditors from available funds.  Inasmuch as federal benefits are exempted, they are safe from administration by your appointed Trustee.  In the realm of federal student aid, this includes Pell grants, federal direct loans, work-study funds and Perkins loans.  None of these programs or benefits can be intercepted by the Trustee.
The exemption remains firmly intact even if those funds are deposited in your personal checking or savings account.  The bankruptcy Trustee and creditors are prohibited from garnishing federal student assistance.  On the flip side, most federal student loans are not dischargeable in bankruptcy unless you convince the Court there is an “undue hardship”.
STUDENT FINANICAL AID –
Debtors who seek an education either later in life after raising a family or simply because the opportunity wasn’t there at the traditional age may be concerned about how a bankruptcy will affect their ability to qualify for student aid in the future.  In addition, we sometimes see young people of college age in need of filing bankruptcy.
The Bankruptcy Reform Act of 1994 (P.L. 103-394) amended the US Bankruptcy Code to expressly prohibit the denial of government student grants and loans based solely on a student borrower’s past or present bankruptcy filing [11 U.S.C. 525(c)].  A federal Stafford loan does not depend on a borrower’s credit history, thus a prior or current bankruptcy petition will not disqualify the student from obtaining a student loan.  On the same token, a child remains eligible for federal student loans in spite of the parent’s bankruptcy history.  Likewise, the fact a parent previously filed a bankruptcy, does not disqualify the child student from federal grants, state grants, scholarships or student employment programs.
PLUS LOAN BORROWERS:  Despite the protections outlined above, parents are ineligible to borrow from the PLUS loan program for five years from the date of a bankruptcy discharge.  This is because PLUS loan borrowers cannot have “an adverse credit history” as mandated by statute.  Specifically, the law defines adverse credit history as a record of a forclosure, repossession, tax lien, wage garnishment, default determination or a bankruptcy discharge within five years or a current delinquency in excess of 90 days for any debt.  On the flip side, if a child’s parent is denied a PLUS loan due to their credit history, the child will be eligible for increased unsubsidized Stafford loan limits (increases of $4,000-$5,000).
WHEN A PARENT FILES BANKRUPTCY (Fraudulent Transfers) –
When Mom and Dad pay for their adult child’s tuition expenses, they are in essence making a gift to the child.  After all, once the child reaches the age of majority (18), the parent is no longer legally obligated to pay for the child’s education expenses.  If the tuition is paid directly to the college or university, the institution becomes the target of an avoidance action by creditors or a bankruptcy trustee should the parent later declare Chapter 7 or Chapter 13.
Federal law outlines two types of transfers which can be voided by the bankruptcy trustees – those based on “deliberate fraud” (with purposeful intent) and those resulting from “constructive fraud” (no intent required so long as the statutory factors are shown).  Actual fraud is difficult to prove and is rarely asserted.  The bankruptcy trustee will more likely pursue the easier argument that tuition payments amount to constructive fraud.  In an avoidance action, the Trustee must show that the payment or transfer was made within two (2) years of filing the voluntary petition in bankruptcy and the payor who was insolvent at the time of transfer received “less than a reasonably equivalent value in exchange” for the transaction [11 U.S.C. § 548(a)(1)].  (for more information see the article on Fraudulent Transfers and Preferences).
Because it is the student who receives and primarily benefits from the provided education, many courts are handing down decisions that the parent did not receive “reasonably equivalent value” for the tuition payment.  Bear in mind, the parent must have made the transfer during a time of insolvency (obligations exceed value of non-exempt assets) AND the transfer was made within a two year period of declaring bankruptcy.

 

 

From the Author: Troy Jensen Legal

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