Massachusetts Bankruptcy and the Unsecured Line of Credit

In a recent case handed down by federal Bankruptcy Court Judge Joan Feeney, a Massachusetts debtor who filed for bankruptcy protection intended to discharge a debt to Liberty Bay Credit Union. This was an unsecured debt. Such debts, in a Chapter 7 personal bankruptcy are generally discharged. In this case, however, a hand written note made by the debtor, relied on by the Credit Union, resulted in non dischargabilty!

Here is what happened. Patricia Belforte applied for a loan from the Liberty Bay Credit Union. It was an unsecured loan for $10,000 in 2001; she made payments through 2007 when she applied for an increase by $4,000. The “application” for the additional monies included a hand written note stating that they would be used for “tuition” for her children. There was no requirement that the monies actually be used as a student loan.

In 2010 Ms. Belforte filed for personal bankruptcy. It was a standard chapter 7 petition and schedules. Unfortunately for Ms. Belforte, counsel for Liberty Bay Credit Union did their homework. They dug up the credit application and determined that this debt should not be dischargable under Section 523(a)(8) because it was a loan for an “educational benefit.” Under the 2005 amendments to the Bankruptcy laws, private lenders, including credit unions, can issue educational loans. So they filed an Adversary Proceeding in the bankruptcy court.

This decision seems particularly egregious. The credit union loan to Ms. Belforte was 14%; student loans have a better interest rate. Student loans usually require more than a handwritten note modifying an existing unsecured line of credit. Furthermore, the initial funds borrowed were not for any “educational purpose.”

But Judge Feeney, who is usually right on, determined that this was the will of Congress. She determined that even if there was “an additional business purpose” for increasing the loan, that “additional” purpose does not pull the loan for educational loans, she held. It did not matter that, unlike a typical educational loan, the lender exercised no control over how the money was spent; the check was not made to an educational institution, but merely credit given to Ms. Belforte, to use as she pleased. What hurts here is that notwithstanding the handwritten note about using the monies for education, Ms. Belforte, according to her counsel, did not even use all of the monies for educational expenses.

From a broader perspective, as personal bankruptcy lawyers, we are concerned that the next big wave of economic defaults will be student loans. Called the “biggest problem that nobody is talking about” by Senate candidate Elizabeth Warren, student loans are becoming a new problem in America. In 2011, the “two year default rate” on student loans was up, from 8.8% in 2010 to 9.1% in 2011. There are 4.1 million people with student loans, 375,000 of those outstanding loans are in default by more than 270 days.

If you have personal loans, contact a Boston bankruptcy lawyer with experience to review your situation and give you advice. Neil Burns has been representing clients in Massachusetts since 1985 and offers free initial consultations. Call 617227-7423.