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PRB 01-26E

Treatment of Student Loans Under Canadian Bankruptcy Law*

Alysia Davies
Legal and Legislative Affairs Division

Revised 26 November 2008

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Contents

  • Introduction
  • Canada Student Loan Program
  • Bankruptcy Law
  • Student Loan Debt and Bankruptcy Levels
  • Student Loans and Bankruptcy: Issues and Proposals for Change
  • Conclusion
  • Endnotes

  • Introduction

    Many Canadian high school graduates pursue some form of post-secondary education, and many of these graduates borrow from federal and provincial student loan programs to help finance their education.

    In the past decade, student loan borrowings increased, as did the number of bankruptcies involving student loans. During the second half of the 1990s, changes to the Bankruptcy and Insolvency Act (BIA) made student loan debt non-dischargeable in a bankruptcy if the bankruptcy occurred within ten years after studies ended. This change ensures that student loan obligations will survive a bankruptcy even if other debts have been wiped out by a discharge.

    This period has recently been reduced to seven years, but it is still the subject of considerable debate. Lenders support the rule because it improves their chances of being repaid. Students, some insolvency practitioners and academics have questioned its soundness; as well, the Canadian Federation of Students has launched a court challenge to the rule under the Canadian Charter of Rights and Freedoms.

    This paper:

    Canada Student Loan Program

    The federal government instituted the Canada Student Loan Program (CSLP) in 1964. From 1964 to 1995, the CSLP made available financial assistance by way of a 100% government guarantee for student loans made by private financial institutions. The guarantee scheme had drawbacks, however. It was costly for government, created little incentive for financial institutions to seek repayment, and did not provide suitable levels of service to borrowers.(1)

    In 1995, the Government of Canada changed the CSLP. The guarantee scheme was replaced by risk-premium financing agreements with financial institutions. Under these arrangements, participating financial institutions managed the repayment of student loans and accepted the risk of nonpayment. In return, the Government of Canada paid the financial institutions an annual risk premium of 5% of the value of the loans. The risk premium was designed to compensate financial institutions for the high number of student loan defaults. These arrangements expired at the end of July 2000.(2)

    In early 2000, the federal government canvassed interested financial institutions about a new CSLP arrangement. According to a Human Resources Development Canada communiqué, too few financial institutions expressed an interest in concluding a new arrangement to make the program viable.(3) As a result, the Government of Canada resumed issuing student loans directly through the National Student Loans Service Centre.

    Not all student loans are administered through the CSLP. Ontario, Saskatchewan, Newfoundland and Labrador and New Brunswick coordinate the student loans they provide with the CSLP, and they are administered together as an “Integrated Loan.” British Columbia, Alberta, Manitoba, Nova Scotia and Prince Edward Island administer their own loans, separately from the CSLP, which means students must deal with two separate tiers of administration for their government loans. Quebec, the Northwest Territories and Nunavut do not participate in the CSLP at all, and students can only access separate provincial and territorial loans.(4)

    However, all of these loans are included in the blanket exemption for student loan debt to the government in the BIA. The only types of student loans which are not exempt are those provided as direct private loans from the major banks independently of any scheme under the Canada Student Loans Act and the Canada Student Financial Assistance Act. These loans are often sought by students in the more expensive professional programs, such as law and medicine. This does not mean that private borrowers escape the BIA exemption, since the banks generally require such applicants to seek government student loan funding as a pre-condition to being eligible for a supplementary private loan. Many of these students also owe at least a portion of their loan money to the government, and this portion would be subject to the BIA exemption.

    Bankruptcy Law

    The purpose of the bankruptcy process is to wipe out the outstanding debts of a bankrupt debtor and give the debtor a “fresh start.” But the bankruptcy process does not wipe out all debts – the Bankruptcy and Insolvency Act provides that certain kinds of debts survive a bankruptcy and remain outstanding even though all other debts are discharged. Surviving debts include:

    In 1992, major changes to Canadian bankruptcy law took effect; one of these changes abolished preferred creditor status for debts owed to the government. This change relegated the Crown to the ranks of ordinary creditors who would share pro-rata in the bankrupt debtor’s assets after secured creditors and preferred creditors. Consequently, the Crown had no priority over other creditors for student loan debts.

    Amendments to the Bankruptcy and Insolvency Act (BIA) that took effect in September 1997 changed the status of student loan debts by making them non-dischargeable if a student filed for bankruptcy before ceasing full- or part-time studies or within two years after studies ended. A student who went bankrupt during the two-year period, however, could apply to the court at the end of the two-year period to discharge the student loan; the court could order a discharge if the student was able to demonstrate that he or she had acted in good faith and could not repay the loan due to financial difficulty. Students who filed for bankruptcy after the two-year period could have their student loans discharged as part of the normal bankruptcy process.

    This change in the status of student loan debt was intended to alleviate the impact of the loss of preferred creditor status for debts owed to the Crown in the face of: mounting numbers of loan defaults; increasing loan losses; and perceptions that students were abusing the bankruptcy process to rid themselves of their loan obligations.

    Less than one year after the two-year rule became effective, however, the Minister of Finance introduced a number of changes to the student loan program. The 1998 federal Budget contained measures aimed at reducing student loan defaults and helping students deal with their mounting debts, including:

    At the same time, the Minister announced a change in the student loan non dischargeable period under the BIA from two years to ten years. This provision became effective on 18 June 1998. As a result, student loan debt was not discharged by a bankruptcy if the bankruptcy occurred within ten years after a person ceased being a student. As with the two-year rule, the court could, however, order the discharge of a student loan debt after the ten-year period expired if the debtor was able to satisfy the court that he or she acted in good faith and could not repay the loan due to financial difficulty.

    Recent amendments to the BIA have reduced this ten-year period to seven years, effective 7 July 2008.(6) Student loan recipients who declare bankruptcy before their government student loans are eligible for discharge will be able to make an application to have them discharged after five years if they are able to show hardship.(7)

    Student Loan Debt and Bankruptcy Levels

    Statistics Canada data confirm that the number of bankruptcies involving loans under the Canada Student Loans Program rose during the 1990s. Data on student debt from 1990-1991 to 1995-1996 also reveal:

    An analysis of student loan borrowing (using National Graduates Survey databases of students graduating from Canadian colleges and universities in 1982, 1986, 1990 and 1995) indicates higher rates of borrowing and increased levels of repayment problems:

    Other studies also shed light on the student bankruptcy issue. An Empirical Study of Canadians Seeking Personal Bankruptcy Protection (1998) by Saul Schwartz and Leigh Anderson confirms the importance of student loans as a factor in the bankruptcy of younger Canadians. Schwartz and Anderson report:

    For young people seeking bankruptcy, student loans were very likely to comprise a large share of overall debt. For 28% of the young people, student loans were 50% or more of the overall debt and, for 10%, student loans were more than 90% of total debt.

    Over the past decade, on the order of $10 billion … has been lent to hundreds of thousands of Canadian post-secondary students (Finnie and Schwartz, 1996). Some of these borrowers were university students with relatively strong post-schooling job prospects. A large proportion of student loans, however, were issued to students enrolled in short-term courses whose vocational value was much less certain.

    Most importantly, however, student loans are issued without any assessment of the borrower’s potential to repay; instead, they are based on student financial need. That practice may encourage post-secondary access, but it also leads to situations where some young people have relatively large debts and no means to repay them.(10)

    In a 1999 paper, Saul Schwartz notes that approximately 9% of Canada student loan borrowers had defaulted on their loan obligations in 1980, but by 1990, the Auditor General of Canada had put the default rate at “one in six.”(11) As the number of student bankruptcies rose, so did the cost to government. In 1996-1997, for example, student loans in bankruptcy reportedly cost the federal government $70 million, up from $30 million in 1990-1991.(12)

    Using data pertaining to more than 1,000 debtors who filed for bankruptcy in 1997, Schwartz examined the situation of bankrupt individuals with student loan debts. Comparing the economic status of those individuals with the overall sample, Schwartz concluded:

    Schwartz summarized his findings this way:

    The economic situation of all those declaring bankruptcy suggests that bankruptcy is used primarily as a last resort. The economic situation of those seeking bankruptcy protection with student loans among their debts, or whose student loans were critical in their bankruptcy, is even worse than the already desperate situation of the whole group. To be sure, they are younger and have more education, but they have lower annual household income and lower monthly income at the time of filing for bankruptcy. More than 40% had received income assistance in the two years previous to filing, and about 30% had received unemployment insurance. A surprisingly large proportion – more than one-third – had occupations that were unskilled.(17)

    This conclusion was echoed in a report funded by the Office of the Superintendent of Bankruptcy in 2005, which examined the treatment of government-funded student loans in bankruptcy, both in Canada and in four other countries. This report noted that while the main motivation for the policy of requiring student loans to survive bankruptcy in all of these countries was a perception that students were using bankruptcy casually to avoid repaying their loans, the factual record to support this perception was thin to non-existent.(18)

    The report noted that other factors, rather than students taking the easy way out, might be related to the rise in student loan-related bankruptcies during the 1990s. During the period when the cost of student loan defaults to the Canadian government increased from $30 million to $70 million, the number of loans given out increased by 53.6%, and the average amount of the loan increased by 61.2%. The rate of losses may have been due to students’ greater dependence on larger loans, because the cost they had to shoulder for their education increased over this period.(19) This trend was consistent with the trend in the United States, where student loans were increasingly relied upon to meet higher student tuition fees, eventually leading to legislation exempting student loans from being discharged in bankruptcies in order to stem the tide of government loan losses.(20)

    The trends in New Zealand, where student loans are still discharged in bankruptcies, match those in other countries. Currently only one in ten post-secondary students is debt-free, and the total student debt owing to governement is projected to grow from over $5 billion in 2002 to almost $20 billion by 2020.(21)

    According to the Canadian Federation of Students, the average overall student debt load in Canada rose from $8,000 in 1990 to $25,000 in 1998, tuition fees rose by 126% in the same period, and grants were “eliminated in most provinces.”(22) The federal loan program still dispenses grants to assist students with low incomes, dependents or a disability, however.

    According to federal government statistics, 42% of all students in participating provinces and territories relied on student loans from the federal government in the 2002–2003 fiscal year.(23) In the 2003–2004 fiscal year, the percentage was 41%.(24) In both 2004–2005 and 2005–2006, the percentage was 40.3%, although the actual number of borrowers increased.(25)

    The average student debt owing to the Crown in 2005–2006 was $11,323, up 2.5% over the previous year.(26) (This does not include overall student debt load from other sources.) More recent numbers are not yet publicly available.

    Student Loans and Bankruptcy: Issues and Proposals for Change

    Whether student loan debt should be treated differently in a bankruptcy from debts owed to ordinary creditors is a subject of considerable debate. When the two-year rule was introduced in Bill C-5 (First Reading, 6 March 1996), the Standing Senate Committee on Banking, Trade and Commerce questioned whether student loans should be singled out for special treatment. Stories abounded about students completing their studies and then going bankrupt to erase their student loan debts, but the Committee wanted to know if evidence existed to demonstrate that students were blatantly manipulating the bankruptcy system to simply avoid paying their loan obligations.(27)

    Industry Canada officials told the Committee that the number of student loan defaults had increased from “$20 million to $60 million over the last two or three years”(28) and that 65% to 70% of bankruptcies involving student loans occur within the first two to three years after graduation. They suggested that students in financial difficulty should be seeking assistance under the debt relief provisions of the student loan program before resorting to bankruptcy.(29) In fact, the two-year non-dischargeable period was chosen to coincide with the grace period offered under the then student loan program.

    We picked the two-year period because, under the student loans arrangements, there is a six-month period where there is no requirement to pay back that loan. Then there is a further 18-month period where there is assistance on the interest payments. It coincides with that 24-month period in which the student is already given [a] period of grace to deal with the repayment of the loan.(30)

    Although the Committee heard no direct evidence to suggest that large numbers of students were abusing the bankruptcy process, the fact that a significant percentage of student bankruptcies occurred during a period when, according to government officials, some form of debt relief was available, indicates that the two-year rule was instituted to steer students away from bankruptcy.

    The introduction of the ten-year non-dischargeable rule in 1998 less than a year after the two-year rule took effect came as a surprise to many. Insolvency practitioners criticized the lack of consultation about the rule change, particularly in light of the extensive consultations that had preceded previous bankruptcy amendments. They argued that the ten-year period was too long and failed to strike the appropriate balance between allowing bankrupt students to rehabilitate themselves with a fresh start and combating alleged abuse of the bankruptcy system.(31)

    One critic of the concept of a non-dischargeable period for student loan debt argued:

    Regardless of the government’s rationale for introducing the ten-year waiting period, the empirical evidence … suggests that most of those seeking bankruptcy protection with student loans among their debts have very low incomes and no guarantee of higher future incomes. Waiting ten years is not only unlikely to change their economic situation, but will deny them the “fresh start” that is one of the aims of the BIA.(32)

    The Canadian Federation of Students has also been highly critical of the ten-year rule. In late 2000, the Federation took legal action to challenge the rule under the equality provisions of the Canadian Charter of Rights and Freedoms. However, the Ontario Superior Court ruled in 2005 that student loan borrowers do not constitute a separate social group of the type protected by the equality provisions of section 15 of the Charter.(33)

    Others have called for a reduction of the ten-year period. In 2001, the Personal Insolvency Committee of the Insolvency Institute of Canada recommended that:

    In addition, the ten-year rule has been scrutinized by the Personal Insolvency Task Force (PITF)(35) established by the Office of the Superintendent of Bankruptcy to review the BIA’s provisions relating to personal bankruptcy. Sub Group 5 of the PITF, examining student loan bankruptcies, made two recommendations: change the ten-year non-dischargeable period to five years; and permit bankrupt student loan debtors to apply to the court for relief on the basis of financial hardship after one year instead of after the current ten-year waiting period. The specific recommendations call for:

    In the 2003 federal budget, the debt relief program was enhanced by removing the restriction that limited it to half the amount of the outstanding debt, up to $10,000. Further reductions of $5,000 were made available if debt difficulties still existed one year later, and again two years after that. The rules were also altered to allow debtors who had defaulted on their student loans or declared bankruptcy to claim interest relief.(37)

    In November 2003, the Senate Standing Committee on Banking, Trade and Commerce completed a review of the BIA. It recommended that the ten-year period be reduced to a five-year period, and that the BIA empower the courts to allow the discharge of some student loan debt earlier than in cases where the debtor can establish undue hardship.(38) The Senate again found that those students who did not repay their student loans were in the minority, and that defaults were usually due to financial difficulty, not an unwillingness to pay. In fact, the Senate suggested that holders of student loans who file for bankruptcy may often be in worse financial condition than the average bankrupt.(39) However, the Senate did not support returning to the original two-year period, citing the need to ensure that the costs to the taxpayer of the loan program are kept in check.(40)

    A new set of amendments were made to the Canada Student Financial Assistance Regulations(41) in 2004, and they incorporated some of the approaches recommended by the Senate. The good standing requirement for obtaining debt relief was replaced with less restrictive eligibility criteria, and the amount of available relief was increased. The ceiling on debt relief was also increased again to allow for more of the debt to be forgiven in cases of hardship. In addition, students who had declared bankruptcy were no longer excluded from obtaining new student loans from the government for later studies, or from applying for debt relief.(42)

    In 2005, a further set of amendments to these regulations increased the debt relief ceiling again, to a total of $26,000 ($10,000 upon the original application, $10,000 on the second application, and $6,000 on the third).(43) However, any applicants must have first applied for, received, and exhausted all possible interest relief up to the maximum of 30 months, must be in good standing with respect to the payment of the principal, and must be making loan payments in excess of a given percentage of income, as established by a table in the regulations.(44) A debtor suffering from a disability may also qualify for a Permanent Disability Benefit, where all or a portion of the loan is forgiven.(45)

    As indicated earlier, amendments to the BIA itself, introduced in 2005, came into effect in July 2008, along with additional amendments by the subsequent government to clarify them.(46) (The original amendments had been passed on an expedited basis and given Royal Assent earlier than anticipated owing to an imminent election, although the Senate Standing Committee on Banking, Trade and Commerce was still in the process of hearing witnesses on them).(47) The amendments have reduced the bankruptcy exemption for student loans from the ten-year period to a seven-year period. These amendments have also permitted debtors to apply to the courts to include government student loans in their discharge five years after studies have ended.(48)

    A new Repayment Assistance Plan, to take effect in the autumn of 2009, has also been announced by Human Resources and Social Development Canada. According to the CanLearn website, the new plan is designed to ensure that:s

    The details of the plan are not yet publicly available.

    Conclusion

    While recent amendments to the BIA have created slightly milder terms for the treatment of government student loans in bankruptcy, the fundamental approach of exempting them from discharge continues. Although even more restrictive versions are now common throughout Western countries,(50) this approach remains a controversial one.

    Students would prefer to have student loan debt fully dischargeable. Lenders, on the other hand, want to have their interests protected and remain concerned that increased levels of student borrowing and higher student debt loads will lead to more bankruptcies and greater loan losses. The student loan issue is likely to provoke lively discussion as the debate continues over how such loans should be treated under Canadian bankruptcy law.


    Endnotes

    * This is a revised version of this document, prepared by Margaret Smith, formerly of the Library of Parliament.
    1. Human Resources Development Canada, “The Government of Canada Ensures the Continuation of the Canada Student Loans Program,” News Release, 9 March 2000.
    2. Ibid.
    3. Ibid.
    4. Yukon provides CSLP loans only.
    5. Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3, s. 178, as amended.
    6. BankruptcyCanada.com, “Canadian Bankruptcy Reform. Changes to the Bankruptcy Laws,” 7 July 2008.
    7. Sections 178(1)(g) and (h) and 178(1.1) of the current Bankruptcy and Insolvency Act provide as follows:

      (g) any debt or obligation in respect of a loan made under the Canada Student Loans Act, the Canada Student Financial Assistance Act or any enactment of a province that provides for loans or guarantees of loans to students where the date of bankruptcy of the bankrupt occurred

      1. before the date on which the bankrupt ceased to be a full- or part-time student, as the case may be, under the applicable Act or enactment, or
      2. within seven years after the date on which the bankrupt ceased to be a full- or part-time student; or
      (h) any debt for interest owed in relation to an amount referred to in any of paragraphs (a) to (g).

      Court may order non-application of subsection (1)

      (1.1) At any time after five years after a bankrupt who has a debt referred to in paragraph (1)(g) ceases to be a full- or part-time student, as the case may be, under the applicable Act or enactment, the court may, on application, order that subsection (1) does not apply to the debt if the court is satisfied that

      1. the bankrupt has acted in good faith in connection with the bankrupt’s liabilities under the debt; and
      2. the bankrupt has and will continue to experience financial difficulty to such an extent that the bankrupt will be unable to pay the debt.

    8. Statistics Canada, “Student debt from 1990–91 to 1995–96: An analysis of Canada Student Loans Data,” Education Quarterly Review, Summer 1999, Vol. 5, No. 4, Article Highlights.
    9. Ross Finnie, Student Loans: Is It Getting Harder? Borrowing, Burdens and Repayment pdf (38 pages), March 2000, pp. 11–12. See also: Ross Finnie and Gaétan Garneau, Student Loans in Canada: A Cross-Cohort Micro Analysis of Student Borrowing for Post-Secondary Education, R-96-16E, July 1996, Applied Research Branch Strategic Policy, Human Resources Development Canada; Ross Finnie and Saul Schwartz, Student Loans in Canada: An Economic Analysis of Borrowing and Repayment Using the National Graduate Surveys, W-96-3E, January 1996, Applied Research Branch Strategic Policy, Human Resources Development Canada.
    10. Saul Schwartz and Leigh Anderson, An Empirical Study of Canadians Seeking Personal Bankruptcy Protection pdf (98 pages), School of Public Administration, Carleton University, January 1998.
    11. Saul Schwartz, “The Dark Side of Student Loans: Debt Burden, Default, and Bankruptcy,” pdf (32 pages) Osgoode Hall Law Journal, Vol. 37, Nos. 1 & 2, 1999, p. 317.
    12. Ibid., p. 318.
    13. Ibid., p. 326.
    14. Ibid., p. 327.
    15. Ibid., p. 328.
    16. Ibid., p. 329.
    17. Ibid.
    18. Stephanie Ben-Ishai, “Government Student Loans, Government Debts and Bankruptcy: A Comparative Study,” Office of the Superintendent of Bankruptcy, Insolvency Research Initiative, 30 August 2005, pp. 3–4 and 13–14.
    19. Ibid., pp. 15–16.
    20. Ibid., p. 16.
    21. Ibid., p. 16.
    22. Standing Senate Committee on Banking, Trade and Commerce, Debtors and Creditors Sharing the Burden: A Review of the Bankruptcy and Insolvency Act and the Companies’ Creditors Arrangement Act, November 2003, p. 53.
    23. Ben-Ishai (2005), p. 5.
    24. Human Resources and Skills Development Canada, Canada Student Loans Program Annual Report 2003–2004, p. 4.
    25. Human Resources and Social Development Canada, Canada Student Loans Program Annual Report 2004–2005, 2007, p. viii; Human Resources and Social Development Canada, Canada Student Loans Program Annual Report 2005–2006, 2007, p. viii.
    26. Canada Student Loans Program Annual Report 2005–2006 (2007), p. viii.
    27. Twelfth Report of the Standing Senate Committee on Banking, Trade and Commerce, Issue 17, 11 February 1997, p. 7.
    28. Senate, Standing Committee on Banking, Trade and Commerce, Evidence, 2nd Session, 35th Parliament, 4 November 1996 (Mr. David Tobin).
    29. Ibid.
    30. Ibid.
    31. Senate, Standing Committee on National Finance on Bill C-36, Evidence, 1st Session, 36th Parliament, 11 June 1998, (Canadian Bar Association and the Canadian Insolvency Practitioners Association).
    32. Schwartz, “The Dark Side of Student Loans” (1999), p. 332.
    33. Canadian Federation of Students, Campaigns and Lobbying: Student Loan Bankruptcy, “Current Case Status – Updated 4 July 2005,” updated 4 July 2005.
    34. Report of the Personal Insolvency Committee of the Insolvency Institute of Canada, Recommendations for Reform and Further Amendments to the Bankruptcy and Insolvency Act – Personal Insolvency, January 2001, pp. 8–9.
    35. PITF was comprised of stakeholders interested in bankruptcy such as creditors and/or creditor representatives, debtor representatives, members of the judiciary, trustees, a member of the Canadian Insolvency Practitioners Association as well as a number of academic scholars in the field of bankruptcy law.
    36. Office of the Superintendent of Bankruptcy Canada, Personal Insolvency Task Force, Sub Group 5 Issues, “Summary of PITF Issues and Proposed Recommendations,” n.d.
    37. Department of Finance Canada, The Budget Plan 2003.
    38. Standing Senate Committee on Banking (2003) , Recommendation 9, p. xv.
    39. Ibid, p. 48.
    40. Ibid., p. 56.
    41. Canada Student Financial Assistance Regulations, SOR/95-329, as amended.
    42. Ben-Ishai (2005), pp. 7–8.
    43. Canada Student Financial Assistance Regulations, s. 42.
    44. Ben-Ishai (2005), pp. 7–8.
    45. Ibid., p. 8.
    46. Marcia Jones, Bill C-12: An Act to amend the Bankruptcy and Insolvency Act, the Companies’ Creditors Arrangement Act, the Wage Earner Protection Program Act and Chapter 47 of the Statutes of Canada, 2005, LS-584E, Parliamentary Information and Research Service, Library of Parliament, 14 December 2007.
    47. Industry Canada, Bill C-55 Receives Royal Assent, rev. 13 November 2008.
    48. Bankruptcy and Insolvency Act (see note 7).
    49. Government of Canada, CanLearn, “Student Financial Assistance – Repayment Assistance Plan,” rev. 1 October 2008.
    50. Ben-Ishai (2005), p. 20.

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