Sanction Against Student Loan Servicer Exceeded Court’s Civil Contempt Power

Posted by NCBRC - June 23, 2021

The bankruptcy court’s contempt order against a student loan servicer requiring it to pay off the entire amount of the debtor’s student loan was punitive rather than compensatory or coercive and, therefore, the award exceeded the court’s civil contempt power. Great Lakes Educ. Loan Serv. Inc. v. Leary, No. 20-8050 (S.D.N.Y. June 22, 2021).

The debtor filed for chapter 7 bankruptcy with outstanding student loans in the amount of $380,000. He named Great Lakes as the owner of four of the loans totaling $259,741 and filed an adversary complaint seeking to have the loans discharged under section 523(a)(8). When Great Lakes failed to respond to the adversary action, the bankruptcy court entered default judgment discharging those loans owned by Great Lakes. Unfortunately, Great Lakes was merely the servicer of the loans which were actually owned by the DOE. Believing the DOE loans had been discharged, the debtor ceased payment, the loans went into default and the DOE threatened tax refund and wage garnishment.

At the debtor’s request, the bankruptcy court reopened the adversary proceeding to address whether Great Lakes violated the discharge order. Neither Great Lakes nor the DOE responded to the reopened adversary proceeding. The court ordered Great Lakes to show cause why it should not be sanctioned. When Great Lakes failed to appear at the show cause hearing, the court sanctioned it in the amount of $123,625.52. When Great Lakes failed to pay that amount, the court issued a second show cause order threatening additional sanctions. Great Lakes appeared at that hearing explaining that its failure to respond was due to “rare, unintentional, and regrettable processing errors as to papers served in the adversary proceeding.”

Finding its behavior “cavalier” and its conduct grossly negligent, the bankruptcy court held Great Lakes in civil contempt and upped the sanctions against it to $354,629.62, representing the amount of the debt to the DOE, and $24,000 in reimbursement to the debtor for the delays caused by Great Lakes’s conduct.

Great Lakes appealed the $354,629.62 award to the district court arguing that it was a punitive criminal sanction rather than a civil contempt sanction. Neither the pro se debtor nor the DOE filed briefs in the appeal.

The district court began with the premise that civil contempt may be used to coerce compliance with future orders and to compensate the injured party, while criminal contempt has a punitive function. The nature of the sanction rather than the characterization applied by the issuing court determines whether it is civil or criminal.

The court found that the $354,629.62 sanction was not compensatory because it was not intended to reimburse the debtor for the costs of Great Lakes’s recalcitrance. The court found the debt to the DOE was a result of the debtor’s borrowing money, not, as the bankruptcy court found, a result of Great Lakes’s stonewalling. Though a timely response by Great Lakes might have put the debtor in a position to address his discharge motion to the correct party, the debtor would still have had to show undue hardship. Therefore, Great Lakes’s failure to respond did not deprive the debtor of discharge.

The court also found the award was not coercive stating that a “hallmark of coercive sanctions was that ‘the contemnor is able to purge the contempt and obtain his release by committing an affirmative act, and thus carries the keys of his prison in his own pocket.’” Here, there were no orders with which Great Lakes was to comply other than the order to pay the sanction.

Finally, the court found that because the “rhetoric of the Bankruptcy Court’s opinion and preceding orders reveal that the Bankruptcy Court acted to punish improper conduct and to vindicate its authority,” the sanction award was, in fact, punitive.

The court vacated that portion of the sanction award requiring Great Lakes to pay off the debtor’s student loan debt to the DOE.

Leary SD NY June 2021


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