• The CFPB sued student-loan company PHEAA, accusing it of illegally collecting borrowers’ payments.

• The lawsuit claimed PHEAA was collecting on private loans already discharged through bankruptcy.

• It also accused PHEAA of sending false information about borrowers to credit agencies.

A federal consumer watchdog just hit a major student-loan company with a new lawsuit.

On Friday, the Consumer Financial Protection Bureau sued the Pennsylvania Higher Education Assistance Agency, or PHEAA, which is a student-loan servicer that works with American Education Services to facilitate private student loan programs.

According to the press release, the CFPB accused PHEAA of illegally collecting payments from student-loan borrowers whose loans had already been discharged in bankruptcy and sending “false information” to credit reporting agencies. Those actions violate the Consumer Financial Protection Act and the Fair Credit Report Act, the lawsuit said.

The CFPB is requesting that the court require PHEAA to provide relief to impacted consumers and pay a civil penalty to the CFPB over its claims of illegal behavior.

“PHEAA has ignored its responsibilities and illegally pursued borrowers for loans they no longer owe,” CFPB Director Rohit Chopra said in a statement. “The CFPB is suing PHEAA for demanding money from borrowers that they do not owe and for reporting false information to credit reporting companies.”

A PHEAA spokesperson told Business Insider that it disagrees with the claims that it violated the bankruptcy code and the lawsuit is “another example of regulatory overreach by the CFPB.”

“This issue comes down to a matter of interpreting bankruptcy law,” the spokesperson said. “The accusation that PHEAA knowingly acted in a way that was contrary to the law is absolutely inaccurate and PHEAA will defend itself vigorously through the legal process.”

The lawsuit, filed in the US District Court for the Middle District of Pennsylvania, said that under the US bankruptcy code, some private student loans are not subject to the stringent standards that most student loans are when it comes to receiving relief through bankruptcy.

Typically, a borrower has to meet the “undue hardship” standard, which requires them to prove that they cannot maintain a minimal standard of living, that their circumstances aren’t likely to improve, and that they have made a good-faith effort to repay their debt.

But, as the CFPB claimed, PHEAA has failed to recognize that some private loans can receive a discharge order without having to meet undue hardship and “treats certain discharged private student loans as though the consumer still owes those debts.”

For example, the bankruptcy code exempts student loans that do not meet the definition of a “qualified education loan” from the hardship requirement, which are loans used solely to pay for the cost of attendance at a school eligible for federal funding, and while the student attends at least half-time.

“PHEAA’s failure to distinguish between discharged and nondischarged private student loans, its collection on discharged debts, and its furnishing inaccurate information to consumer reporting agencies causes or is likely to cause substantial injury, as consumers will either pay debt they do not owe or risk negative credit reporting and default for nonpayment,” the complaint said.

Per the CFPB, American Education Services collected or tried to collect 7,934 private student loans after a bankruptcy proceeding between 2017 and 2021, and 177 of them were non-qualified education loans.

The CFPB has previously issued guidance over potential illegal collections of borrowers’ payments after bankruptcy proceedings. In March 2023, the agency released supervisory findings on servicers that improperly collected loans and warned servicers of enforcement action should that practice continue.

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