Second Circuit Rule Private Student Loan May Be Dischargeable in Bankruptcy

The Second Circuit Court of Appeals has joined the Tenth and Fifth Circuits in ruling that certain private student loans may be dischargeable in a Chapter 7 bankruptcy.

The Second Circuit Court of Appeals has joined the Tenth and Fifth Circuits in ruling that certain private student loans may be dischargeable in a Chapter 7 bankruptcy. The Second Circuit specifically held in Homaidan v. Sallie Mae, Inc., 3 F.4th 595 (2d Cir. 2021) that the loans at issue did not qualify as “student loans” under 11 U.S.C. § 523(a)(8)(A)(ii)—which excepts from discharge “an obligation to repay funds received as an educational benefit, scholarship, or stipend.”

Bankruptcy Dispute Over Student Loans

Hilal K. Homaidan took out loans totaling $12,567 from Defendant-Appellants Sallie Mae Inc., Navient Solutions, LLC, and Navient Credit Finance Corporation (collectively, “Navient”). Although the loans helped underwrite Homaidan’s college education, they were not made through Emerson’s financial aid office, nor—Homaidan alleges—were they made solely to cover Emerson’s cost of attendance. They went straight to Homaidan’s bank account, and the loan proceeds exceeded the cost of Emerson’s tuition.

After receiving the loans, Homaidan graduated from Emerson College, and later filed for Chapter 7 bankruptcy. The bankruptcy court’s 2009 discharge order was ambiguous as to whether the Navient loans were discharged. Navient pursued repayment after the discharge order was issued, and Homaidan complied. After paying off the loans in full, Homaidan reopened the bankruptcy case and commenced this adversary proceeding against Navient seeking, among other things, actual damages for Navient’s alleged violation of the discharge order.

In response, Navient argued that Section 523(a)(8) of the Bankruptcy Code prevented the loans from being discharged in Homaidan’s bankruptcy. Under Section 523(a)(8), several categories of educational debt can’t be discharged in bankruptcy absent a showing of undue hardship. In general terms, the following three categories of educational debt can’t be discharged in bankruptcy: (1) loans and benefit overpayments made, insured or guaranteed by government unit or a nonprofit institution; (2) obligations to repay funds received as an educational benefit, scholarship, or stipend; and (3) certain qualified private educational loans.

The United States Bankruptcy Court for the Eastern District of New York rejected Navient’s argument that the loans were excepted from discharge under 11 U.S.C. § 523(a)(8)(A)(ii), which excepts from discharge “obligation[s] to repay funds received as an educational benefit, scholarship, or stipend.” Accordingly, it denied Navient’s motion to dismiss.

Second Circuit Finds Student Loan Dischargeable

The Second Circuit affirmed, the Bankruptcy Court, concluding thatHomaidan’s loans fall outside the scope of § 523(a)(8)(A)(ii). “Under Navient’s reading of that provision, the term ‘educational benefit’ would encompass virtually all private student loans,” the court wrote. “But that reading cannot be reconciled with the text and structure of § 523(a)(8), both of which confirm that § 523(a)(8)(A)(ii) excepts from discharge a far narrower category of debt.”

As emphasized in the Second Circuit’s opinion, its decision began and ended with the statutory text. The court ultimately concluded that “§ 523(a)(8)(A)(i) covers government and nonprofit-backed loans and educational benefit overpayments; § 523(a)(8)(A)(ii) covers scholarships, stipends, and conditional education grants; and § 523(a)(8)(B) covers private loans made to individuals attending eligible schools for certain qualified expenses.”

The Second Circuit further determined that § 523(a)(8)(A)(ii) excepts from discharge only a narrow category of conditional grant payments, not all private student loans. As explained by the appeals court, “[e]ducational benefit” is “best read to refer to conditional grant payments similar to scholarships and stipends.”

In reaching its decision, the Second Circuit agreed with the bankruptcy court that the phrase “an obligation to repay funds received as an educational benefit” would be “an unconventional way to discuss a loan.” In further support of its decision, the appeals court stated that “if Congress had intended to except all educational loans from discharge under § 523(a)(8)(A)(ii), it would not have done so in such stilted terms.” The court further noted that “there are educational benefits that students may become obligated to repay—such as conditional grants—which fit the statutory text more naturally.”

Key Takeaway

The Second Circuit’s holding, while in line with recent decisions of the Fifth and Tenth Circuits, represents a departure from the trend of courts holding that private student loans were not dischargeable. For private student loan lenders and servicers, the decisions by the Second, Fifth, and Tenth Circuit Courts may lead to a growing number of borrowers seeking to discharge private student loans through bankruptcy cases. While it is unclear whether other federal appeals courts will reach the same conclusion with regard to when private student loans may be discharged, the decisions will certainly be persuasive.

With regard to how federal student loans are handled in bankruptcy, changes also may be on the horizon. In July, U.S. Senate Majority Whip Dick Durbin (D-IL) and U.S. Senator John Cornyn (R-TX) introduced the FRESH START Through Bankruptcy Act of 2021. The bipartisan legislation would allow borrowers to seek a bankruptcy discharge for federal student loans after a waiting period of ten years. The bill would retain the existing undue hardship discharge option for private student loans and for federal student loans that have been due for less than ten years.

Given the shifting legal landscape for both private and federal loans, we encourage lenders, servicers, and other businesses that may be impacted to stay on top of legal developments. Additionally, any questions should be addressed with experienced counsel.

If you have questions, please contact us

If you have any questions or if you would like to discuss the matter further, please contact me, David Edelberg, or the Scarinci Hollenbeck attorney with whom you work, at 201-896-4100.