Second Circuit Court of Appeals Rules that Private Student Loans May be Discharged in Bankruptcy

Second Circuit Court of Appeals Rules that Private Student Loans May be Discharged in Bankruptcy

On July 15, 2021, the U.S Court of Appeals for the Second Circuit, delivered a ruling that private student loans are not explicitly exempted from a debtor’s Chapter 7 bankruptcy discharge. Homaidan v. Sallie Mae, Inc. 20-1981 (2^nd Cir. July 15, 2021). The Court interpreted Section 523(a)(8)(A)(ii) of the Bankruptcy Code to state that private student loans can be discharged from bankruptcy as the same are not “educational benefits”.

As per the facts of the case, the debtor, soon after graduating from the Emerson College, filed a Chapter 7 bankruptcy petition in the year 2007. He obtained a discharge in 2009. However, the order notifying the discharge did not specify whether the debtor’s two private student loans, amounting to $12,567.00 would be discharged as well. Thus, the loan servicer demanded repayment of the two private student loans, which the debtor gradually paid off in 2017.

The debtor, later decided to reopen the bankruptcy case and filed a putative class action adversary proceeding against the loan services for violating the discharge order. In reply, the loan servicer filed a motion to dismiss, stating that Section 523(a)(8)(A)(ii) of the Bankruptcy Code prevented the private student loans from getting discharged. The servicer argued that the term “educational benefit” stated in the mentioned section includes all private student loans. Adjudicating upon the arguments, the district court disagreed with the loan servicer, and held that the text and structure of Section 523(a)(8) and 523(a)(8)(A)(ii) exempt a far narrower category of debt. Thereafter, the loan servicer filed an interlocutory appeal before the Second Circuit Court, and the district court judgment was affirmed.

The issue which came before the Court was, “whether the loans at issue constitute “an obligation to repay funds received as an education benefit “ and were therefore excepted from discharge under Section 523(a)(8)(A)(ii)”. To resolve the same, the Court held that under Section 523(a)(8), only three categories of loans could not be discharged, viz. 1) loans and benefit overpayments backed by the government or a nonprofit; 2) obligations to repay funds received as an educational benefit, scholarship, or stipend; and 3) qualified private educational loans. The loan servicer contended that the private student loans in question created an “obligation to repay funds” and as the loans were granted with the objective of advancing debtor’s education, they should be considered as “educational benefit”. The Court analyzed the statutory interpretation of the U.S. Bankruptcy Court in order to determine the underlying meaning of “education benefit” in the provision. It found that plain reading of the provision does not support loan servicer’s interpretation. Instead, it stated that if Congress had intended to bar all student loans from discharge under Section 523(a)(8)(A)(ii), “it would not have done so in such stilted terms”. Further, the Court held that the term “education benefit” is to be read to refer to conditional grant payment like scholarships and stipends and does not cover all private student loans. The judgment of the Court provides a needed clarification with regards to the exemption