Second Circuit Rules for Dischargeable Student Loans in Bankruptcy


July 15, 2021, in the Homaidan[1] notice, the Second Circuit has joined the Fifth[2] and tenth[3] Circuits for deciding that certain student loans are dischargeable in the event of bankruptcy. These three opinions are very important to the student loan industry, but may not be as important as they seem at first glance, as they do not claim to make all student loans potentially dischargeable.

The question in these cases is whether the loans in question qualify as “student loans” within the meaning of the Bankruptcy Code. Section 523 (a) (8) states that certain debts commonly known as “student loans” are not dischargeable in bankruptcy unless they “would impose undue hardship on the debtor and his dependents”. (The “undue hardship” scope of investigation is itself complex and does not apply to such cases.) Generally speaking, debts exempt from discharge are those which involve (1) overpayments of educational allowances or loans made with the participation of the government; (2) obligations “to repay funds received as an educational benefit, scholarship or allowance”; or (3) other educational loans to persons qualified under the IRS tax code as “qualified educational loans”. Until the last five or six years, most courts have ruled that any student loan is deemed non-dischargeable under the second tier because all student loans involve an obligation to repay funds and confer an educational benefit.

The radical change is that the courts are now analyzing the second branch against the other two. Many decide that if Congress had provided for the second tier to cover actual loans, it would have been easy for Congress to simply include the term “loans” as it did in the other two streams. In addition, people generally do not describe loans as “educational benefits”; the term “benefit” is more commonly used in connection with scholarships or grants. These courts classify non-dischargeable debts into three broad categories: (a) loans granted with the participation of the government; (b) the repayment requirements of grants and scholarships (for example, if the student does not meet the conditions of a scholarship); and (c) private student loans that meet IRS guidelines that could make them tax deductible. Private loans that not who meet IRS criteria are thus increasingly at risk of being discharged in bankruptcy proceedings.

Some private student loans have been made under programs that may not benefit from the preferential tax treatment of the IRS. This makes these court decisions very important to the student loan industry, especially as some law firms seek to review the treatment of student loans in bankruptcy cases of up to ten years ago. However, many other loans have been made in accordance with IRS guidelines and are therefore unaffected by this revised approach to reviewing student loans. Still others could benefit from favorable tax treatment in the absence of the debtor’s misuse of funds or other wrongdoing; these loans generally remain non-dischargeable as well. So while these Circuit Court decisions are important, they are unlikely to revolutionize the student loan industry or resolve the reported student loan crisis.

[1] Homaidan v. Sallie Mae, Inc., ___ F.4th ___, 2021 WL 2964217 (2d Cir. 2019 July 15, 2021).

[2] Crocker v. Navient Solutions, LLC (In re Crocker), 941 F.3d 206 (5th Cir. 2019).

[3] McDaniel v. Navient Solutions, LLC (In re McDaniel), 973 F.3d 1083 (10th Cir. 2020).

© 2021 Miller, Canfield, Paddock and Stone PLC Revue nationale de droit, volume XI, number 218

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