The non-discharge of private student loans in bankruptcy proceedings has long been assumed near absolute, but a July 15, 2021 ruling (Homaidan v. Sally Mae) by the United States Court of Appeals for the Second Circuit suggests that this is not always the case.
Contrary to many headlines surrounding this case, however, the Court of Appeals has generally not ruled that private student loans are dischargeable. On the contrary, the Court narrowly concluded that the creditor’s discharge exception relied on for its appeal was not, in law, applicable to the private student loan at issue in the case.
To review, the US Bankruptcy Code (the Code) renders certain educational debts non-dischargeable (except discharge) absent a demonstration of undue hardship to the debtor and their dependents. In the relevant part, Section 523 of the Code lists the three non-dischargeable student debts as follows:
- An overpayment or educational benefit loan made, insured or guaranteed by a government unit, or made under any program funded in whole or in part by a government unit or non-profit institution.
- An obligation to repay funds received as an educational benefit, scholarship or stipend.
- Any other education loan that is a qualifying education loan, as defined in Section 221(d)(1) of the Internal Revenue Code of 1986, incurred by a debtor who is an individual.
The question in Homaidan was whether the borrower’s loan fell within the exception for “funds received as an educational benefit”. The creditor argued that the debt should be exempt from discharge under this exception, but the Court of Appeal found this argument unconvincing, largely because the exception for funds received as a benefit education did not expressly refer to loans (unlike the other two exemptions which use the word “loan”) and was instead limited to conditional grant payments similar to scholarships and stipends. Based on this reasoning, the Court of Appeal upheld the dismissal of the defendant creditor’s motion to dismiss.
Importantly, the only issue decided by the court was whether the exception to the discharge related to an obligation to repay funds received as an educational benefit applies to private student loans. The court said that was not the case, but it did not analyze the scope of the “qualified education loan” exception to discharge. We therefore believe that this case should not be read as a significant change with respect to the dischargeability of private student loans. Most private student loans will meet the definition of a “qualified student loan,” the typical exception that private student loan creditors rely on. In most cases, the practical effect of this exception will mean that the borrower will not be able to repay the loan unless he can demonstrate to the court that repayment of the loan would constitute undue hardship. . the Homaidan case did not change this result.