October 7, 2020Client Alert

Debtors May Discharge Private Student Loans in Bankruptcy Coming Soon to a Circuit Near You

The Tenth Circuit recently joined the Fifth Circuit by holding that certain private student loans are dischargeable in bankruptcy.

In McDaniel v. Navient Solutions, LLC, No. 18-1445 (10th Cir. Aug. 31, 2020), the Tenth Circuit held that an educational loan does not constitute “an obligation to repay funds received as an educational benefit” under Section 523(a)(8)(A)(ii) of the Bankruptcy Code.

Section 523(a)(8) of the Code provides, in pertinent part:

  1. A discharge under this title does not discharge an individual debtor from any debt —

(8) unless excepting such debt from discharge under this paragraph would impose an undue hardship on the debtor and the debtor’s dependents, for —

(A)(i) an educational benefit overpayment or loan made, insured or guaranteed by a governmental unit, or made under any program funded in whole or in part by a governmental unit or nonprofit institution; or

(ii) an obligation to repay funds received as an educational benefit, scholarship or stipend; or

(B) any other education loan that is a qualified education loan, as defined in section 221(d)(1) of the [IRS Code], incurred by a debtor who is an individual.

In McDaniel, the debtors borrowed over $100,000 in private loans for college living expenses. These loans were not qualified education loans, nor were they made or guaranteed by a governmental unit or nonprofit institution. Whether the loans were dischargeable, then, was left to the Tenth Circuit’s interpretation of § 523(a)(8)(A)(ii).

The Court provides a lengthy analysis of canons of statutory interpretations to interpret § 523(a)(8)(A)(ii)and ultimately finds that the statutory terms “obligation to repay funds received as an educational benefit” and “educational loan” mean separate things. The Tenth Circuit explained:

It is clear to us that when § 523(a)(8) refers to an “educational benefit,” just like when normal speakers of English refer to things like a health benefit, unemployment benefit, or retirement benefit, it is using a definition of “benefit” that implies a “payment,” “gift,” or “service” that ordinarily does not need to be repaid.

The Court concluded that Congress did not intend § 523(a)(8)(A)(ii) to cover loans. Finding otherwise “would violate the canon against surplusage because then there would be no need for a separate provision excepting from discharge specific categories of student loans.” (internal quotations omitted).

Applying the canon of Noscitur a sociis—interpreting an ambiguous word by considering the surrounding words—the Tenth Circuit determined that “the language ‘an obligation to repay funds received as an educational benefit’ signifies a conditional grant of funding for education—akin to a stipend and scholarship—as opposed to a loan of funds for education.” And so, the Court concluded that § 523(a)(8)(A)(ii) was “designed to except from discharge grants of money that are tied to service obligation—a category wholly distinct from loans.”

McDaniel cited and relied heavily on another case from the Fifth Circuit, Crocker v. Navient Solutions, LLC (In re Crocker), 941 F.3d 206 (5th Cir. 2019). There, the Fifth Circuit rejected a private lender’s argument that all private student loans were made non-dischargeable by the 2005 amendments to section 523(a)(8).The Court held that subsection 523(a)(8)(A)(ii) “applies only to educational payments that are not initially loans but whose terms will create a reimbursement obligation upon the failure of conditions of the payments.”

Takeaway from the McDaniel and Crocker Decisions:

While these decisions deal with private student loans for non-tuition expenses, they reinforce the national trend of easing restrictions on discharging student loans through bankruptcy proceedings. Bankruptcy Judges are aware of the financial hardships imposed by crippling student debt, and there is a growing desire to ease the historically rigid standards to discharge private student loans, provided that such loans impose an undue hardship on debtor borrowers.

Private lenders and servicers should follow the developments of similar cases to monitor their respective circuit’s interpretation of § 523(a)(8)(A)(ii). Lenders who provide private student loans for living expenses and other costs not directly related to tuition should closely monitor future cases relating to the McDaniel and Crocker decisions, and engage competent counsel to assist where a borrower seeks bankruptcy protection.

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