The non-dischargeability of private student loans in bankruptcy proceedings has long been assumed to be almost absolute, but a July 15, 2021 decision (Homaidan v. Sallie Mae) by the U.S. Court of Appeals for the Second Circuit suggests that is not always the case.
Contrary to many headlines surrounding this case, however, the Appeals Court did not generally hold that private student loans are dischargeable. Rather, the Court narrowly held that the exception to discharge the creditor relied upon for its appeal was not, as a matter of law, applicable to the private student loan at issue in the case.
To review, the U.S. Bankruptcy code (the Code) makes certain educational debts non-dischargeable (excepted from discharge) absent a showing of undue hardship on the debtor and the debtor’s dependents. In relevant part, Section 523 of the Code lists the three non-dischargeable educational debts as:
- 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.
- An obligation to repay funds received as an educational benefit, scholarship, or stipend.
- Any other educational loan that is a qualified 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 issue in Homaidan was whether the borrower’s loan fell under the exception for “funds received as an educational benefit.” The creditor argued that the debt should be excepted from discharge under that exception, but the appeals court found that argument unpersuasive, in large part because the exception for funds received as an educational benefit did not expressly refer to loans (unlike the other two exemptions that use the word “loan”) and was instead limited to conditional grant payments similar to scholarships and stipends. Based on that rationale, the appeals court affirmed the denial of the defendant creditor’s motion to dismiss.
It is important to note that the only issue decided by the court was whether the exception to dischargeability related to an obligation to repay funds received as an educational benefit applies to private student loans. The court said that it did not, but the court did not analyze the scope of the “qualified educational loan” exception to dischargeability. We therefore think that this case should not be read as a significant change with respect to the dischargeability of private education loans. Most private education loans will meet the definition of a “qualified education loan,” the typical exception relied upon by private student loan creditors. In most instances, the practical effect of this exception will mean that the borrower will not be able to discharge the loan unless the borrower is able to show the court that repayment of the loan would be an undue hardship. The Homaidan case did not change that outcome.