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Second Circuit Finds Certain Student Loans Can be Discharged

The Second Circuit in the recent case of In Homaidan v. Sallie Mae recently held that some kinds of private student loans do not require the repayment of debts that can be categorized as an educational benefit. This decision resulted in the Second Circuit joining the Fifth Circuit and Tenth Circuit on the matter. Neither the Bankruptcy Court’s decision nor the Second Circuit’s decision influenced the background by which the loans can be discharged during bankruptcy as the result of either 11 U.S.C. § 523.

Private student loans can still be discharged under either 11 U.S.C. § 523 provided these loans can be categorized as “qualified education loans.” The Homaidan court, however, failed to consider this possibility. In the aftermath of the coronavirus, bankruptcies involving either outstanding or past-due student loan debt will likely rise dramatically. This decision could result in more disputes involving whether debts can be discharged. On August 2, 2021, the FRESH START Through Bankruptcy Act of 2021 was introduced. This legislation is focused on helping borrowers facing financial hardships by revising the Bankruptcy Code sections that address the discharge of student loans. 

On July 15, 20201, a three-judge panel for the Second Circuit held in Homaidan that private loans at issue are not subject to the exemption found in Section 523(a)(8)(A)(ii)  addressing obligations to pay back funds that are categorized as an educational benefit. In this case, the lender who was also the servicer filed a motion to dismiss a proceeding initiated by a debtor claiming that a lender broke the terms of a discharge order by accepting payments on private student loans that had been discharged. The Bankruptcy Court considered the exemption to discharge an obligation to repay funds that qualified as an educational benefit and found that the discharge does not sweep in all education-related debt. The Bankruptcy Court subsequently denied the defendant’s motion to dismiss. The Second Circuit later affirmed the decision.

Important Laws Involved With the Case

To fully appreciate the arguments raised by both sides in Homaidan, there are some important bankruptcy rules to understand. Consider the following regulations:

  • 523(a)(8)(A)(ii). This regulation states that an obligation to repay funds received as an educational benefit is exempt from discharge unless excepting this debt would lead to undue hardship. 
  • 11 U.S.C. § 523(a)(8)(B). This rule states that a bankruptcy discharge does not discharge an individual debtor from any debt unless exempting the debt would impose an undue hardship on the debtor and the debtor’s dependents for any qualified education loan. 

The Nature of the Second Circuit’s Decision

Similar to the Bankruptcy Court, the Second Circuit relied on the appropriate regulatory text, which states that certain things are excluded from discharge including the obligation to repay funds that are received as an “educational benefit” including scholarships and stipends. The defendant’s sole argument in its motion to dismiss is that the private student loan to the plaintiff represented an educational benefit. The defendant reserved its right to address the plaintiff’s argument that loans did not constitute qualified education loans.

The Second Circuit found that Section 523(a)(8)(A)(ii) does not permit a reading of loan handlings where this specific word is used in connected legislation but missing from this section. The court also found that it could not apply the defendant’s expansive reading of this statute, under which any loan is nondischargeable under Section 523(a)(8)(A)(ii) provided it was utilized to advance’s one’s education because this would lead to “virtually all” students loans to fall within this exemption. The court found that this result would leave the exemptions relatively meaningless. Consequently, the court noted that the phrase “educational benefit” should be limited to conform with the terms “scholarship” and “stipend” as specified in Section 523(a)(8)(A)(ii). 

Lastly, the court noted that because the appeal had been introduced by a decision on a motion to dismiss, a conclusion could not be reached on whether the plaintiff’s loan was discharged in bankruptcy. Instead of arriving at this decision, the Second Circuit remanded the case to the Bankruptcy Court for additional proceedings. 

How In Homaidan Could Influence Future Cases

In reaching its decision, the Second Circuit failed to explain the regulations addressing when student loans can be discharged. The court failed to examine whether private student loans represent “qualified student loans” which would mean that the debt was not capable of being discharged under Section 523(a)(8)(B). 

The Second Circuit’s decision similarly does not implicate public student loans, which are not included in discharge unless a person can establish that paying this amount would create an “undue hardship.” In the landmark case of McCoy v. the United States, the plaintiff sought the Supreme Court’s review of a circuit split addressing what the correct test is for assessing what constitutes an “undue hardship.” The Supreme Court, however, declined to hear this case. 

Some of the critical points that the Homaidan will have on the area of bankruptcy and student loan debt include the following:

  • Unresolved questions. The court in Homaidan found that private student loans are not required to repay educational benefits, which are classified as nondischargeable in bankruptcy. The Homaidan court, however, did not contemplate whether private student loans are dischargeable as “qualified educational loans.”
  • Room for future arguments. Future parties might be able to argue that other provisions found in n 11 U.S.C. § 523(a)(8)(B) support the dischargeability of educational debts. 
  • Potential Increase in Parties Seeking Discharge. The Second Circuit’s opinion which brings it into line with the Fifth and Tenth Circuits may result in additional debtors seeking the discharge of student loans. 
  • Pending legislation. The FRESH START through Bankruptcy Act of 2021 as well as other proposed legislation if passed could end up modifying existing Bankruptcy Code regulations in a way that makes it substantially easier to discharge student loans.

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