Student loans are a big issue in the United States. According to the most recent data by the Federal Reserve Bank of New York, there is currently $1.57 trillion in outstanding student debt, up from just $0.26 trillion 17 years ago.[1] Before the CARES Act suspended payments and interest accruals from August 2020-January 2022, student debt holders were also the most likely borrowers to be 90+ days delinquent, hovering around 11% from 2012 – 2019. Current bankruptcy law makes the discharge of most student loans extremely difficult; the borrower has to establish “undue hardship,” a term not defined in the Bankruptcy Code, but which has been interpreted very strictly against student borrowers. The stratospheric rise in total student debt has many causes, but the exemption from discharge in bankruptcy for student debt is one of the more contentious. After a recent decision by the Court of Appeals for the Second Circuit, the extent of that exemption may be narrowing.

On July 15, 2021, the Second Circuit found that a student borrower’s private loans could be discharged because they were not covered by the definition in the exemption statute. The student borrower got his loans from Navient Solutions, LLC and Navient Credit Finance Corporation (together “Navient”), and after graduating from college filed for chapter 7. After a discharge order in 2009 that was ambiguous about whether it applied to his Navient loans, Navient pursued repayment and the borrower complied. After repaying the loans in full, the borrower reopened his chapter 7 case and sought damages against Navient for violating the discharge order, arguing that his specific loans were not exempt. Navient’s motion to dismiss the claim was denied by the Bankruptcy Court in the Eastern District of New York. The Second Circuit affirmed, finding for the borrower.

The Bankruptcy Code specifies three categories of debt that will not be discharged: (1) loans issued by the government or a nonprofit, (2) obligations to repay funds received as an educational benefit, scholarship, or stipend, and (3) qualified private educational loans. “Qualified” loans must fund only qualified higher education expenses. The Navient loans were not qualified because they were disbursed directly to the student borrower to be used as he wished. Navient argued the loans were an “an obligation to repay funds” for the purpose of advancing his education, thereby deriving an “educational benefit.” The Second Circuit disagreed, finding the statute covers only a narrow category of conditional grant payments, not all private student loans. In a decision based on pure statutory analysis, the Second Circuit found that not all private student loans are exempt from discharge.

Only about eight percent of student loans outstanding are private, but that still totals approximately $130 billion in outstanding debt. This decision may end up being a camel’s nose on student debt relief. Certainly many holders of private loans in New York City will be questioning whether their debts are “qualified” or dischargeable.

The case is Homaidan v. Sallie Mae, Inc., 3 F.4th 595 (2d Cir. 2021).