Courts Split on Arbitrating Dischargeability of Student Loans

Unless the circuit courts are unanimous, the Supreme Court ultimately will decide whether individual debtors can be forced to arbitrate the dischargeability of student loans. Indeed, if the courts say that dischargeability of student loans must be arbitrated, it won’t be long before dischargeability disputes involving loans of all types are taken out of the bankruptcy courts and decided by arbitrators.

And if dischargeability must arbitrated, why can’t arbitrators also rule on the allowance of claims?

Bankruptcy Judge Jeffrey J. Graham of Indianapolis has most recently written on a subject where the lower courts are divided. He declined to follow Williams v. Navient Solutions LLC (In re Williams), 564 B.R. 770 (Bankr. S.D. Fla. 2017), where Bankruptcy Judge Erik P. Kimball of West Palm Beach, Fla., required the debtor the arbitrate the dischargeability of a student loan under Section 523(a)(8).

Instead, Judge Graham decided in his November 16 opinion to follow Bankruptcy Judge Elizabeth S. Stong of Brooklyn, N.Y., who refused to enforce an arbitration agreement when the debtor mounted an adversary proceeding to discharge student loans. Golden v. JP Morgan Chase Bank NA (In re Golden), 587 B.R. 414 (Bankr. E.D.N.Y. 2018).

The facts before Judge Graham were not unusual. The debtor had received a general discharge, which, of course, did not include about $36,000 in student loan debt. The student loan agreement contained a provision requiring arbitration of any claim or dispute regarding the debt.

The debtor filed a complaint contending that the student loans were dischargeable under Section 523(a)(8). He alleged that the debt was not a “qualified educational loan,” and if it was, he argued that the obligation represented an undue hardship.

In lieu of an answer, the lender responded with a motion to compel arbitration.

To aid Judge Graham in ruling on the enforceability of the arbitration agreement, Supreme Court authority only adds to the confusion.

Until recently, authority from the Supreme Court held that a court could decline to enforce an arbitration agreement if there was an inherent conflict between arbitration and the statute’s underlying purpose. Shearson/American Express Inc. v. McMahon, 482 U.S. 220, 227 (1987).

In the Supreme Court earlier this year, the justices split 5/4, adopting a seemingly more stringent test by holding that the language of the statute must be “clear and manifest” before a court can override an arbitration agreement. Epic Systems Corp. v. Lewis, 138 S. Ct. 1612, 1624 (2018).

Were Epic the only authority, Judge Graham said he would enforce the arbitration agreement, because there is no clear congressional intent shown in the Bankruptcy Code to override arbitration agreements. However, he said that McMahon is still good law because the Supreme Court cited the decision in Epic.

Judge Graham said that McMahon remains good law also because Epic showed no clear attempt at overruling prior authority.

Judge Graham noted that five circuit courts, in opinions all handed down before Epic, held that bankruptcy courts have discretion to disregard an arbitration agreement if the dispute is a core proceeding and arbitration would conflict with the purposes of the Bankruptcy Code.

For two reasons, Judge Graham declined to compel arbitration. First, he said that compelling arbitration would result in “more than an inherent conflict” with the Bankruptcy Code. Arbitrating dischargeability, “the central purpose of the Bankruptcy Code, would effectively allow parties to contractually override the application of federal bankruptcy law.”

Second, Judge Graham said that centralizing disputes about a debtor’s obligations is a “pillar of federal bankruptcy law.”

Judge Graham denied the lender’s motion to compel arbitration because enforcement of the clause “would create an inherent conflict with the Bankruptcy Code’s fundamental policies of affording debtors a fresh start and centralizing disputes about a debtor’s obligations for efficient resolution."