Second Circuit Further Opens Door to Dischargeability for Private Student Loan Borrowers as Call for Student Loan Reform Heats Up

In July, the Second Circuit issued an opinion favoring the dischargeability of certain private student loans in what appears to be a growing circuit trend. This trend correlates with the call for student loan reform, which has been at the forefront of the news in recent months.

In Homaidan v. Sallie Mae Inc., the Second Circuit affirmed the bankruptcy court’s denial of lender Navient’s motion to dismiss on the basis that 11 U.S.C. § 523(a)(8)(A)(ii) does not except private student loans from discharge. [1] Debtor Homaidan filed for chapter 7 after graduating from Emerson College, listing private student loans from Navient as liabilities. [2] These loans had been disbursed from Navient directly to Homaidan, not to or through Emerson’s financial aid office. [3] After the closure of Homaidan’s bankruptcy case, Navient hired a collection firm to “pester” Homaidan. [4] Believing, therefore, that he still had a legal obligation to pay the loans, Homaidan paid them in full. [5] However, Homaidan later moved to reopen his bankruptcy case and initiated a putative adversary proceeding seeking determination that the loans had been discharged. [6] Homaidan alleged that Navient “has employed a scheme of issuing dischargeable loans to unsophisticated student borrowers and then demanding repayment even after those loans are discharged in bankruptcy.” [7] Navient moved to dismiss, arguing that the loans were excepted from discharge pursuant to § 523(a)(8)(A)(ii). [8] In its thorough analysis of the statutory language and construction of § 523(a)(8), the Second Circuit concluded that the term “educational benefit” found in § 523(a)(8)(A)(ii) is “best read to refer to conditional grant payments similar to scholarships and stipends.” [9] The Second Circuit thus joined the Fifth [10] and Tenth [11] Circuits, which also disagreed with the argument that § 523(a)(8) provides a blanket discharge for all private student loans. [12]

As of July 10, 2021, the national private student loan balance was approximately $137 billion. [13] This balance makes up approximately 8.4% of the total national student loan debt, which is approximately $1.73 trillion. [14] Although it is unclear exactly what impact Homaidan and its ilk will have on the national private student loan debt, the courts continue to widen the opening in the door to dischargeability — certainly a welcome development for hopeful debtors who previously stared down the formidable Brunner test [15] as potentially their only avenue for relief.

This developing litigation-driven trend is, at the moment, coinciding with a call for Congress to amend the Bankruptcy Code to eliminate the undue hardship standard altogether. Recently, a bipartisan bill targeted at federal student loans was introduced to this effect. [16] Said bill proposes to make these loans eligible for discharge 10 years after the date they become due. [17] It also proposes to require “Institutes of Higher Education” “who receive a certain amount of federally-backed student loans” “to repay a portion of discharged federal student loans to the taxpayer” and potentially refund the government for a portion of said loans received by an institution if the default rate is high and repayment rate is low consistently for that institution. [18] The goal is to incentivize “Institutes of Higher Education” to provide value to borrowers and penalize those institutions that fail to do so. [19] Although the discharge provision in this bill does not extend to private student loans, these incentives may benefit all borrowers and decrease the default and overall debt numbers across the board. But with favorable circuit level decisions, such as Homaidan, stacking up, private student loan borrowers seemingly need not despair.

The movement in recent months toward easing overall student loan debt does not begin or end with that bill or those circuit decisions. In July, the Department of Education exercised its muscle to cancel student loans from three for-profit colleges that had engaged in predatory lending, [20] the result of a rollback from the previous administration’s stance, [21] resulting in relief for more than 1,800 borrowers from approximately $55.6 million of student loan debt. [22] In August, the Department of Education also rolled back the previous administration’s bar on the states’ ability to monitor and litigate against federal student loan servicers that fail to provide quality service to borrowers — which can result in increased repayment costs. [23] Additionally, in August, the Young Lawyers Division of the American Bar Association drove a vote to adopt a resolution to urge Congress to broadly reform repayment and forgiveness programs and consolidation and refinancing opportunities, with a special focus on law school loan debt. [24] These actions and efforts, coupled with courts’ favorable interpretations of the Code, may profoundly ease the student loan burden before the bubble bursts.