Private Student Loan Update: Second Circuit Finds "Educational Benefit" Category Of Section 523 Does Not Apply To Private Student Loans

• Published date: 24 September 2021
• Subject Matter: Finance and Banking, Insolvency/Bankruptcy/Re-structuring, Debt Capital Markets, Financial Services, Insolvency/Bankruptcy
• Law Firm: Arnold & Porter
• Author: Mr Benjamin Mintz and Brendan M. Gibbons

The US Court of Appeals for the Second Circuit recently ruled in favor of a private student loan borrower and found that his loans were discharged without his meeting the undue hardship requirement usually applied to student loans.¹ The court found that the borrower's loans were not an "obligation to repay funds received as an educational benefit" and were therefore subject to discharge. In reaching that conclusion, the court held that private education loans that were not "qualified" within the meaning of the bankruptcy code were generally subject to discharge, without regard to the undue hardship standard. The opinion noted that applying the "educational benefit" prong to a loan would make every student loan an educational benefit and improperly broaden the statute's scope, which separately excepts from discharge "qualified private educational loans." Navient Corp., the successor to Sallie Mae, the loan's initial servicer, did not argue that the borrower's loans were qualified private educational loans, likely because the loans were issued directly to the student and used for living expenses rather than tuition. This decision puts the Second Circuit in agreement with the Fifth and Tenth Circuits, which have recently reached similar conclusions.

The Homaidan Case

Hilal K. Homaidan received two direct-to-consumer "tuition answer loans" from Sallie Mae totaling more than $12,000. The funds went directly to Homaidan's bank account and, according to him, were not used for educational expenses. In 2009, after declaring bankruptcy under Chapter 7, Homaidan obtained a discharge order from the United States Bankruptcy Court, Eastern District of New York, however, the order did not specify which debts were discharged and noted that "debts for most student loans are not dischargeable in a Chapter 7 proceeding." According to Homaidan, Navient then "pester[ed]" him to pay back his loans, causing him "to assume that the loans had not been discharged." He paid back his loans in full. In 2017, Homaidan reopened his bankruptcy case and commenced a putative class action adversary proceeding against Navient, alleging that Navient "employed a scheme of issuing dischargeable loans to unsophisticated student borrowers and then demanding repayment even after those loans are discharged in bankruptcy." Navient argued that Homaidan's loans were not discharged.

Section 523(a)(8) typically prevents most educational loans from being discharged. The court, acknowledging that...