Here is Why Your Private Student Loan May Able to Be Eliminated in Bankruptcy

The following guest post by Austin Smith may be a bit technical but it contains critical information for both consumers and bankruptcy attorneys. For people who are not attorneys, this information may get a bit technical but you can print a copy of this article and take it with you to your bankruptcy attorney.

I am constantly frustrated by the vast number of people who continue to believe that student loans are not dischargeable in bankruptcy, yet many are. Even large swaths of bankruptcy attorneys continue to believe this urban myth.

Hopefully the following information, in conjunction with this, this, and this, will help to show people that a blanket belief that student loans are not dischargeable is just not a true fact.

So without further deal, let’s hear from bankruptcy attorney Austin Smith.

Steve – Get Out of Debt Guy

Where A Student Loan Is Not Really A Student Loan

In 2005, Congress amended section 523(a)(8) of the Bankruptcy Code to except from discharge private student loans that are “qualified education loans.” Qualified education loans are defined in both the Tax Code and the Higher Education Act as debts incurred solely to pay for (i) qualified higher education expenses (ii) at an accredited institution by (iii) an eligible student. (See 26 U.S.C. § 221(d)) Qualified higher education expenses are defined as the “cost of attendance” which is a sum determined by the institution, to cover tuition, fees, room, board, and books. (See See 20 U.S.C. § 1087ll)

This is not only a question of bankruptcy law, it is foremost a question of tax law, because the interest paid on a qualified education loan can be deducted from the taxpayer’s income tax. And you can be sure that the IRS will not allow taxpayers to bend the rules to deduct interest paid on educational loans that do not meet these strict requirements. So, how do you prove that your loan is not a qualified education loans?

Ineligible Schools: Check your client’s school against the Department of Education’s Title IV eligible school list for the year in which your client attended. If the school does not appear, the school was not Title IV eligible, and the loan could not be a qualified education loan.

Ineligible Expenses: Check the school’s “cost of attendance” and compare that to the total of amount of money you received from all federal, state, and private sources, including scholarships, grants, work-study, and loans. If you borrowed even one dollar more than was necessary to cover the “cost of attendance,” the private loan was not incurred solely to pay for qualified higher education expenses and is not a qualified education loan. (See See IRS, 26 C.F.R. 1, REG-116826-97 (“Student I signs a promissory note for a loan which is secured by I’s personal residence. Part of the loan proceeds will be used to pay for certain improvements to I’s residence and part of the loan proceeds will be used to pay qualified higher education expenses of I’s spouse. Because the loan is not incurred by I solely to pay qualified higher education expenses, the loan is not a qualified education loan.”).

Ineligible Students: Check to be sure you met the requirements to be an eligible student under the Higher Education Act and the Tax Code. In order to be an eligible student, you must have been enrolled in an eligible program for “half-time” or more. If you were only part time, your loan was not a qualified education loan.

Now that you understand the difference between a “real student loan (i.e., a qualified education loan)” and “a loan made to a student (i.e., a non-qualified education loan)” you may be wondering why debtors have such a hard time in court. It seems pretty straight-forward and surely could not have caused much confusion since the law was passed in 2005.

True enough. But the biggest challenge you will face in discharging these debts is not section 523(a)(8)(B), but rather, section 523(a)(8)(A)(ii). That is, the challenge won’t be because the parties dispute whether the private education loan is “qualified” under section 523(a)(8)(B). Rather, it will be because the creditors are going to argue that even if the loan is not “qualified” it remains non-dischargeable as an “obligation to repay funds received as an educational benefit” under section 523(a)(8)(A)(ii).

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What on earth does that provision mean? We’re going to tell you, but bear with us. It’s a little complicated. In the 1980s, only federal student loans were non-dischargeable. But in addition to student loans, the government further higher education in other ways. For example, the government offers conditional scholarships to students who agree to perform government service after graduation. Sometimes this means joining the army after college, or working in a low-income clinic after medical school.

What happened was that students in the 1980s were taking this federal money, graduating from school, and then breaching their contract by not showing up to boot camp, or not showing up to the low-income clinic. Thus, the student would incur an “obligation to repay funds received as an educational benefit” but instead of paying it, would declare bankruptcy, and seek to discharge the debt under a literal reading of section 523(a)(8) because technically the debt was not a “student loan.” (See U.S. Department of Health and Human Services v. Smith, 807 F.2d 122 (8th Cir. 1986) (concerning a student who took a PSASP scholarship with the condition that he work for a certain number of years in a physician shortage area after graduation, breached the contract with the government, declared bankruptcy, and tried to discharge the debt).

In 1990, Congress sought to fix this problem created by these unscrupulous scholarship students, and added a clause that restricted discharge of “an obligation to repay funds received as an educational benefit, scholarship, or stipend,” which has since become section 523(a)(8)(A)(ii) of the Code. Legislative history demonstrates that what Congress was seeking to capture here were defaulted conditional educational grants, NOT any debt that provided an “educational advantage.” (See Federal Debt Collection Procedures of 1990: Hearing on P.L. 101-647 Before the H. Subcomm. on Econ. and Commercial Law , H. Judiciary Committee 101st Cong. 74-75 (June 14, 1990) (“This section [523(a)(8)] adds to the list of nondischargeable debts, obligations to repay educational funds received in the form of benefits (such as VA benefits), scholarships (such as medical service corps scholarships) and stipends. These obligations are often very sizeable and should receive the same treatment as a “student loan” with regard to restriction on dischargeability in bankruptcy.”).

Unfortunately, for the last 10 years, some courts have misapplied this section, and used it to refuse discharge of any educational debt that provided educational advantages (i.e., educational benefits).

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But recent courts have realized the error of their ways, and begun applying the law as written for three major reasons. (See See Christoff v. Institute of Imaginal Studies (In re Christoff), 527 B.R. 624, 634 (B.A.P. 9th Cir. 2015); Campbell v. Citibank, N.A., et al, (In re Campbell), 547 B.R. 49, 55 (Bankr. E.D.N.Y. 2016); Nunez v. Key Educational Resources (In re Nunez), 527 B.R. 410, 415 (Bankr. D. Or. 2015); Decena v. Citizens Bank (In re Decena), 549 B.R. 11 (Bankr. E.D.N.Y. 2016); In Matter of Swenson, No. 16-10016, 2016 WL 4480719, at *3 (Bankr. W.D. Wis. Aug. 23, 2016); In re Meyer, No. 15-13193, 2016 WL 3251622, at *2 (Bankr. N.D. Ohio June 6, 2016).

First, courts realized that Congress did not use the word “loan” in section 523(a)(8)(A)(ii) and courts cannot inject the word “loan” where it does not appear. Since Congress used this obscure term “obligation to repay funds received” rather than “loan,” Congress must have meant something other than a loan. While “loans” and “obligations to repay funds received” may have similar qualities, the terms are not interchangeable. (See Christoff v. Institute of Imaginal Studies (In re Christoff), 527 B.R. 624, 634 (B.A.P. 9th Cir. 2015), appeal dismissed (Aug. 7, 2015) (“The bankruptcy court therefore concluded that, while the transactions between Debtor and Meridian were clearly loans, § 523(a)(8)(A)(ii) does not extend to loans but, instead, grants an exception to discharge for “an obligation to repay funds received.”).

Accordingly, section 523(a)(8)(A)(ii) cannot be used to except from discharge any type of loan.

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Second, such an interpretation violates the statutory cannon of noscitur a soccis. This cannon states that where the meaning of a word is ambiguous and is used in a series of other words, it should be defined in relation to those other words. (See Campbell v. Citibank, N.A., et al, (In re Campbell), 547 B.R. 49, 55 (Bankr. E.D.N.Y. 2016). (“[T]he canon of statutory construction known as noscitur a sociis instructs that when a statute contains a list, each word in that list presumptively has a similar meaning. To the extent that educational benefit (defined nowhere in the Bankruptcy Code) is ambiguous, it should be presumed to have a meaning similar to the other items in the list set forth in § 523(a)(8)(A)(ii). Scholarship and stipend both refer to funds which are not generally required to be repaid by the recipient. Therefore, in the absence of plain meaning to the contrary, or compelling legislative history, educational benefit must be understood to refer to something other than a loan, especially given that Congress uses the word loan elsewhere in § 523(a)(8). The concept which unites the three separate terms in the list in § 523(a)(8)(A)(ii) is that they all refer to types of conditional grants.”).

Note that the word “benefit” has two distinct meanings. The first is a “profit or advantage derived from something.” But the second is “a payment made by the state, an insurance company, or an employer.” Creditors are seeking to use the first definition. But Congress clearly intended the second. We know this because of the other two items listed in the series, “scholarships and stipends,” are both types of “payments made by an employer or the state.” Thus, we must define “benefit” in the same way in order to comport with the cannon of noscitur a soccis.

Third, such an interpretation violates the cannon against superfluity because it renders the rest of the statute superfluous. And this is quite simple: if any debt for educational purposes is non-dischargeable, why did Congress create such specific subsections to the law? (See Nunez v. Key Educational Resources (In re Nunez), 527 B.R. 410, 415 (Bankr. D. Or. 2015)(“I see no basis to untether the language in § 523(a)(8)(A)(ii) to apply the student loan exception to discharge to “all obligations to repay funds received as an educational benefit, scholarship or stipend,” without limitation. Such an interpretation would render§ 523(a)(8)(B), the provision that Congress added to § 523(a)(8) in BAPCPA, superfluous and makes no sense. After all, if any educational loans of any kind are excepted from discharge by § 523(a)(8)(A)(ii), what addition does excepting qualified educational loans under the Internal Revenue Code make to the discharge exception? The educational loans excepted from discharge under § 523(a)(8)(B) would be no more than a subset of such loans already excepted from discharge under § 523(a)(8)(A)(ii).”).

So, now that you understand the grammatical history of section 523(a)(8)(A)(ii), don’t let those creditors try to cheat you by arguing your client’s private student loan is an “obligation to repay funds received as an educational benefit.” It isn’t.

Austin C. Smith is a litigator who focuses on discharging private student loans in bankrutpcy.Mr. Smith's article, The Misinterpretation of 11 USC 523(a)(8) (reposted on GetOutOfDebt.org), was foundational in articulating the proper scope and application of the student loan non-dischargeability provision of the Bankruptcy Code, and its arguments and reasoning have been adopted by bankruptcy courts all across the country.Mr. Smith's work on behalf of debtors and has been profiled by the Wall Street Journal, NPR, ABC News, The Financial Times, the National Law Journal, the American Bankruptcy Institute, and more.