Shocking Landmark Ruling on Private Student Loan Bankruptcy Discharge

Let’s hope that August 31, 2020, can be remembered as an important day in the fight to break student loan debtors free from the lifelong debt slavery of student loans.

The appeal court opinion in a case involving the discharge of Navient private student loans was McDaniel v. Navient. This case involved Navient Tuition Answer loans.

I’ll give specifics on this case lower down. You will also find a copy of the Appeal Court Opinion.

Some people may incorrectly think this celebration is about the ability for people to just walk away from their debt or get a free education. It’s not.

Bankruptcy plays an important role in a capitalist society and in fact, is a right specifically described in the U.S. Constitution.

Without the ability for people to discharge debts in a legal process, they would be shackled for life under crushing debt and never be able to get a fresh start.

It is important for people to get a fresh start after life-altering financial events like massive medical debts from an unexpected accident or illness, a financial breakup after divorce, natural disaster recovery, or economic disaster caused by external events.

The list of triggering events is almost endless but what they have in common is a list of external events that drastically alter the financial life of consumers and leave them unable to make ends meet.

In 2012 I began researching the issue of discharging private student loan debt in bankruptcy. From my research, it sure seemed like the common perceptions that private student loans could not be discharged in bankruptcy and what the rules said, was in conflict. Read this post and a year or so later I wrote this post.

The initial post in 2012 introduced me to a young lawyer, Jason Iuliano. What Iuliano found in his research was that “99.9 percent of student loan debtors in bankruptcy never attempt to get a discharge” in bankruptcy because they incorrectly believed private student loans were protected from a bankruptcy discharge.

And so began my interest in this topic with a number of posts over the years.

Iuliano and I connected back then and have stayed in touch ever since.

Iuliano’s work in the years since we initially met is growing in stature and importance. He’s frequently referenced in the court opinion.

Regarding this specific case, Iuliano said, “With this ruling, the Tenth Circuit dealt a major blow to the myth that student loans are never dischargeable in bankruptcy.

With a single ruling, Judge Holmes and the Tenth Circuit made billions of dollars of student loans dischargeable in bankruptcy. This decision is a major win for the millions of Americans who are struggling with educational debt.”

Iuliano has been instrumental in launching a new service, Lexria, to assist debtors to get their loans discharged in bankruptcy.

But on the shoulders of Iuliano stood attorney Austin Smith. Smith has been on the sharp end of the arrow in leading this effort to get courts to properly deal with private student loans.

In 2016 Smith wrote a post on the site, “Here is Why Your Private Student Loan May Able to Be Eliminated in Bankruptcy” where he presented some of the reasons it appeared Congress never intended all private student loans to be not dischargeable in bankruptcy.

Smith was a leader in McDaniel’s case. After the positive opinion issued by the Tenth Circuit, Smith told me, “15 years ago, the Supreme Corut made an off-hand remark that “student loans are presumptively non-dischargeable.”

And for 15 years, bankruptcy courts have treated that statement as an iron rule of law.

The Tenth Circuit has now finally said that statement wasn’t meant literally; it wasn’t a rule of law, it was a casual and generalized description of the law.

Hopefully, student debtors will get the same due process in bankruptcy as everyone else. Just cause its labeled a student loan doesn’t mean its non-dischargeable.”

History will never remember the sacrifice that Smith and Iuliano have made to push this appropriate recognition of private student loans in bankruptcy, forward. But I’m very proud to say I know them both.

Attorney Chad Van Horn looked at the recent opinion and added, “this is another chip away at the notion that any loan made by a traditional “student loan” lender is automatically protected from discharge. For too many years, student loan lenders have been taking advantage of debtors by not taking the time to discern between dischargeable vs. non-dischargeable loans taking the position that all loans made by them are dischargeable.”

Let’s Take a Look at the Court Opinion

I think Navient is probably going to fight back against this court ruling because they absolutely will not like the conclusion the opinion reaches.

But here are the facts from the issued opinion.

“The Bankruptcy Code excepts from discharge “an obligation to repay funds received as an educational benefit, ” unless doing so imposes undue hardship on the debtors and their dependents. 11 U.S.C. § 523(a)(8)(A)(ii). Plaintiffs Appellees Byron and Laura McDaniel claim that they discharged some private student loans in their Chapter 13 bankruptcy. Defendant-Appellant Navient Solutions, LLC (“Navient”), the loans’ creditor, moved to dismiss the McDaniels’ claim under Federal Rule of Civil Procedure 12(b)(6), contending that the loans are excepted from discharge under § 523(a)(8)(A)(ii). This case raises a question of first impression in this circuit: does an educational loan constitute “an obligation to repay funds received as an educational benefit, ” within the meaning of § 523(a)(8)(A)(ii)? 1 We conclude that it does not.”

“The McDaniels filed a voluntary Chapter 13 bankruptcy petition in 2009. They acknowledged that they had, among other debts, eleven accounts with Sallie Mae, owing about $200,000 on them. They categorized their debts to Sallie Mae as “[e]ducational. ” Aplt. ’s App., Vol. I, at 41–43 (Ch. 13 Pet., filed Dec. 24, 2009). It is undisputed that those Sallie Mae accounts covered six private student loans (“Tuition Answer Loans”) that Laura McDaniel had used to pay her college expenses.”

“The bankruptcy court confirmed the McDaniels’ amended Chapter 13 plan in 2010. In early 2015, the McDaniels certified that they had carried out all of their plan’s payments and obligations. According to the Trustee’s final report and account, the McDaniels had paid nearly $27,000 in principal towards Navient’s debt claims under their confirmed plan.”

“In March 2015, the bankruptcy court granted the McDaniels a discharge of their debts under 11 U.S.C. § 1328(a). Its brief order, however, did not identify which of their debts were thereby discharged. As relevant here, it simply stated that “[d]ebts for most student loans” were not discharged.”

“In June 2017, the McDaniels moved the bankruptcy court to reopen their case. After the court did so, the McDaniels filed a complaint against Navient, seeking 1) a declaratory judgment that their Tuition Answer Loans were discharged in bankruptcy, and 2) damages based on Navient’s collection activities on those loans in violation of 11 U.S.C. § 524(a). The McDaniels stated that the loans “were not ‘qualified education loans’” under 11 U.S.C. § 523(a)(8)(B) because they “were not made solely for the ‘cost of attendance’” at Laura McDaniel’s college.”

“Navient moved the bankruptcy court to dismiss the McDaniels’ complaint under Rule 12(b)(6), arguing 1) it is res judicata that their Tuition Answer Loans are excepted from discharge because their confirmed plan provided as much, and 2) the loans in any event are nondischargeable under 11 U.S.C. § 523(a)(8)(A)(ii) because they constitute “an obligation to repay funds received as an educational benefit.”

“Navient maintains next that these student loans are nondischargeable because, under 11 U.S.C. § 523(a)(8)(A)(ii), they constitute “an obligation to repay funds received as an educational benefit. ” We agree, however, with the bankruptcy court’s contrary view: viz., it is plain to us from the unambiguous language of § 523(a)(8)(A)(ii) that educational loans do not constitute such an obligation.”

“The bankruptcy court held that the McDaniels’ confirmed Chapter 13 plan did not decide whether their student loans are nondischargeable under 11 U.S.C. § 523(a)(8)(A)(ii) because it “did not specify one way or the other whether [those loans] were—or were not—discharged. ” Aplt. ’s App., Vol. III, at 605; see id. (“Nowhere in the Plan does it state the Tuition Answer Loans, or any of [the McDaniels’] student loans, were nondischargeable . . . . ”)”

“Finally, the bankruptcy court, applying the interpretative canon of noscitur a sociis, determined that the phrase “funds received as an educational benefit” does not include student loans because each of the terms in the series “educational benefit, scholarship, or stipend” signify conditional grants of money that generally need not be repaid by their recipients, whereas loaned money must be repaid.”

“As relevant here, the bankruptcy court’s reasoning is sound. It is clear to us that the statutory terms “obligation to repay funds received as an educational benefit” and “educational loan” mean separate things.”

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“If Congress had wanted the exception set forth in § 523(a)(8)(A)(ii) to cover student loans, we presume it would have used the term “educational loan” or an iteration thereof in that provision, just as it used the term in defining the scope of the exceptions in the statute’s adjoining subsections.”

“It is clear to us that when § 523(a)(8) refers to an “educational benefit, ” just like when normal speakers of English refer to things like a health benefit, unemployment benefit, or retirement benefit, it is using a definition of “benefit” that implies a “payment, ” “gift, ” or “service” that ordinarily does not need to be repaid. In re Crocker, 941 F.3d at 220 (observing that such a benefit “generally does not need to be repaid”); see Jason Iuliano, Student Loan Bankruptcy and the Meaning of Educational Benefit, 93 AM. BANKR. L.J. 277, 292 (2019) (noting that “the term [educational benefit] denotes conditional educational grants—i.e., educational funds that a student receives in exchange for agreeing to perform services in the future”) see also Am. Stores Co. & Subsidiaries v. Comm ’ r, 170 F.3d 1267, 1279–80 (10th Cir. 1999) (describing an employee plan wherein employees “may take the full amount of vacation for the current year at any time during the calendar year” but “must repay [any] advance vacation benefits [they received] if they terminate employment.”

“Indeed, if a person were to say that he is looking for a way to receive benefits so that he can attend college, we might reasonably infer that he is interested in educational benefits like the GI Bill—not in applying for private student loans.”

“When a student receives funds but is not in school, this is a[n] educational benefit overpayment. ”). Likewise, no normal speaker of English would say that mortgages are housing benefits or that automobile loans qualify as transportation benefits.”

“We, thus conclude that a student loan is not an educational benefit.”

“Navient nonetheless maintains that § 523(a)(8)(A)(ii) excepts the McDaniels’ Tuition Answer Loans from discharge. We reject all of its arguments as meritless and thus conclude that Navient fails to shoulder its burden of proving that the bankruptcy court’s construction of the statute was mistaken.”

“[T]he most important point is that not all student loans are excepted from discharge. . . . Unless an educational debt falls within one of these classifications [enumerated in § 523(a)(8)], it is dischargeable through the normal bankruptcy process.”

“In sum, we conclude that Navient’s arguments for reversal fail to withstand scrutiny. We, accordingly, uphold the bankruptcy court’s determination that the statutory exception to discharge set forth in § 523(a)(8)(A)(ii) does not cover the McDaniels’ Tuition Answer Loans.”