Student Debtors Win in Bankruptcy Debt Fight

A recent Second Circuit ruling is fueling growing momentum in the courts to allow borrowers to eliminate certain types of student loans issued by private lenders in the event of bankruptcy.

The United States Court of Appeals for the Second Circuit, siding with a student debtor, July 15 ruled that a private direct consumer loan did not fall within the scope of the definition of “student loan” in bankruptcy law and could be canceled in the event of bankruptcy. The loan in question exceeded the tuition fee and was issued directly to the borrower rather than going through the financial aid office.

Navient Corp., which purchased the “Tuition Response” loan originally issued by Sallie Mae Inc., argued that it was an “educational benefit” – one of three categories of debt. studies which cannot be discharged in the event of bankruptcy without presenting undue hardship.

The outstanding student debt is approximately $ 1.7 trillion in the United States. The kind of private “educational benefits” loan that Circuit 2 discussed is only a fraction of that total, but could still be around $ 30 billion, said Jason Iuliano, associate professor of law. at the University of Utah. Other researchers estimate the total could exceed $ 50 billion, he said.

Second Circuit ruling marks third such ruling by a federal appeals court, which could lead to more legal challenges over ability to write off student loan debt in bankruptcy, researchers say and consumer advocates.

the Fifth and Tenth The circuits reached similar conclusions. All three involved Navient’s pursuit of loan repayments after the borrowers successfully emerged from bankruptcy and were discharged of their debts.

“It hits me like falling dominoes,” said Iuliano, who studies bankruptcy and student loans.

“This shows people that, hey, student loan debt can be released from bankruptcy, ”he said. “It might get them thinking: can we win these undue hardship cases? Is there more to do? “

Navient is exploring his legal options, according to spokesman Paul Hartwick.

“Presumption not releasable”

For nearly two decades, private loan managers have capitalized on a widespread belief that the law prevents borrowers from eliminating any type of student loan debt in bankruptcy.

That means borrowers who continued to pay off their student loan debt after filing for bankruptcy may have paid back “tens of millions” of dollars they didn’t really owe, Iuliano said.

“Bankruptcy lawyers and individuals assumed that all private student loans, taken out for any purpose, were deemed non-dischargeable,” said Pamela Foohey, professor at the Cardozo School of Law at Yeshiva University .

“I expect this ruling to inspire litigation in the remaining circuits that have yet to rule in the same way regarding private student loans,” she said.

In most cases, borrowers can only pay off student loans in bankruptcy if they can prove that repayment would cause “undue hardship,” a very high standard to meet, said Richard M. Alderman, director of the Bankruptcy. Center for Consumer Law at the University of Houston. Center of Law.

This standard applies to three types of student debt: government guaranteed student loans, including federal loans and loans from certain non-profit institutions; private loans that meet IRS criteria, such as not covering more than the cost of attending an accredited institution where students can obtain federal student aid; and funds received as an “educational benefit, scholarship or allowance”.

The Second Circuit ruled that Hilal Homaidan’s loans were not an “educational benefit” obligation, as Navient argued. The term “educational benefit” refers closely to conditional grant payments similar to scholarships and stipends, and does not encompass all private loans, the court said.

To better ensure repayment, most private lenders today distribute educational loans directly to the institution, or at the very least have a school certify that it is a qualified student loan, according to Scott Buchanan. , executive director of the Student Loan Servicing Alliance, a nonprofit trade association.

The types of loans involved in the Navient business “haven’t been granted for a decade,” he said.

Boom in private loans

Homaidan took out the loans between 2003 and 2007, when private lenders encouraged students to borrow more than the cost of tuition.

“There has been a great boom in private student loans during this time,” said Geoffry Walsh, an attorney at the National Consumer Law Center who focuses on consumer bankruptcy. Private lenders have encouraged students to borrow above “eligible expenses” such as tuition and room and board, he said.

Some say this type of private loan is now stronger than ever. Last year, a coalition of consumer advocates led by the Student Borrower Protection Center warned federal regulators of “operating loan and credit products” from private lenders that have been marketed to resemble student loans.

“We’ve actually seen more of this type of product released recently,” said Cody Hounanian, program director at Student Debt Crisis, a non-profit organization dedicated to student debt reform.

The Second Circuit ruling, however, “further solidifies the position that not all private student loans are exempt from discharge under bankruptcy law,” Alderman said. “This is a substantial advantage for some student borrowers. “

“It could also inspire a restructuring of the private student loan market,” Foohey said.

It is not known how many private loans are used by borrowers to pay for things other than higher education expenses, she said.

Private lenders can now ensure that they structure student loans so that no part “can be considered to be used for anything other than qualifying education expenses,” she said.

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