A long-standing rule on bankruptcy and student loans just got turned on its head in the Fifth Circuit. The case surrounds two individuals who filed for bankruptcy, one in Texas and another in Virginia. One obtained a $15,000 loan from a Sallie Mae subsidiary to fund his bar exam preparation, while the other took out around $11,000 for tuition and expenses at a technical school.
When they filed for Chapter 7 bankruptcy, both were given notice that most of their debts had been discharged - but not their student debt. When the loan servicer sought repayment, both borrowers filed adversary proceedings seeking declarations that their student loans had been discharged.
Student loans ("educational benefits") are generally not dischargeable in bankruptcy unless the person can show "undue hardship." However, the borrowers in this case argued that the undue hardship exemption doesn't apply to private, for-profit loans. And the court agreed.
Exceptions to discharge in bankruptcy are usually interpreted narrowly, to preserve the "fresh start" bankruptcy is meant to afford. The court limited educational benefits to "conditional payments with similarities to scholarships or stipends." This meant the student loans at issue didn't qualify as exemptions because the repayment was always unconditional.
The court made sure to point out that this ruling applies only to loans discharged in the case's originating bankruptcy court - or at most, that judicial district - but it remains an important decision for other borrowers.
Student loan servicers and collectors will no doubt be looking at this ruling with apprehension. Although most will still view bankruptcy as a last resort, it would be an option for more who are struggling with their student loan debt. Will we see an increase in interest rates as a result? Or will other courts interpret the issue differently? This will certainly be a trend worth keeping an eye on.