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Second Circuit Holds Private Student Loans Dischargeable in Bankruptcy

Graduation cap on table of $100 bills
By Joseph Fawbush, Esq. | Last updated on

It is well-documented how notoriously difficult it is for student borrowers to discharge federal student loans. For students who take out private loans, however, the news may be getting better. On Thursday, July 15, the Second Circuit Court of Appeals sided with student borrowers in a class-action lawsuit, holding that private student loans can be discharged in a Chapter 7 bankruptcy. The Second Circuit joins the 5th and 10th Circuits in interpreting bankruptcy law to allow the discharge of private student loans.

Unclear Language in Bankruptcy Case

Hilal Homaidan filed the lawsuit on behalf of student borrowers. In 2009, Homaidan successfully obtained a discharge through Chapter 7 bankruptcy. However, the discharge was not clear about his private student loans. Navient, the massive student lender, sought to recover the debt. Eventually, Homaidan paid it off but reopened his bankruptcy case to clarify the legal obligation he had and open up a path for the lawsuit against Navient.

Under bankruptcy law, borrowers have “an obligation to repay funds received as an educational benefit" that cannot be discharged in bankruptcy. Navient argued that this statutory language covers private student loans. Homaidan argued that Navient intentionally provides loans to unsophisticated student borrowers and then demands repayment even after those loans are discharged in bankruptcy.

An Unconventional Way to Discuss a Loan

Both the district court and the federal appeals court agreed with Homaidan. According to the unanimous panel decision, the statutory text says that funds are not dischargeable if they are “an obligation to repay funds received as an educational benefit, scholarship, or stipend." The text does not mention a loan. According to Circuit Judge Dennis Jacobs, this is “an unconventional way to discuss a loan." If Congress had meant to include private student loans in this category, it would have done so in less “stilted terms."

Help for Underwater Borrowers?

The decision should be welcome news for the millions of student borrowers struggling under massive debt. All three federal appeals courts to have taken on the issue have agreed that bankruptcy law does not prohibit the discharge of private student loans. According to Reuters, even Navient, the defendant in the case, has publicly stated that it supports bankruptcy reform to allow the discharge of both federally-backed and private student loans in bankruptcy. Certainly, students who are struggling to pay the increasing costs of tuition understand the issue. LendingTree notes that students borrowed over $100 billion for the 2019-20 academic year, with 14% of that involving private loans.

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