The situation: On Homaidan v. Sallie Mae, Inc., et al., The US Court of Appeals for the Second Circuit recently stated that certain types of private student loans are not “mandatory[s] to repay funds received as educational benefit, scholarship or stipend “that are exempt from discharge in the event of bankruptcy in the absence of undue hardship.

The result: This decision aligns the Second Circuit with the Fifth and Tenth Circuits on this issue. However, neither the Bankruptcy Court decision below nor the Second Circuit decision on appeal determined the circumstances under which loans can be canceled in bankruptcy pursuant to 11 USC § 523 (a) (8) ( A) (i) or 523 (a) (8) (B).

Looking to the future: Private student loans can still be canceled under Section 523 (a) (8) (A) (i) or 523 (a) (8) (B) as “qualified student loans,” which the court in Homaidan I do not consider. However, following the COVID-19 pandemic, bankruptcies involving outstanding and past-due student loan debt are likely to increase, and this precedent aligns the Second Circuit with the Fifth and Tenth Circuits and could lead to further disputes over whether those debts can be canceled. Discharged. And on August 2, 2021, the bipartisan NEW BEGINNING through the Bankruptcy Act of 2021 it was announced for presentation in the Senate. This proposed legislation is intended to assist distressed borrowers by amending the provisions of the Bankruptcy Code governing the cancellation of student loans. Market participants must continue to monitor these developments.

On July 15, 2021, a three-judge panel of the U.S. Court of Appeals for the Second Circuit held at Homaidan v. Sallie Mae, Inc., et al.. that the private student loans in question were not subject to the liquidation exemption in Section 523 (a) (8) (A) (ii) of the Bankruptcy Code for “obligation[s] to repay the funds received as an educational benefit. “In the following case before the Bankruptcy Court, the defendant lender and servicer (hereinafter,” lender “) moved to dismiss an adversarial proceeding initiated by a Chapter bankruptcy debtor 7 alleging that the lender violated a bankruptcy annulment order by accepting repayment of private student loans that were, in fact, annulled because they covered more than qualified education expenses. Defendant argued that the loans were exempt from annulment The Bankruptcy Court considered the exemption to annul the obligation[s] to repay funds received as an educational benefit “under Section 523 (a) (8) (A) (ii) of the Bankruptcy Code and determined that it” does not sweep away all education-related debts, “including student loans in Therefore, the defendant’s motion for dismissal was denied, and the Second Circuit granted an interlocutory appeal and affirmed.

The second circuit decision

Like the Bankruptcy Court, the Second Circuit relied largely on the plain language of the relevant legal text, which exempts from discharge, among others, the “obligation[s] to reimburse funds received as an educational benefit, scholarship, or stipend. “Decision at 9; See also 11 USC § 523 (a) (8) (A) (ii). The defendant lender’s only argument in its motion to dismiss was that the plaintiff’s private student loan was an “educational benefit” under Section 523 (a) (8) (A) (ii). However, the defendant reserved the right to address the plaintiff’s assertions that the loans were not “qualified educational loans.[s]”under Section 523 (a) (8) (B) at a later point in the litigation.

The Second Circuit concluded that Section 523 (a) (8) (A) (ii) cannot be interpreted to include “loans” where that specific word was used in related provisions and specifically absent from the governing subpart. The court also noted that it could not adopt the defendant’s broad interpretation of the provision: “according to which any loan is not dischargeable under Section 523 (a) (8) (A) (ii) if it is used to promote the education of a person “[as it] would take out virtually all student loans within “the exemption. This, according to the court, would make the Section 523 (a) (8) (A) (i) and 523 (a) (8) (B) exemptions not Therefore, the phrase “educational benefit” was limited by the court to align with the terms “scholarship” and “stipend” also specified in Section 523 (a) (8) (A) (ii). Because the appeal stemmed from a decision on a motion to dismiss, the court did not reach a conclusion as to whether the plaintiff’s loan was effectively canceled in his bankruptcy and returned the case to the Bankruptcy Court for further proceedings.

Impact on future litigation

The Second Circuit’s decision does not fully clarify the rules surrounding the cancellation of student loans. In fact, the court did not consider whether the private student loans in question are “qualified educational loans.[s]”and therefore is not subject to forgiveness pursuant to Section 523 (a) (8) (B). Furthermore, the decision does not at all involve public student loans, which are exempt from forgiveness in absence of determinations that the payment of the debt would cause the debtor “difficulties”. Thelma G. McCoy vs. United States, a plaintiff recently petitioned the United States Supreme Court for a writ of certiorari to resolve a circuit division regarding the appropriate test to assess “undue hardship.” However, in June 2021, the Court denied the petition, leaving the circuit division intact and opening the door to continued inconsistent rulings.

Four key takeaways

  1. Homaidan contends that the private student loans in question are not “mandatory[s] to repay … educational benefits “, which are not dischargeable in bankruptcy. However, Homaidan did not consider the forgiveness of private student loans as a “qualified student loan[s]”under Section 523 (a) (8) (B).
  2. Future litigants can use the other provisions in 11 USC § 523 (a) (8) to argue that an educational debt is forgivable.
  3. The Second Circuit’s decision to align with the Fifth and Tenth Circuits may lead additional borrowers, including those affected by the COVID-19 pandemic, to request forgiveness of their student loans.
  4. Market participants should also monitor developments related to the FRESH START Through Bankruptcy Act of 2021 and any other proposed legislation that, if enacted, would modify the Bankruptcy Code provisions governing the cancellation of student loans.

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