Student Debtors Notch Win in Fight to Wipe Out Debt in Bankruptcy

A recent Second Circuit decision is adding fuel to a growing momentum in the courts to allow borrowers to eliminate certain types of private lender-issued student loans in bankruptcy.

The U.S. Court of Appeals for the Second Circuit, siding with a student debtor, July 15 ruled that a private, direct-to-consumer loan fell outside the scope bankruptcy law’s definition of a student loan and can be wiped out in bankruptcy. The loan in question exceeded the cost of tuition and was issued directly to the borrower rather than going through the financial aid office.

Navient Corp., which purchased the Tuition Answer loan initially issued by Sallie Mae Inc., argued that it was an educational benefit”-one of three categories of student debt that cannot be discharged in bankruptcy without showing undue hardship.

Outstanding student loan debt totals about $1.7 trillion in the U.S. The type of private educational benefit loan the Second Circuit addressed is only a fraction of that total, but still could account for about $30 billion, said Jason Iuliano, an associate professor of law at the University of Utah. Other researchers estimate the total could top $50 billion, he said.

The Second Circuit’s decision marks the third such ruling from a federal appeals court, potentially giving rise to more legal challenges over the ability to wipe student loan debt in bankruptcy, researchers and consumer advocates say.

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

It shows people that, hey, student loan debt can be discharged in bankruptcy, he said. It might get them thinking: can we win these undue hardship cases? Is there more that can be done?

Presumptively Non-Dischargeable’

For nearly two decades, private loan servicers have capitalized on a widespread belief that the law blocks borrowers from eliminating any kind of student loan debt in bankruptcy. Read more