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When are Private Student Loans Discharged in Bankruptcy?

The one thing everyone knows about bankruptcy is that student loans are not discharged. Prior to 2005, non-dischargeable student loans were loans guaranteed by the government or provided by not-for-profit educational institutions. But as part of the changes made to the bankruptcy code in 2005 (known as "BAPCPA"), private student loans were included in this non-dischargeability definition.

I regularly receives inquiries as to whether this or that private training loan is dischargeable in bankruptcy. In this blog I will go through the statute step-by-step to show what is the definition of a non-dischargeable student loan.

Here is the actual text of the bankruptcy code prior to the 2005 changes: Section 523(a)(8) states that a debt is not discharged in bankruptcy if it is "for an educational benefit overpayment or loan made, insured or guaranteed by a governmental unit, or made under any program funded in whole or in part by a governmental unit or nonprofit institution".

Debts could be discharged if "excepting such debt from discharge under this paragraph would impose an undue hardship on the debtor and the debtor's dependents", but that hardship discharge is very very difficult to obtain.

In 2005, the definition of a non-dischargeable student loan was expended, to include "any other educational loan that is a qualified education loan, as defined in section 221(d)(1) of the Internal Revenue Code of 1986." (11 USC Section 523(a)(8)(B).) In other words, private student loans.

The bankruptcy code basically shifts to the Internal Revenue Code the definition of private student loans, and to nail down the definition one must wade through a cascade of IRS definitions. In summary, a non dischargeable private student loan is (1) a 'qualified education loan' incurred solely to pay (2) 'qualified education expenses', which are (3) the 'cost of attendance' at a (4) 'qualified educational institution'.

But be warned, even if you follow through all these definitions, which I set forth in detail below, you may find a bankruptcy judge that might find the private loan non-dischargeable by way of an alternative theory: that it is for an 'educational benefit' - but more on that at the end of this blog.

Before filing a Chapter 7 case, a debtor with private student loans should have those loans examined very carefully by an experienced bankruptcy practitioner. For more information on filing chapter 7, see my website.

(1) For starters, how does Section 221(d)(1) of the Internal Revenue Code define a 'qualified education loan'? That section states that a 'qualified education loan' is one incurred solely to pay 'qualified education expenses'. 

Here is the full text of 26 USC Section 221(d)(1): "Definitions: For purposes of this section - (1) Qualified education loan; The term "qualified education loan" means any indebtedness incurred by the taxpayer solely to pay qualified higher education expenses - (A) which are incurred on behalf of the taxpayer, the taxpayer's spouse, or any dependent of the taxpayer as of the time the indebtedness was incurred, (B) which are paid or incurred within a reasonable period of time before or after the indebtedness is incurred, and (C) which are attributable to education furnished during a period during which the recipient was an eligible student. Such term includes indebtedness used to refinance indebtedness which qualifies as a qualified education loan. The term "qualified education loan" shall not include any indebtedness owed to a person who is related (within the meaning of section 267(b) or 707(b)(1)) to the taxpayer or to any person by reason of a loan under any qualified employer plan (as defined in section 72(p)(4)) or under any contract referred to in section 72(p)(5)."

(2) So, what constitutes 'qualified education expenses? That is described in the next paragraph of the Internal Revenue Code. IRC Section 221(d)(2) states that a 'qualified higher eductaion expense' is the 'cost of attendance' at an 'eligible educational institution.'

The full text of 26 USC Sect. 221(d)(2): "Qualified higher education expenses - The term "qualified higher education expenses" means the cost of attendance (as defined in section 472 of the Higher Education Act of 1965, 20 U.S.C. 108711, as in effect on the day before the date of the enactment of the Taxpayer Relief Act of 1997) at an eligible educational institution, reduced by the sum of - (A) the amount excluded from gross income under section 127, 135, 529, or 530 by reason of such expenses, and (B) the amount of any scholarship, allowance, or payment described in section 25A(g)(2). For purposes of the preceding sentence, the term "eligible educational institution" has the same meaning given such term by section 25A(f)(2), except that such term shall also include an institution conducting an internship or residency program leading to a degree or certificate awarded by an institution of higher education, a hospital, or a health care facility which offers postgraduate training."

OK, now we need two more definitions: 'cost of attendance' and 'qualified educational institution.' One at a time, please.

(3) The Internal Revenue Code defines 'cost of attendance' as basically tuition, fees, books, equipment, room & board, and miscellaneous personal expenses as determined by the school.

Here is the statutory text of 20 USC Sect. 108711: "Cost of attendance: For the purpose of this subchapter and part C of subchapter I of chapter 34 of title 42, the term "cost of attendance" means (1) tuition and fees normally assessed a student carrying the same academic workload as determined by the institution, and including costs for rental or purchase of any equipment, materials, or supplies required of all students in the same course of study; (2) an allowance for books, supplies, transportation, and miscellaneous personal expenses, including a reasonable allowance for the documented rental or purchase of a personal computer, for a student attending the institution on at least a half-time basis, as determined by the institution; (3) an allowance (as determined by the institution) for room and board costs incurred by the student which - (A) shall be an allowance determined by the institution for a student without dependents residing at home with parents; (B) for students without dependents residing in institutionally owned or operated housing, shall be a standard allowance determined by the institution based on the amount normally assessed most of its residents for room and board; (C) for students who live in housing located on a military base or for which a basic allowance is provided under section 403(b) of title 37, shall be an allowance based on the expenses reasonably incurred by such students for board but not for room; and (D) for all other students shall be an allowance based on the expenses reasonably incurred by such students for room and board"

(4) And what is an 'qualified educational institution'? Basically that is a post-secondary school authorized to participate in the U.S. Department of Education Student Loan program. The formal definition is found in 26 USC 25A(f)(2): "Eligible educational institution - The term "eligible educational institution" means an institution - (A) which is described in section 481 of the Higher Education Act of 1965 (20 U.S.C. 1088), as in effect on the date of the enactment of this section, and (B) which is eligible to participate in a program under title IV of such Act."

Page 37 of IRS publication 970 describes an eligible educational institution as "any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the U.S. Department of Education. It includes virtually all accredited public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions. The educational institution should be able to tell you if it is an eligible educational institution."

So, again, a non-dischargeable private student loan is (1) a 'qualified education loan' incurred solely to pay (2) 'qualified education expenses', which are (3) the 'cost of attendance' at (4) a 'qualified educational institution'. There are very few bankruptcy court cases on this definition. Here are three:

Wills v. Sallie Mae; (Bankruptcy Court S. D. Ind. 4-23-2010; Case #08-80404, Adversary Proceeding #08-58043; decision April 23, 2010 (see paragraph #20, on page 13, of this opinion.)

Noland v. Iowa Student Loan Liquidity Corp.
(Bankruptcy Court D. Neb. Case #09-80873, Adversary proceeding #09-8048; decision March 30, 2010

Carow v. Chase Student Loan Service
; (Bankruptcy Court D. N.D. Case #10-30264, Adversary proceeding #10-7011; decision March 2, 2011

Now, in case the debtor escapes all these definitions, there is an alternative argument the lender may make, that the loan is non-dischargeable as an 'educational benefit.' Even before the BAPCPA changes of 2005, the definition of a non-dischargeable student loan included "an obligation to repay funds received as an educational benefit, scholarship or stipend."

In one post-2005 case, a bankruptcy judge has said that a private student loan is just such an educational benefit, even if it doesn't meet all the requirements of IRC 221(d()1): In re Baiocchi; 389 B.R. 828 (Bankr. E. D. Wis. 2008).

The Baiocchi argument goes like this: prior to 2005, 11 USC 523(a)(8), the student loan exception to discharge, read like this:

"for an educational benefit overpayment or loan made, insured or guaranteed by a governmental unit, or made under any program funded in whole or in part by a governmental unit or nonprofit institution, or an obligation to repay funds received as an educational benefit, scholarship or stipend"

After 2005, the paragraph was reset to read like this:
"(A)(i) for an educational benefit overpayment or loan made, insured or guaranteed by a governmental unit, or made under any program funded in whole or in part by a governmental unit or nonprofit institution, or

(ii) an obligation to repay funds received as an educational benefit, scholarship or stipend
"

The text is identical, but the paragraph has been split. By separating the old paragraph into two new sub-paragraphs, the section now "must be read as encompassing a broader range of educational benefit obligations..." Baiocci 389 at 832.

Why this stylistic change 'must be' read as broadening the statute is not explained, but three other courts have followed this reasoning.

In re Roy; Bankr. D. N.J. Bk #08-33318; AP #098-1406; 4/8/2010
In re Skipworth; Bankr. N. D. Ala. Bk 09-83982; AP #09-80149; 4/1/2010
In re Carrow; Bankr. D. N.D. Bk #10-30264; AP #10-7011; 3/2/2011

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