Many borrowers, lenders, and student loan administrators operate under the assumption that student loans are generally not dischargeable in bankruptcy, absent “undue hardship.” This notion may no longer be a clear rule, following a recent decision by the Fifth Circuit Court of Appeals. The court ruled that some private for-profit student loans can in fact be discharged without the borrower proving undue hardship. This move is all the more remarkable as private, for-profit student loans – including loans to cover growing tuition fees not covered by federal loans, refinancing loans, and consolidation loans – continue to be used more and more.

In Crocker et al. v. Navient Solutions, LLC, et al., one bankrupt debtor had previously obtained private for-profit loans to cover the costs of preparing for the bar exam, while the other debtor had used private for-profit loans to attend a technical school. Both debtors had completed Chapter 7 bankruptcy and received a discharge from debt. When the bankruptcy ended, the loan manager demanded repayment of the loans, believing that they had not been discharged. The debtors responded by filing adversarial proceedings seeking a declaration that their private education debt had been discharged.

Included in 11 USC § 523 (a) (8) are three categories of educational debt that are exempt from discharge in the absence of proof of undue hardship. The issue at issue in that case was the exemption provided for in § 523 (a) (8) (ii). The debtors urged the court to find that this exemption for “the obligation to repay funds received as an educational benefit, scholarship or allowance” does not include private for-profit loans; the court accepted.

In a complex process of statutory interpretation, the Fifth Circuit determined that the definition of the term “educational benefit” was limited to “conditional payments with similarities to scholarships and stipends”. In other words, education payments that are do not loans initially but the terms of which will create an obligation to repay in the event of failure of the terms of payments. The court noted that the most recent changes made by Congress to Section 523 (a) (8) did not indicate an intention to make private, for-profit student loans non-repayable. In this case, the loans of the bankruptcy debtors did not qualify for the exemption because their repayment was still unconditional.

Agents and debt collectors should be aware of the type of student loan involved before seeking to collect following the release of the borrower. If this legal trend continues, we should expect to see a corresponding increase in interest rates on private for-profit student loans, with lenders responsible for the increased risk of release.