Student Loan Bankruptcy Discharge Ruling May Signal Big Boon to Borrowers

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Even since a major reform of the bankruptcy laws in 2005, discharging private student loans through bankruptcy has been very difficult if not almost impossible. But on Aug. 31, 2020, a court affirmed the cancellation of nearly $200,000 in student debt for a Colorado couple.

Although student loan bankruptcy discharge is still tough to achieve, this important case – McDaniel versus Navient – could represent a loosening of restrictions.

Filing for bankruptcy with student loans

After earning undergraduate and graduate degrees, Laura Paige McDaniel was left struggling to repay $120,000 in student loans. McDaniel said her loan servicer Navient was unwilling to work with her to work out affordable payments on her loans, according to a Forbes report.

McDaniel and her husband eventually filed for Chapter 13 bankruptcy. But her private student loans weren’t canceled, and Navient added tens of thousands of dollars of interest to her debt, causing it to balloon to nearly $200,000.

The McDaniels petitioned the court to reopen the bankruptcy case, and it ultimately ruled in favor of canceling their student loans. Student loan servicing giant Navient then appealed the court’s decision, but it ultimately lost when the U.S. Court of Appeals for the 10th Circuit affirmed the original ruling.

Finding a way past the Brunner Test

In most cases involving bankruptcy and student loans, a borrower has to pass the Brunner Test, which requires they prove their loans cause “undue hardship.” It can be difficult to meet the legal definition of undue hardship, and the costs involved in going to court deter many borrowers from trying in the first place.

In McDaniel versus Navient, however, the judge ruled that McDaniel did not need to prove undue hardship, since the loans weren’t used only for her school’s cost of attendance, according to the court’s published opinion.

“The bankruptcy court held that the borrower’s private student loans were not ‘an obligation to repay funds received as an educational benefit’ within the meaning of the bankruptcy code because they ‘were not made solely for the cost of attendance’ at the borrower’s school,” student loan lawyer Adam Minsky – who reported on the case for Forbes – told Student Loan Hero.

In other words, Minsky said, these specific student loans “were not covered by the bankruptcy code’s discharge exceptions for student debt.”

The door to bankruptcy discharge opens, even if only slightly

While this ruling doesn’t change the laws around student loan discharge through bankruptcy, it may set a precedent offering a way to discharge private student loans in the future, particularly for loans that exceeded the cost of attendance at a school or that were used at a non-accredited institution.

At the moment, however, it only applies to a small jurisdiction.

“In terms of precedent, the ruling is only binding for the jurisdiction of the 10th Circuit, and it pertains to what effectively is a relatively small portion of private student loans,” Minsky said. “But, it’s still a potentially important decision and could be cited in future bankruptcy cases.”

 

Published in News & Policy