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New York attorney Austin C. Smith writes an important article in the American Bankruptcy Institute under the heading The Misinterpretation of 11 U.S.C. 523(a)(8) suggesting that federal courts have been misapplying the student loan exception to discharge since 1990.
Section 523(8) of the Bankruptcy Code provides that bankruptcy does not discharge an individual debtor from any debt for:
(A)(i) 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; or
(B) any other educational loan that is a qualified education loan, as defined in section 221(d)(1) of the Internal Revenue Code of 1986.
Prior to the Bankruptcy Reform Act of 2005, private student loans were dischargeable in bankruptcy. The change in the bankruptcy law in 2005 was to add subsection (B) above to provide that a Qualified Education Loan as defined by Section 221(d)(1) of the Internal Revenue Code was excepted from discharge. In all other respects, the law remained the same.
The error federal courts are making, according to Smith, is when they deny discharge to private student loans because they are “educational benefits” under section A(ii) when in fact section A(ii) does not address private student loans. Section A(ii) existed prior to the reform act of 2005, so to claim that any loan that confers an educational benefit is excepted from discharge is to argue that private student loans were not dischargeable prior to 2005, and that simply is not the case.

The term “educational benefit” is being interpreted so broadly that it makes the addition of Section (B) unnecessary. Indeed, how could any private student loan not also be an educational benefit? Is not any loan to a student also a benefit to their education?

According to Smith, the courts have lost track of the history of 523(a)(8). In 1990 Congress amended the law to deny discharge to any obligation to repay an educational benefit, scholarship or stipend. The amendment was spurred by an 8th Circuit case of U.S. Dept. of Health and Human Services v. Smith in which the bankruptcy court discharged the debt of a medical student who accepted a scholarship on the condition that he work in a “physician shortage” location for a certain number of years. The law was amended in 1990 to prevent discharge of these conditional scholarships. The 1990 amendment prevented discharge for any debt:
 (a)(8) 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 for an obligation to repay funds received as an educational benefit, scholarship or stipend.
Smith argues persuasively that the 1990 amendment was never designed to protect loans. Conditional scholarships were the target of the 1990 amendment.

[A] growing number of courts have realized the difficulty of the resultant logic: Interpreting “educational benefit” to except from discharge any loan that in any way facilitates education renders the remaining provisions of the statute meaningless. If any money lent to any person for any educational purpose is protected, then the remaining provisions of § 523(a)(8) — provisions carefully crafted to protect federally insured loans, nonprofit loans and other loans qualified by the IRC — become superfluous.”

What is a Qualified Educational Loan under Internal Revenue Code 221(d)(1)?
A QEL is “any indebtedness incurred by the taxpayer solely to pay qualified higher education expenses. The term “qualified education expenses” is defined as “the cost of attendance at an eligible educational institution.” Cost of attendance is “tuition, books, and a reasonable allowance of room and board as defined by the institution.” Private loans in excess of this limit are not “qualified” (i.e., they may not be taken as deductions on a tax return) and they are not protected from the bankruptcy discharge.
The problem is, federal bankruptcy courts are, according to Smith, bypassing the required tax analysis demanded by IRC 221(d)(1) and just declaring private loans nondischargeable educational benefit.
The most extreme example of this misapplication of the student loan discharge law in found in the case of Carrow v. Chase Loan Serv., 2011 Bankr. Lexis 823 (Bankr. N.D. 2011). Despite the fact that the debtor received the maximum federal loan amount for which she was eligible and thus all the private loans issued by Chase Bank could not be certified because they were beyond the debtor’s eligibility, the court nevertheless declared the debts to be nondischargeable because they were clearly an “educational benefit.”
Contrast the Carrow opinion with the opinion of the 7th Circuit in case of In re Oliver, 499 B.R. 617 (7th Cir. 2013). In that case the 7th Circuit held that a debtor’s failure to repay tuition did not constitute a qualified educational loan and therefore ruled the tuition debt discharged. The bankruptcy court for the Northern District of California made a similar decision recently. Inst. of Imaginal Studies v. Christoff, 310 B.R. 876, (N.D. Cal. 2014).
The Take Away:
Bankruptcy attorneys need to spend more time determining whether the private loans their clients are facing are Qualified Educational Loans under IRS 221(d)(1) and, if not, bringing Adversary Proceedings to determine whether those debts are excepted from the bankruptcy discharge. Special attention must be paid as to whether the private loans exceed the school’s certified cost of attendance.
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