CHAPTER 6, A. Arbitrability of Student Loan Dischargeability

• Jurisdiction: United States

A. Arbitrability of Student Loan Dischargeability

ABI Journal

August 2019

Amir Shachmurove

Troutman Sanders LLP

Washington, D.C.

In their first years of coexistence, the Bankruptcy Code and Federal Arbitration Act (FAA) rarely, if ever, intersected. As planned, the former provides many a debtor with a mechanism for the discharge of much burdensome debt.¹ Made less forgiving for debtors in 1990, 1998 and 2005, § 523(a)(8) of the Bankruptcy Code excepts any type of student loan, whether privately provided or federally backed, from such relief.²

Meanwhile, in the eyes of its defenders, arbitration promises a relatively economical resolution of commonplace disputes.³ This belief lies behind the expansion in the coverage of the FAA, effectuated by the U.S. Supreme Court in the 1980s and 1990s, that rendered claims founded on most federal statutory rights presumptively arbitrable by 2000.⁴ For a crucial two decades, then, the ambits of the FAA and Code, particularly § 523(a)(8), grew apace yet apart.

It was the modern explosion in this nation's student loan debt that finally led to the entanglement of the Code and FAA. Today, the issue of whether the FAA compels debtors to arbitrate the dischargeability of a debt under § 523(a)(8) divides dozens of bankruptcy courts. With each new report about the nation's student loan debt crisis,⁵ the stakes and fervor of this debate — not just for the debtors desperate to avoid arbitration and discharge their educational debts but also the creditors banking on repayment — only multiply.

Legal Landscape

Law of Arbitrability

Congress enacted the FAA in 1925 to counteract the judiciary's endemic aversion to arbitration.⁶ Pursuant to its second section's first clause (the "Command Clause"), the FAA pre-empts any state law in cases involving interstate contracts or maritime transactions.⁷ As written, this clause extends the FAA to more than the purely business-to-business accords that likely concerned Congress in the 1920s.⁸ Section 2's next clause (the "Savings Clause") permits any court to refuse to enforce an arbitration agreement on "such grounds as exist at law or in equity for the revocation of any contract."⁹

Beginning in 1985, the Supreme Court revivified the FAA's somnolent provisions. In several seminal opinions, successive majorities read the Command Clause as banning laws that prohibited arbitration outright,¹⁰ targeted arbitration agreements for unusually rigorous review,¹¹ or "frustrate[d]" realization of the FAA's apparent objectives.¹² Similarly tenacious majorities held that (1) the real possibility that a party might be saddled with prohibitive arbitration costs¹³ or (2) an implicit congressional aim to preclude waiver of judicial remedies for the relevant statutory rights would qualify as defenses under the Savings Clause.¹⁴

In accordance with Shearson/American Express Inc. v. McMahon, this "contrary congressional command" can only be found in a statute's text or legislative history or deduced from "an inherent conflict between arbitration and ... [its] underlying purposes."¹⁵ It was not until 2018's Epic Sys. Corp. v. Lewis decision did the Court even hint at McMahon's refinement by stating that requisite intention must be "clear and manifest."¹⁶

Law of Student Loan Dischargeability

Section 523(a) codifies numerous nondischargeable debts.¹⁷ The eighth subparagraph excepts obligations for an educational benefit, loan, scholarship or stipend.¹⁸ Today,¹⁹ these liabilities might only be discharged if their continued payment would "impose an undue hardship on the debtor and the debtor's dependents,"²⁰ as determined by a controversial-yet-longstanding standard.²¹ As the Code states, the adjudication of a debt's nondischargeability under § 523(a)(8) is a "core" proceeding.²²

Relevant Case Law: Bankruptcy's Modified McMahon Test

Logically, the metric established in McMahon as to all federal statutes²³ should govern the arbitrability of any dispute over § 523(a)(8).²⁴ By law and custom, however, bankruptcy courts exclusively look to McMahon's third factor: whether arbitration of this exception would create an inherent conflict with the Bankruptcy Code.²⁵ Two reasons explain this funneled approach.

First, the Code and its legislative history do not reveal any congressional intent to bar arbitration.²⁶ This fact renders the first two McMahon factors irrelevant, especially considering the courts' "healthy regard for the federal policy favoring arbitration."²⁷ Consequently, only "an inherent conflict between arbitration and the ... underlying purpose" of § 523(a)(8) can supply the prohibitory intent required under McMahon.²⁸

Second, beginning in 1997, two circuit panels (followed by numerous lower courts) modified the McMahon framework for use in bankruptcy cases.²⁹ Pursuant to this presently dominant approach, a bankruptcy court must compel arbitration of matters not involving "core" bankruptcy proceedings,³⁰ and only enjoys the "discretion to refuse to compel arbitration of core bankruptcy matters, which implicate more pressing bankruptcy concerns."³¹

In exercising this autonomy, a bankruptcy court must perform a "particularized inquiry into the nature of the claim and the facts of the specific bankruptcy."³² Only if it thereafter finds "that the proceedings are based on provisions of the ... Code that inherently conflict with the ... [FAA] or that arbitration of the claim would necessarily jeopardize the objectives of the ... Code" can it refuse to enforce an arbitration clause under the Savings Clause.³³ Based on this regnant rubric, because § 523(a)(8)'s adjudication constitutes a "core" proceeding, this conflict-centric analysis cannot be sidestepped.³⁴ Crucially, and seemingly by design, this inquiry aligns perfectly with the test imposed by McMahon as to the arbitrability of any federal statute with an opaque text and indeterminate history.

A Divided Judiciary

Majority

As to § 523(a)(8), most bankruptcy courts have found precisely such "a severe conflict"³⁵ based on two purposes.³⁶ First, a "main purpose" of the Bankruptcy Code, like its immediate predecessor, is "to aid the unfortunate debtor by giving him a fresh start."³⁷ The Code "contains broad...