Chapter 2 Section 523(A)(8): Treatment of Educational Debt under the Bankruptcy Code

• Jurisdiction: United States

Chapter 2 Section 523(A)(8): Treatment of Educational Debt under the Bankruptcy Code

Section 523(a)(8) of the Bankruptcy Code excludes public and private student loans from discharge in bankruptcy unless "excepting such debt from discharge ... would impose an undue hardship on the debtor or the debtor's dependents."⁸¹ The present statute is the product of a series of amendments to the Bankruptcy Code that roughly parallels the development of the modern student loan industry.⁸² This chapter begins with a brief introduction to the history of the statute, provides an in-depth analysis of the scope and coverage of the current statute, and concludes by examining the policy arguments used to support the nondischargeability of educational debt.

A. The Development of the Current Statute

Before 1976, educational loans were completely dischargeable in bankruptcy. The first provision restricting the discharge of educational loan debt appeared in 1976, when the former Bankruptcy Act was amended to make most government-backed student loans nondischargeable for a period of five years after the date the loan first became due.⁸³ During this five-year period, student loans continued to be dischargeable if disallowing the discharge would impose an undue hardship on the debtor or the debtor's dependents.

When the Bankruptcy Code was adopted in 1978, these provisions were carried forward, and the five-year provision was expanded in 1979 to apply to any educational loan funded, made, insured or guaranteed by a governmental unit or funded by a "nonprofit institution of higher education."⁸⁴ In 1984, the statute was amended to include private student loans funded or guaranteed by a governmental or nonprofit entity.⁸⁵ Congress increased the five-year limit to seven years in 1990.⁸⁶ The seven-year rule was eliminated completely in 1998, leaving undue hardship as the only avenue for the discharge of most educational debt.⁸⁷ The most recent amendment to the statute came in 2005, when BAPCPA extended the application of § 523(a)(8) to "an obligation to repay funds received as an educational benefit" and "any other educational loan that is a qualified educational loan as defined in section 221(d)(1) of the Internal Revenue Code," making student loans originated by private lenders nondischargeable even when these loans are not backed by a governmental entity.⁸⁸

B. The Current Statute

In its present form, § 523(a)(8) excludes both public and private student loans from discharge in bankruptcy, subject only to an "undue hardship" exception. In its entirety, the statute now reads:

(a) A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt —

... (8) unless excepting such debt from discharge under this paragraph would impose an undue hardship on the debtor and the debtor's dependents, 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, incurred by a debtor who is an individual....

By its terms, § 523(a)(8) applies to all cases filed under chapters 7, 11, 12 or 13 of the Bankruptcy Code and prevents an individual debtor from discharging most types of education debt absent a showing of undue hardship.

The broad scope of the present statute places a heavy emphasis on the debtor's ability to prove undue hardship.⁸⁹ However, several preliminary considerations may allow the debtor to exclude some obligations from the operation of the statute and discharge these debts without reference to undue hardship. First, not every obligation is considered a loan or an "educational benefit" for purposes of § 523(a)(8). Second, although § 523(a)(8) applies to educational loans from most sources, it does not apply to loans from every possible source. These initial questions of scope may excuse some debts from the operation of § 523(a)(8).

1. Obligations Within the Operation of § 523(a)(8)

Four broad categories of debts are made nondischargeable by the three subsections of § 523(a)(8).⁹⁰ First, § 523(a)(8)(A)(i) applies to an "educational benefit overpayment or loan made, insured, or guaranteed by a governmental unit." Second, the same subsection also makes an overpayment or loan nondischargeable if "made under any program funded in whole or in part by a governmental unit or nonprofit institution." Third, § 523(a)(8)(A)(ii) excepts from discharge any "obligation to repay funds received as an educational benefit, scholarship, or stipend." Finally, § 523(a)(8)(B) excepts from discharge "any other educational loan that is a qualified educational loan" as defined in § 221(d)(1) of the Internal Revenue Code.

a. Section 523(a)(8)(A)

Section 523(a)(8)(A)(i) makes all federal loans nondischargeable, including Stafford loans, PLUS loans (Parent PLUS) and Consolidation loans.⁹¹ The phrase "governmental unit" also extends nondischargeability to any loan made, insured, guaranteed or funded by a state agency or other non-federal governmental entity.⁹² Section 523(a)(8)(A)(i) also applies to any loan funded by a nonprofit organization, a term that includes most educational institutions.⁹³ This subsection specifically applies to overpayments, in addition to loans.

Section 523(a)(8)(A)(ii) further extends nondischargeability to any obligation to repay funds received as an educational benefit, scholarship or stipend.⁹⁴

Because of the expansive language used in § 523(a)(8)(A), a long list of obligations is clearly included within its scope. The coverage of the statutory definitions is so broad that it has led the case law in surprising directions. For example, neither subsection of § 523(a)(8)(A) is limited to loans connected to post-secondary or higher education. This has led to arguments about the nondischargeability of private secondary school tuition,⁹⁵ a debtor's obligation to pay for tutoring services provided to her child,⁹⁶ and an unsecured line of credit used to pay for tuition and books for the debtor's children.⁹⁷

Despite the comprehensive nature of § 523(a)(8), debtors have still found ample room to argue that particular obligations are outside its scope. If the debtor prevails at this level of analysis, two major advantages result. First, the normal burden of proof in a student loan case is reversed in favor of the debtor. Although the debtor bears the burden of proof on undue hardship, it is clear that the "lender has the initial burden to establish the existence of the debt and that the debt is an educational loan within the statute's parameters...."⁹⁸ Second, if the court finds that the obligation is not within the coverage of § 523(a)(8), it will be discharged without any need for the debtor to reference the difficult body of law interpreting the concept of undue hardship.

The cases in this area fall into three broad categories. First, debtors have questioned whether the debt at issue is properly categorized as a loan. Second, debtors have contended that particular debts are not properly categorized as "educational." Finally, a growing number of decisions have addressed the debtor's argument that an obligation is excluded from § 523(a)(8)(A)(ii), typically because the obligation does not involve an "obligation to repay funds," is not connected to an "educational benefit," or because of a debate over the impact of amendments made by BAPCPA.

i. Is the Debt a "Loan"?

Courts have applied a common-sense approach when determining whether a loan exists, looking for "(i) a contract, whereby (ii) one party transfers a defined quantity of money, goods or services to another, and (iii) the other party agrees to pay for the sum or items transferred at a later date."⁹⁹ Under this definition, the debtor clearly incurs a loan by signing a promissory note, even when the funds are deposited into a student account and not transferred directly to the debtor.¹⁰⁰ This is true even when the promissory note evidences nothing more than a revolving credit arrangement that is effectively a credit card originated by the university.¹⁰¹

In McKay v. Ingleson,¹⁰² the debtor entered into a "Vanderbilt University Graduate and Professional Student Account and Deferment Agreement" that allowed her to purchase "educational services" through a revolving credit arrangement that was billed monthly on terms similar to a credit card. The debtor used this account to pay for tuition, activity fees and housing, and also made dining and "flexible spending" charges. The Ninth Circuit found that this agreement evidenced a loan, noting that the definition of a loan does not necessarily require an exchange of funds.

On the other hand, the "mere 'failure to pay a bill when due does not create a loan,'" even when the unpaid bill is owed to an educational institution.¹⁰³ Thus, a college that is owed unpaid tuition or another unpaid bill by a student/debtor does not hold a loan unless the college has extended credit or agreed to make a transfer of educational benefits in return for future payment.¹⁰⁴ For example, the Third Circuit has held that a debt for delinquent tuition was not a nondischargeable "loan" because the university had simply allowed a student to enroll after his federally guaranteed student loan was denied.¹⁰⁵

After McKay, a steady line of decisions has examined whether the debtor's obligation to repay tuition is a nondischargeable educational loan.¹⁰⁶ In In re Oliver, the court found that a tuition debt becomes a "loan if either (a) funds have changed hands from [the university], as lender, to Debtor, as borrower, or (b) there is an agreement reached prior to or contemporaneously with the transfer of educational services whereby...