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Exceeding the Cost of Attendance: A Case Study In Discharging Non-Qualified Education Loans

The following fact pattern is a compilation of several actual student loan adversary proceedings concerning debtors with “non-qualified education” loans. Names have been redacted to protect the innocent.

John Doe owed approximately $23,000 in debt to a private bank. In addition, John owed the federal government $20,000 in federal student loans. We analyzed our client’s private debt, and determined that all of the private loans made in excess of the “cost of attendance” and thus were not “qualified education loans” under the Bankruptcy Code.  Note that this does not require that all of the money exceed the “cost of attendance”—if one loan is partially within and partially without the “cost of attendance,” the entire loan is dischargeable because in order to be a “qualified education loan,” the debt must be solely made for qualified higher education expenses.

However, be careful about the timeline of origination. In this case, our client was eligible for $20,000 in qualified education loans in a certain year, and recieved $45,00 in total educational funding.  Well, which loans fall within the cost of attendance and which loans are in excess of the cost of attendance?  This question has never been addressed by any court, but common sense would suggest that the loans should be categorized on a “first in first out” accounting system.  Imagine the timeline as follows:

– Federal loan for $10,000 on August 15
– School scholarship  for $2,000 on September 1
– Private loan for $3,000 on September 15
– Federal loan for $10,000 on October 1
– Private loan for $20,000 on October 15

Obviously, the $20,000 private loan from October 15 was the last loan made, and was made after the debtor had already borrowed his total “cost of attendance.”  But what about the $3,000 private loan from September 15?  Technically, that was made before the debtor reached his borrowing limit and before the government loan for $10,000 on October 1—so was it a “qualified education loan”?

We argue no for two reasons.  First, we argue that the government always has priority.  It does not matter when they disbursed the money, because once the FAFSA application is filed, the government’s money is the “first” no matter when it was actually disbursed. So even though the government did not disburse the second loan for $10,000 until October 1, that loan should be treated as having been originated at the time the FAFSA application was approved (you can play here with the distinction between “originated” and “disbursed”). Second, the burden remains on the creditor to prove their loans are qualified.  Point being, you don’t have to prove the timeline is in your favor—the bank has to prove the timeline is in its favor. And since exceptions to discharge are to be construed narrowly against a creditor, any uncertainty should be resolved in your client’s favor.  Nonetheless, be prepared to address this issue with your adversary.

Back to the case.  The first thing we did was file a motion for summary judgment, seeking to get the debt discharged because the debts did not fall within any of the three subsections of 11 U.S.C. 523(a)(8) and thus were not presumptively non-dischargeable.  The bank responded arguing the opposite, and further arguing that under the “Purpose Test,” it did not matter how much money was lent, it was merely enough that the loans were used for educational purposes.

The court granted our motion for summary judgment in part and denied in part, ruling that whatever else the loans were, they were not “obligations to repay funds received as an educational benefit.”  The court further rejected the bank’s attempt to use the “Purpose Test” to transform what might be dischargeable debt into non-dischargeable debt.[1]  However, the court concluded that there remained a factual dispute about whether the loans were “qualified education loans” and set that issue for trial.

After that ruling, the pressure was really on the bank. The timeline of originations was still up in the air.  And further, the bank still had the stipulations in the promissory notes wherein our client had agreed that the funds were to be used only for qualified education expenses, but the court had not even bothered to address those arguments in its ruling on summary judgment.  As we had argued at the hearing, conclusions of law cannot be “stipulated to” by parties—only the court gets to decide whether a debt is a “qualified education loan.”  The judge seemed to agree with us on that point.

So now came the moment of truth.  Remember that banks also don’t like adverse opinions on this issue, because of the publicity they receive.  So they could either go to trial and try to prove the loans were qualified education loans and risk an adverse opinion or else simply concede the issue and write the debt off.  In the end, the bank remembered its Shakespeare: prudence is the better part of valor and agreed to discharge the entirety of the $23,000 in non-qualified education loans.  Case closed.

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[1] See, e.g., In re Dufrane, 2017 WL 1148172, at *8 (Bkrtcy.C.D.Cal., 2017) (“With respect to SunTrust’s argument that ‘[t]he purpose of the loan, not its use, controls whether the loan confers an educational benefit,’ the court agrees with Dufrane that ‘[t]he ‘Purpose Test’ restricts a federally-subsidized or qualified educational loan from degenerating into a non-qualified loan’ [and] ‘it cannot be used to elevate a non-qualified educational loan into a qualified educational loan.’”).