Are All Loans To Students Exempt From Discharge?

by Kent Anderson, Esq.

August 18, 2007

When unable to pay a loan, you may consider filing bankruptcy.  But what if the loan was in connection with school, a student loan or an educational loan?  When an educational institution provides consumer credit, it becomes a nondischargeable student loan in bankruptcy, or so it appears from a recent decision in United States Bankruptcy Court (McKay v Vanderbilt University, Adversary no. 07-3182-tmb) affirmed by US District Judge Garr King in an unpublished opinion.

During Spring term, 1997, Vanderbilt University extended to Elle McKay, a graduate student, an open-ended line of credit covering not only tuition and class fees, but the whole range of purchases and assessments payable to the University, including many consumer items which could be obtained from a private provider. At the time McKay filed for chapter 7 bankruptcy in 2003, Vanderbilt University claimed a total indebtedness of $38,250.53. But, the story does not end here.

Following discharge, Vanderbilt University resumed efforts to collect on the debt, and McKay brought an adversary action on the grounds that the contract in question was not a student loan within the meaning of  523(a)8 of the Bankruptcy Code, and should have been discharged.

The court ruled in favor of Vanderbilt University for the entire amount saying it was a student loan as considered by the laws on discharge.

In another unpublished opinion, the judge cited Roosevelt University vs. Oldham 220 B.R. 607, 612-13 (Bankr. N.D. Ill. 1998):   

the nature of the debt, if for some clear educational benefit to the debtor, should be the principal focus for determining whether the exception of   523(a)(8)(A) should apply. The court adheres to the view that the substance of the debt and what it was incurred for should control over the form in which the debt was created or structured.

With respect to the portion of the debt incurred for tuition and fees, the argument that this is a student loan within the meaning of the bankruptcy act seems unimpeachable.

Expanding the definition of student loan, and the protection provided by bankruptcy law, to include a private University’s blanket extension of credit for all services provided by the University, including purchases made at a University bookstore which (if typical) offered a wide range of consumer goods represents a very troubling development.

Presumably this student could have obtained a standard credit card and used it for the same goods and services. The credit terms offered by Vanderbilt University (1.5% monthly “late fee” on unpaid balances) were not even particularly favorable.

The practice of allowing – nay, encouraging – students living on campus to use University-issued plastic for living expenses and consumer purchases is rampant. If the Vanderbilt University example is at all typical, it confers no particular benefit upon the student and may be resulting in nontrivial profit to the University both in interest collected and discouraging competition.

A University in the consumer credit business certainly does not deserve more protection in bankruptcy than a private corporation offering essentially the same service.

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I was admitted to practice in 1978. I am certified as a Consumer Bankruptcy Specialist by the American Board of Certification. I regularly speak on tax and bankruptcy issues at state, regional and national conferences. Years of experience in practice before the Internal Revenue Service and Oregon Department of Revenue have given me the background to resolve a large variety of consumer tax issues.

Last modified: May 31, 2013