Bankruptcy and Education Benefits

As student debt increases and more students file for bankruptcy, a major issue in these actions is the definition of an “educational benefit”. Under current bankruptcy law, similar to the non-dischargeability of student loans, an educational benefit is also non-dischargeable.

Pursuant to 11 U.S.C. sec. 523(a) of the Bankruptcy Code:

A discharge under Section 727…of this title does not discharge an individual debtor from any debt- (8) for an educational benefit overpayment or loan made, insured or guaranteed by governmental unit, or made under any program funded in whole or in part by a governmental unit or non-profit institution, or for an obligation to repay funds received as an educational benefit, scholarship or stipend, unless excepting such debt from discharge under this paragraph will impose an undue hardship on the debtor and the debtor’s dependents.

In other words, an educational benefit made available to the student by either the government or an institution may be non-dischargeable in bankruptcy depending on the definition of “educational benefit”. In a case in the U.S. Bankruptcy Court of New York, the Court ruled against a student arguing that payments made to New York University on her behalf by the New York City Board of Education were dischargeable under the Bankruptcy Code.

Melissa Mehlman (Mehlman) was accepted to the New York University, New York City Board of Education(the Board) approved, Master’s Program in Occupational Therapy. She applied to the Board’s Incentive Program in March 1996. Mehlman was selected as a recipient and signed a contract accepting the award. The Scholarship award document stated in relevant part:

The scholarship being offered to you carries a service obligation of one school-year with the New York Board of Education for every year of scholarship assistance being provided.

Mehlman received the award for the next three semesters.

In 1998, Mehlman was removed from the New York University Occupational Therapist Program because she failed to successfully complete the fieldwork components of the Program. In July 2000, Mehlman was notified by the Board that she was required to repay $47,062.93 to the Board. In October 2000, Mehlman filed for bankruptcy, claiming, in addition to other claims, that the New York Board of Education Scholarship Program was not an “educational benefit” nor a “student loan” as defined by the Bankruptcy Code and therefore was a dischargeable debt.

The Bankruptcy Court ruled against Mehlman. The Judge reasoned that Mehlman’s argument that the Code does not apply when there is a societal or legal objective served by the scholarship program is not supportable by any reasonable interpretation of the Bankruptcy Code. The Judge further ruled that there is nothing in the statute that limits its application regarding an educational benefit to a student when a third party also receives a benefit.