The two cases below held that the Bankruptcy Code section exempting “student loans” from discharge in bankruptcy, does not apply to student loans issued from credit unions.

The first case of TI Federal Credit Union vs. John Delbonis, involved a debtor who, in a four year period, obtained more than $43,000 from TI Federal Credit Union for his children and wife’s education. Although the debtor did not utilize any of the loan proceeds for his own education, the funds were used for the education of his immediate family.

TI Federal Credit Union did issue each of the loans to debtor pursuant to its “Educational Loan” program.

Debtor then filed a Chapter 7 bankruptcy and sought to discharge the $43,000 of student loans from TI Credit Union. The credit union filed an adversary proceeding in Bankruptcy Court and requested the court to declare the debts to be nondischargeable under Section 523(a)(8) of the Bankruptcy Code, which provides, in pertinent part, that a discharge in bankruptcy:

does not discharge an individual debtor from any debt . . . for an educational . . . loan made, insured or guaranteed by a govern- mental unit, or made under any program funded in whole or in part by a governmental unit or nonprofit institution . . . .

The credit union reasoned that these student loans met the two requisite requirements for a nondischargeable debt, since the loans were issued pursuant to the credit union’s “Educational Loan” program and the credit union was a nonprofit institution.

In fact, the credit union noted that it is deemed a “nonprofit institution” and is, therefore, exempt from taxation under the terms of the Internal Revenue Code.  TI Federal Credit Union vs. John Delbonis (U.S. Bkcy. Court, D. Massachusetts, No. 93-2003).

The Massachusetts Bankruptcy Court, however, held that

The fact that TI [Federal Credit Union] was exempted from non-property taxation on the basis of its creation under the Federal Credit Union Act, or its freedom from taxation under the Internal Revenue Code does not of itself qualify it as a nonprofit institution.

This court held that there is no necessary correlation between tax exemption status and nonprofit status.

This court found that nonprofit organizations do not normally have shareholders, nor do they pay dividends to those involved in them. Since TI Federal Credit Union does both, the court found that this credit union was not a nonprofit organization within the meaning of the Bankruptcy Code. Hence, this debt of more than $43,000 would be discharged in bankruptcy.

Another case in Virginia rendered a similar opinion. In that case, Navy Federal Credit Union vs. Michael & Janice Simmons (U.S. Bkcy. Court, E.D. Virginia, Case No. 94-2107-B), loaned more than $6,000 to debtors, to enable debtor-husband to obtain educational instruction training.

Thereafter, debtors filed a Chapter 7 Bankruptcy; and Navy Federal Credit Union filed an adversary proceeding seeking to have this student loan rendered nondischargeable in bankruptcy.

The Virginia court held against the credit union in two respects: first, the court found that the credit union failed to establish that its loan was made pursuant to an educational lending “program,” as required to trigger statutory exception to discharge; and secondly, that the credit union was not a “nonprofit institution” within the meaning of statutory exception to discharge, given evidence that the credit union competed directly with banks, had shareholders, and paid dividends similar to those paid by for-profit corporations. Hence, this court also discharged the educational loan made by Navy Federal.

The Court noted:

Indeed, the credit union hopes to earn a profit. One can appreciate the fact credit unions consider themselves nonprofit; however, is it not much more a mutual society?

‘The noisome weeds, that without
profit suck
The soil’s fertility from wholesome
flowers.

–Words put into the mouth of Richard II by Will Shakespeare.

EDITOR’S COMMENT

Another court reached an opposite result from those cases reported above. In Construction Equipment Federal Credit Union vs. Mark Roberts, 149 B.R. 547 (C.D. Ill. 1993), the court held that credit unions are nonprofit institutions for purposes of engaging the extra protection provided by the Bankruptcy Code.

In the Roberts decision, debtor borrowed more than $25,000 of student loans from a credit union to attend Eastern Illinois University. Seven months after debtor’s student loans became due, debtor filed bankruptcy on that obligation.

Although the bankruptcy trial court found that the credit union was not a “nonprofit” institution and the debt could be discharged, on appeal, the U.S. District Court reversed the trial court decision and found that credit unions are nonprofit corporations and do, in fact, qualify for protection from loss caused by the discharge in bankruptcy of a student loan.

Author:  Charles R. Harroun, Attorney at Law