A federal judge ruled law-school graduates who file for bankruptcy protection can cancel the debt they racked up while studying for the bar exam, finding such loans are different from traditional federal student loans that are rarely canceled by bankruptcy.
In an opinion filed Thursday, Judge Carla Craig of the U.S. Bankruptcy Court in Brooklyn, N.Y., said bar-exam loan debt is “a product of an arm’s-length agreement on commercial terms” and doesn’t fall into the category of student loans that stick with a borrower who files for bankruptcy.
The decision, which is the most thorough recent ruling on the matter, contradicts the widely accepted notion that student loan-related debt can be canceled in bankruptcy only under rare cases of extreme financial hardship.
In her 20-page ruling, Judge Craig said bar-study loans were akin to commercial or consumer loans and weren’t an “educational benefit,” like a scholarship or stipend, and thus could be erased in a bankruptcy case.
The case involves 36-year-old Lesley Campbell, a 2009 Pace University School of Law graduate who had asked the court to cancel the unpaid portion of a $15,000 loan she took out from Citibank to study for the bar.
Ms. Campbell, a Brooklyn resident, didn’t pass the bar exam after graduating in 2009 and took a secretarial job with a $49,000 annual salary at a hotel management company, she said. She filed for bankruptcy in 2014.
Although her bar-study loan was only a small portion of Ms. Campbell’s nearly $300,000 student loan debt, the ruling comes at a time when consumer advocacy groups and some federal lawmakers are pushing for students to be able to use bankruptcy to get at least some relief.
The U.S. Supreme Court recently declined to hear a case that could have made it easier to get rid of student loan debt. The White House, however, said last year that it would examine whether it should be easier for student loans to be canceled by bankruptcy, opening the door for student debt made by private lenders to be treated on par with credit-card debt and mortgages.
“We’re starting to chip away at the absolute immunity of student loans from bankruptcy,” said Austin Smith, Ms. Campbell’s lawyer.
A Citibank lawyer declined to comment on the ruling or to say whether the bank plans to appeal.
Judge Craig’s ruling isn’t binding on other courts but may be helpful to other bankruptcy judges with similar disputes before them.
Judge Craig isn’t the first federal judge to take up the issue of whether bar-study loans can be wiped out in bankruptcy. Her ruling conflicts with an April 2010 decision from Alabama Bankruptcy Judge Jack Caddell, who said a University of Alabama School of Law graduate couldn’t cancel a $9,475 bar-study loan.
Bankruptcy judges have historically had a “reflexive, knee-jerk reaction that if anything like a student loan, it’s nondischargeable,” said John Rao of the National Consumer Law Center.
“Judges are now starting to take a closer look,” he said.
The ruling comes as total student debt has more than doubled since 2007.
“We’ve come to a place where student loan debtors are very much backed into a corner,” said Greta LaMountain Biagi, a bankruptcy lawyer in Amherst, Mass. “This judge clearly to me understands that and is in touch with that.”
Several major lenders, including Wells Fargo & Co., PNC Financial Services Group Inc., Discover Financial Services Inc. and Sallie Mae Inc., offer bar-exam loans typically of up to $15,000 to pay for a law-school student’s time after graduation—a period when many study for the bar exam but haven’t begun working in the field yet.
They are similar to medical students who have access to residency and relocation loans, said Mark Kantrowitz, a Chicago-based publisher at Cappex.com, a website that connects students with colleges and scholarships.
“They’re low-risk for the lender because you know the individual has already received their degree. They just have to pass the bar or their medical boards,” he said.
Ms. Campbell has a new job as a legal document reviewer and plans to retake the bar exam in February. She said she is current on student loan payments.