It is not easy to write off a student loan in bankruptcy. The Bankruptcy Code says it takes an “undue hardship,” but does not define what that means. The courts have been trying to figure out what it means for decades, and have created a series of high hurdles to jump over.
The Three High Hurdles
As one court put it a few years ago:
the debtor must prove that: (1) he cannot maintain, based on current income and expenses, a “minimal” standard of living for himself and his dependents if required to repay the loans; (2) additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period; and (3) the debtor has made good faith efforts to repay the loans.
To be clear, all three of these conditions have to be met by the debtor, who has the “burden of proving undue hardship . . . , and . . . must prove all three elements before discharge can be granted.”
The New Court Opinion
On May 22, 2013, the federal Ninth Circuit Court of Appeals-which hears appeals from Bankruptcy Courts in nine western states including California-published a decision which made it potentially easier to meet the third requirement: whether the debtor had made “good faith efforts to repay the [student] loans” before filing bankruptcy. This decision is called Hedlund v. Educational Resources Inst.
The Facts
When Michael Hedlund filed a Chapter 7 “straight bankruptcy” case, he owed about $80,000 to one student loan creditor-the one involved in this decision-plus an unspecified amount to a second one.
This is the effort he went through to try to repay the first loan:
After deferring repayment as long as he could through hardship forbearances, he completed an application to lower his monthly payments by consolidating the loans. He later learned that this application was never processed, and by the time he found this out he was no longer eligible for consolidation since he had fallen into default. Hedlund then looked into doing an “Income Contingent Repayment Plan,” but based on his online research and on what he was told by his creditor, he understood he was not eligible for that either.
The only purely voluntary payment that Hedlund made on the student loan was about $950 that he paid out of a $5,000 inheritance–the rest went to his other creditors. Next he tried to negotiate payment terms with his student loan creditor, but he did not accept either of the two options presented: to pay $10,000 up front, then $1,300 a month for ten months, and then an adjusted monthly payment; or a lump sum of about $80,000. Instead he offered to borrow $5,000 from his parents and pay that, to be followed by monthly payments, which was rejected. After that, the creditor garnished Hedlund’s wages for nearly a year and a half, without his objection, until nearly $4,300 had been paid. Then Hedlund filed bankruptcy.
Bankruptcy Court Discharges Much of the Student Loan
In his bankruptcy case, Hedlund attempted to discharge both both student loans under the “undue hardship” provision of the Bankruptcy Code . He settled with the other student loan creditor, agreeing to pay $50 per month. Before the trial against the remaining creditor, he rejected 3 settlement offers, each involving 30-year plans with monthly payments of from $307 to $440, arguing that these all left him with insufficient funds for a minimum standard of living for him and his dependents . At the completion of trial, the bankruptcy judge ordered the partial discharge of the student loan, shaving about $50,000 off the $80,000 debt. The judge specifically found that Hedlund had sufficiently shown that he’d made good faith efforts to repay his student loans.
On Appeal, District Court Overturns the Bankruptcy Court
The creditor appealed to the United States District Court, which went through the evidence and found fault with virtually all of Hedlund’s efforts as recited above. Concluding that he had NOT made good faith efforts to repay, it overturned the Bankruptcy Court and reinstated the entire $80,000 student loan. Hedlund appealed to the Ninth Circuit Court of Appeals.
The Court of Appeals Slaps the District Court for Not Doing Its Job
The Court of Appeals first decided that when the District Court reviews a Bankruptcy Court ruling about a debtor’s good faith effort to repay a student loan, it is not supposed to weigh the evidence as if it were a trial court. That’s the job of the Bankruptcy Court. Instead, the job of the District Court on appeal is restricted to considering whether the Bankruptcy Court applied the facts to the applicable law in a way that was “clearly erroneous.” Since the District Court’s ruling was based on a misunderstanding of its appropriate role in the process, its decision to overturn the Bankruptcy Court’s decision was invalid.
Ninth Circuit Weights Whether Bankruptcy Court’s Decision Was “Clear Error”
The Court of Appeals then undertook the same appellate role that it had just required of the District Court, to determine whether the Bankruptcy Court had made any “clear errors.” The Court of Appeals concluded that the Bankruptcy Court had not. It used the appropriate three legal requirements for writing off student loans, and applied the evidence reasonably to them.As for the “good faith effort to repay” requirement, the Court of Appeals divided this further into two sets of related facts:
1. Efforts to obtain employment, maximize income, and minimize expenses.
2. Efforts to negotiate a repayment plan; history of payments; and timing of the attempt to discharge the loan.
Efforts to Obtain Employment, Maximize Income, and Minimize Expenses
The Court of Appeals decided that the Bankruptcy Court had looked reasonably at Hedlund’s efforts at getting better jobs, his reasons for not doing so, his wife’s working only one day per week outside the home, and their expense budget. Although the Court of Appeals said that it “might have viewed certain expenses more skeptically,” the Bankruptcy Court’s own assessment “was not clearly erroneous.”Efforts to Negotiate a Repayment Plan, History of Payments, and Timing of the Attempted Discharge
The Court of Appeals actually expressed concern about the adequacy of Hedlund’s efforts to negotiate a payment plan, his mere single voluntary payment, and his failure to look deeper into an Income Contingent Repayment Plan or to accept any of the payment offers presented to him. But the Circuit Court decided that “[a]lthough this evidence could be interpreted to support a finding of lack of good faith, it was not so strong as to demand such a finding.” Overall, although the Court of Appeals was doubtful about some of the Bankruptcy Court’s weighing of the evidence, it stuck to the job it had just imposed on the District Court and decided that it found no “clear error.” So the Court of Appeals told the District Court to follow the Bankruptcy Court in discharging about $50,000 worth of the student loan.