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Federal law does not allow the discharge of student loan debt in a bankruptcy case, except with a showing of “undue hardship.” The Ninth Circuit Court of Appeals recently ruled in favor of a debtor, who sought discharge of his student loan debt in a decade-old bankruptcy case. In re Hedlund, No. 12-35258, slip op. (9th Cir., May 22, 2013). The court found that the debtor had satisfied the three-part test used to determine “undue hardship,” known as the Brunner test. Brunner v. New York State Higher Educ. Services, 831 F.2d 395 (2nd Cir. 1987). The case shows how courts can hold debtors to a very high standard in establishing undue hardship. The decision may offer some guidance, however, towards establishing a more uniform set of criteria for student loan debtors in bankruptcy.

The debtor graduated from law school in 1997. He took a position as an intern in a district attorney’s office while waiting for his bar results. He failed the bar exam on his first two attempts, and took a job as a probation officer at $10 per hour. He missed his third attempt at the bar exam when he accidentally locked his keys in his car the morning of the test. His loan deferment ended in 1999, and he found himself owing more than $85,000 to Pennsylvania Higher Education Assistance Agency (PHEAA). The debtor and PHEAA each made several offers regarding payment terms, but never reached an agreement. PHEAA began garnishing his wages in 2002, and he filed for Chapter 7 bankruptcy in May 2003.

The case made it all the way to the Ninth Circuit, which remanded it to the bankruptcy court in In re Hedlund, 368 F. App’x 819 (9th Cir. 2010). A new bankruptcy judge discharged all but $32,080 of the PHEAA debt. The district court reversed the ruling, finding that the debtor did not meet one of the prongs of the Brunner test, requiring proof of good faith efforts at repayment. The debtor appealed to the Ninth Circuit.

The bankruptcy court had concluded that the debtor had done what he could to maximize his income, finding that his failure to pass the bar exam was beyond his control, that no higher-paying jobs were available, and that relocating would cost him more than he would gain. It found that he had not minimized his expenses as much as he could, noting the amounts he spent on clothing, “recreation,” and “miscellaneous” budgets including childcare. Hedlund, slip op. at 10. He had made sufficient efforts to negotiate a repayment plan, according to the bankruptcy court, including an application to consolidate loans that the lender allegedly lost. The court did not “fault” him for failing to apply for the Income Contingent Repayment Plan (ICRP). Id. at 11.

These factors satisfied the good faith requirement for the bankruptcy court, but not the district court, which found his expenses “immoderate” and his failure to negotiate a repayment plan “vexatious.” Id. at 11-12. The district court reversed the bankruptcy court’s ruling, faulting the debtor for not applying for ICRP and for rejecting several offers from PHEAA. It even faulted the debtor and his wife for choosing “to live as a single-income family.” Id. at 12.

The Ninth Circuit reversed the district court and remanded the case to the bankruptcy court again. It found that the district court improperly reviewed the “good faith” findings of fact de novo, when the correct standard of review was “clear error.” Id. The court found that the bankruptcy court had properly applied the elements of the Brunner test, and that its findings of fact, while subject to disagreement, were not “clearly erroneous.” Id. at 16. The bankruptcy court’s ruling, it held, should therefore stand.

For the last sixteen years, bankruptcy attorney Devin Sawdayi has helped people in the Los Angeles area get a fresh start by restructuring or discharging their debts through the bankruptcy process. We are committed to representing individuals coping with financial distress with respect and dignity, finding a way to address each client’s unique circumstances. Contact us today online or at (310) 475-9399 for a free and confidential consultation.

More Blog Posts:

Student Loans and Bankruptcy, Part 2 – What Is an “Undue Hardship or Hardship Discharge”? Los Angeles Bankruptcy Lawyer Blawg, June 6, 2013

Student Loans and Bankruptcy, Part 1 – Are They Ever Dischargeable? Los Angeles Bankruptcy Lawyer Blawg, May 28, 2013

A Chapter 13 Bankruptcy Can Help You With Your Large Student Loan Debt, Los Angeles Bankruptcy Lawyer Blawg, May 21, 2013