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Saturday, February 8, 2014

Student Loans Bankruptcy Rules Could Change With Circuit Court Ruling

by Todd Gregor

Identity theft ravaged the lives of millions of Americans in the 1990s, and there was little legal recourse available to them. Congress finally enacted the Identity Theft and Assumption Deterrence Act in 1998, to give victims of identity theft more options besides bankruptcy.

It also strengthened remedies offered by the Fair Credit Reporting Act. Today, consumers can protect themselves even further with services like Lifelock and data encryption on their computers.

Congress, however, is yet to act to provide any options when student loan debt becomes overwhelming. People with overwhelming debts like credit card debt and identity theft debt, at the very least, can file for bankruptcy to remedy their situations. This option, however, was generally not available to those drowning in student loan debt. But a case decided by the Ninth Circuit Court of Appeals this past May could change that.

What The Law Says

It is extremely difficult to get student loan debt wiped out via bankruptcy. U.S. law, pursuant to 11 USC § 523(a)(8), specifically prohibits discharge of student loans unless "undue hardship" can be proven. A three-prong test articulated by the Second Circuit Court of Appeals in the 1987 case of Brunner v. New York State Higher Educ. Serv. Corp., is the burden petitioners must prove by a preponderance of the evidence. Most jurisdictions have adopted this test, with some adding their own unique requirements to pass. The three prongs include:
  • Poverty - Petitioner cannot maintain a minimal standard of living if forced to pay back student loans
  • Persistence - The situation of the Petitioner is unlikely to change anytime soon
  • Good Faith - Petitioner has tried to pay their debt on time; Petitioner is not deliberately keeping themselves in the bad situation
The law as written, along with the tediousness of the process, prevents most borrowers from even attempting discharge. But a 2011 study published in American Bankruptcy Law Journal found that nearly 40 percent of those who attempt discharge are actually granted relief.

The Heglund Case

Michael Heglund, a law school graduate himself, failed the bar exam twice and was unable to secure employment as an attorney. This forced him to work as a probation officer on a salary that wasn't enough to pay back his loans and maintain a decent standard of living. He filed for bankruptcy and initiated the adversary "Brunner" proceeding, which is required for the Courts to consider discharging student loans.

It took 10 years and a lot of patience, but the Ninth Circuit ultimately discharged $55,000 of Heglund's $85,000 in student loan debt. But the interesting part was the way the justices applied the Brunner test. The Court did not hold it against Heglund that his wife refused to work full-time and determined that having cable television and two cell phones did not constitute "bad faith." The Ninth Circuit also set a precedent, in that student loans can be partially discharged by the Bankruptcy Courts.

What This Means For You

Granted the Ninth Circuit ruling covers only the states within its jurisdiction (West Coast), other circuits are jumping on board. The Seventh Circuit, in the case of Krieger v. Educational Credit Management Corp., discharged a woman's student loan debt who had applied for 200 jobs in 10 years without success.

Those who believe they may qualify for student loan discharge should evaluate their situations and consult a qualified attorney.

Todd Gregor brings more than 15 years of public school administration to the table.