We talk now and then about how bankruptcy can affect student loans. The conventional wisdom is that student loans can’t be wiped out in a bankruptcy filing, but that’s not entirely true. The simple fact is that most debtors don’t even ask to have them brought into their filing because they assume it’s a foregone conclusion. But one recent case that’s completed a 10 year odyssey may offer more hope to debtors.
After fighting in court for over a decade, Michael Hedlund was able to have $58,000 of his total $85,000 student loan debt wiped out in a recent appeal he won in the US 9th Circuit Court of Appeals case against the Education Resources Institute and Pennsylvania Higher Education Assistance Agency.
And while outlier cases such as the 7th Circuit Court’s Krieger ruling are not as applicable to most student loan borrowers because the debtor is living in perennial and extreme poverty, the Hedlund case is much more relevant. Hedlund is a middle earner with high student loan balances that he cannot manage.
How did he get to this point and how is it relevant to you? Michael Hedlund financed his University of Oregon BA and Williamette Law School JD with federal Stafford loans fully intent on becoming a practicing attorney. Unfortunately, Hedlund failed the bar exam several times, lost his DA intern job as a result and finally gave up on being a lawyer.
Instead, he became a counselor at juvenile court services, got married and started a family. Unfortunately his $85,000 student debt required monthly payments of $800 that he couldn’t manage on his $40,000 annual salary. But Hedlund didn’t turn to bankruptcy straight away.
He went through steps where he sought forbearance and consolidation solutions to his financial quandary. When Hedlund applied for consolidation, his lender bungled the application resulting in him going into default which then prevented him from being a candidate for any relief options. He continued trying to pay his loans, but his efforts were rejected by his lenders.
Small wage garnishments of $250 per month made his finances difficult, but after one lender garnished $1,100 from his bank account in a lump causing big problems, Hedlund had to try something different and looked to the bankruptcy court for relief. The standard measure used by bankruptcy courts to determine whether student loans can be relieved in bankruptcy is the Brunner test which consists of three prongs that must be demonstrated:
(1) If forced to repay the loans, the debtor will be unable to a minimal standard of living for them and their dependents.
(2) The circumstances in play that lead to this state of unserviceable debt are likely to continue through most of the repayment period of the loans.
(3) Good faith efforts to repay the loans have been made.
Hedlund files for bankruptcy in May 2003 and included an adversary proceeding to include his student loans in the debt relief proceeding. One of his creditors agreed to a settlement of $50 per month to pay off nearly $18,000 of his student debt. The other creditor did not offer any affordable settlement arrangements and the bankruptcy court ruled that over $50,000 of the debt to Pennsylvania Higher Education Assistance Agency would be eligible for bankruptcy relief leaving him owing $30,000 on this debt.
But the creditor appealed and the Bankruptcy Appellate Panel reversed the initial ruling saying that the Brunner test hadn’t been properly applied and the case was bounced back down to the lower court for reconsideration where a new judge ruled again that all but $32,080 of Hedlund’s student loan debt could be relieved. Again there was a creditor appeal on the assertion that he had not made a “good faith effort” to service his debt to them and that his financial situation was “self-inflicted.”
The district court agreed with the lender and reinstated the full amount of Hedlund’s student loan debts. However, the 9th Circuit Court took a look back at all of the decisions and decided the Brunner test had been applied aptly and reinstated the eradication of the debt. Hedlund’s verdict may enable more borrowers to apply for bankruptcy relief, but there are a couple of factors that may block this relief from becoming more widespread:
(1) Legal Fees – Hedlund had pro bono representation for the appeals process. Without this help, this verdict likely would not have been possible and few drowning in student debt can likely afford legal representation of this quality.
(2) Creditor Backlash – As in this case, the creditor pushed back hard to fight this ruling. This will no doubt be the practice of most lenders because they don’t want this option to be available to borrowers!
This ruling is relevant to the plight of many borrowers that took on more loans than they could manage, overestimated their post-grad earnings capabilities or experienced missteps or upsets. Any of these can send borrower finances awry and make them unrecoverable without some sort of legal intervention such as bankruptcy.
This ruling is also important because relief from loans has traditionally been a protection in bankruptcy only afforded to businesses but not individuals making this truly a landmark case!
Forbearance and deferment should be final strategies after income-sensitive options have been explored and bankruptcy protection is truly a last-ditch alternative that may or not play out in your favor. To make sure you keep tabs on your debt, please use Tuition.io’s free student loan management tool to view all of your loans – public and private – in one easy interface! Also check out these related blogs on debt, bankruptcy and options for those struggling with their student loans: