by Dischargeability of student loans is often determined by application of the test set forth in 1987 case of Brunner v. New York Higher Education Services Corp., 831 F.2d 395 (2d Cir.). The Ninth Circuit recently discussed the proper standard of review when the third prong of that test—good faith—is at issue. Hedlund v. ECMC, No. 12-35258 (9th Cir. May 22, 2013).
The debtor incurred the student loan debts at issue through the Pennsylvania Higher Education Assistance Agency (PHEAA) when he was a law student. After three unsuccessful attempts to pass the bar exam, the debtor could not find a job with a salary sufficient to repay the loans at the rates demanded. Therefore, he sought and obtained hardship forbearances on the loans. He later sought to consolidate the loans but the paperwork evidently was not received by the lender and the loan went into default. He then looked into applying for an Income Contingent Repayment Plan (ICRP) but because the loans were in default, he believed that this option was not available to him and did not apply. The PHEAA offered the debtor two options: 1) pay $10,000 up front and $1,300 for ten months, or 2) pay a lump sum of approximately $80,000, neither of which were feasible for the debtor. PHEAA began garnishing the debtor’s wages and the debtor filed for chapter 7 bankruptcy. PHEAA then offered options requiring repayment over 30 years and involving monthly payments ranging from $307 to $440. The debtor did not pursue any of these options. Instead, debtor filed an adversary proceeding seeking partial discharge of the PHEAA loan.
After trial, the bankruptcy court found that all but $30,000 of the loan was dischargeable. PHEAA appealed and the BAP for the Ninth Circuit reversed and reinstated the entire loan. The Ninth Circuit reversed again and instructed the bankruptcy court to reconsider all the evidence and properly apply the Brunner test. The case was resubmitted to a new bankruptcy judge who reviewed the record of the previous hearings and found all three Brunner factors were present and that all but approximately $32,000 of the loan was dischargeable. On appeal, the district court reviewed these findings de novo, looked at the same evidence that the bankruptcy court had considered, and found that the good faith requirement was not met.
The Ninth Circuit began by confirming its continued adherence to the Brunner test (although the current validity of the test was recently questioned by Judge Pappas’s dissenting opinion in Roth v. ECMC, No. 11-1233 (B.A.P. 9th Cir. Apr. 16, 2013)), noting that the issue of what standard of review to apply to the good faith prong of the that test had never been conclusively determined. It reasoned that good faith includes both legal and factual elements. The relevant legal factors include the debtor’s efforts to obtain employment, maximize income, minimize expenses and negotiate a feasible repayment plan. Whether those elements were properly applied is a legal conclusion to be reviewed de novo. But in this case, the bankruptcy court considered each of these legal elements and the disagreement between the lower courts revolved around the interpretation of the facts within that legal framework. By conducting a de novo review of the facts without deference to the bankruptcy court’s findings, the district court erred. Rather, the Ninth Circuit clarified that so long as the proper factors are considered as a matter of law, a bankruptcy court’s factual findings must be reviewed under a deferential clear error standard. Under that standard, the court found that, while much of the evidence if looked at with a less compassionate eye could have supported a different conclusion, the bankruptcy court’s finding of good faith was not clearly erroneous. In fact, the court noted that other cases relied upon by PHEAA in which good faith was found involved less favorable facts.