Test Your Knowledge: Recent Developments in Insolvency Law
| Publication year | 2014 |
| Author | Tom Phinney and Paul Pascuzzi |
Tom Phinney and Paul Pascuzzi
Tom Phinney is a partner with Parkinson Phinney in Sacramento practicing bankruptcy law and commercial litigation, representing creditors, trustees, and committees. He is a member of the Executive Committee of the Business Law Section of the State Bar, and an officer of the California Bankruptcy Forum.
Paul J. Pascuzzi is a partner at Felderstein Fitzgerald Willoughby & Pascuzzi, LLP in Sacramento. Mr. Pascuzzi is a former chair of the Executive Committee and Insolvency Law Committee of the Business Law Section. Mr. Pascuzzi's practice focuses on all aspects of business bankruptcy and insolvency law.
This article tests your knowledge of recent developments in the area of insolvency law. Unless otherwise noted, all references are to the Bankruptcy Code. We provide a summary of the facts and issues in each case and then ask you to choose the answer(s) that reflects the holding of the court. There may be more than one correct answer. We also provide a short commentary on each holding. Good luck!
Student loan debt now exceeds $1.2 trillion, or about 6% of the overall national debt. Over 80% of student loans are backed by the U.S. government, and thus taxpayers ultimately carry the burden for students defaulting on these loans. Since the 1980s, the trend has been to restrict the ability to discharge student loans in bankruptcy, but that trend is now shifting.
In the Hedlund case, Michael Hedlund borrowed a total of about $85,000 to get an undergraduate degree, and then a law degree from Willamette Law School. He failed the bar exam three times. He ultimately took a job as a juvenile counselor. At 33, married and with a child, he declared bankruptcy. He filed an adversary proceeding seeking a declaration that the student loan debt posed an "undue hardship" under section 523(a)(8), and thus was dischargeable.
The Ninth Circuit applies the "Brunner standard"1 to claims of undue hardship, which requires a borrower to prove three things: (1) the borrower and any dependents cannot maintain a minimal standard of living based on current income and expenses; (2) additional circumstances indicate this is likely to be the case for a significant portion of the borrower's repayment period; and (3) the borrower made a good faith effort to repay the loans.
The bankruptcy court discharged all but $32,080 of the student loan debt. The bankruptcy court found that the family's expenses, including two cell phones for the family and leasing a reliable car, were reasonable, and that although other expenses, including cable and children's haircuts, were "marginal," on the whole the debtor lived "frugally." The bankruptcy court rejected arguments that Hedlund should find another part-time job, while noting that his wife could be expected to work three days a week rather than one. The bankruptcy court also found that Hedlund was justified in rejecting repayment options offered by his loan servicer that would have entailed monthly payments that he could not have afforded and that would still have meant repaying his loans for thirty years.
On appeal from the bankruptcy court, the district court reversed, finding that the debtor had not satisfied the rigorous "undue hardship" standard, and in particular that the debtor had not made sufficient good faith efforts to repay the loans.
The case was appealed from the district court to the Ninth Circuit, which:
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- Affirmed the district court (i.e., reversed the bankruptcy court ruling). The Ninth Circuit held that the debtor had not fully maximized income and minimized expenses, and that his efforts to negotiate repayment were incomplete at the time he sought discharge of the loans.
- Affirmed the district court. The Ninth Circuit held that in addition to satisfying the Brunner test, there is a presumption against partial discharge of student loans, which the bankruptcy court findings did not overcome, and remanded the case for further findings.
- Reversed the district court (i.e., affirmed the bankruptcy court ruling). The Ninth Circuit held that the district court erred by reviewing the bankruptcy court's good faith finding de novo, rather than by using the more deferential "clear error" standard of review, and remanded the case to the district court with instructions to reinstate the partial discharge ordered by the bankruptcy court.
- Reversed the district court. The Ninth Circuit upheld the bankruptcy court's relatively lenient application of the Brunner test to the facts in Hedlund's case. The Ninth Circuit ruled that there was substantial evidence to support the bankruptcy court's conclusions that the debtor had maximized income and minimized expenses, and that his efforts to negotiate repayment were sufficient.
Explanation of Hedlund Answers: Discharge of Student Loans
The correct answers are C and D; the Ninth Circuit reversed the district court and affirmed the bankruptcy court decision and its exercise of discretion in assessing "undue hardship," even though it was a relatively lenient application. Notably, Hedlund had an advantage not available to most debtors: he was represented pro bono by Morrison and Foerster over the course of the litigation, which took several years.
As partly reflected in the Hedlund case, there is some judicial momentum toward easing restrictions on the discharge of student loans, which is based in part on the fact that historically it was less difficult to discharge student loan debts. When the Bankruptcy Code was initially enacted in 1978, there were two ways to discharge student loans: (1) showing the loans posed an "undue hardship" or (2) more than 5 years had passed. Thus, at the time the Brunner case was decided, in 1987, the test it adopted applied only during the first five years of a loan's repayment schedule. It stands to reason, therefore, that courts strictly construed the "undue hardship" required to qualify for an early student loan discharge. In 1998, section 523(a)(8) was amended to provide that student loans are never eligible for discharge, yet all student loan discharge requests remained subject to the rigorous Brunner test. This problem was a noted issue in a case from the Ninth Circuit Bankruptcy Appellate Panel, Roth v. ECMC.2
Congress is also attempting to ease repayment obligations of student loans. For example, a bill proposed in the House of Representatives (the "Student Loan Fairness Act") would, among other things, cap borrowers' monthly payment obligations at 10 percent of their discretionary income.
The Gasprom case involves the question of when relief from the automatic stay is needed from the bankruptcy court, an issue that many non-bankruptcy lawyers may deal with from time to time.
In Gasprom, after the corporation's case was converted from Chapter 11, the Chapter 7 Trustee filed a motion for authority to abandon the debtor's sole asset—a non-operational gas station. The grounds for the abandonment were troublesome issues concerning permitting, hazardous waste, and underground storage compliance, and the property was fully encumbered by a valid security interest. The debtor objected to the abandonment and asked for a continuance so that the secured creditor could not foreclose immediately. Relying on In re D'Annies Restaurant,3 the bankruptcy court granted the motion to abandon, noting that the effect of the abandonment would be to vacate the automatic stay, which would allow the secured creditor to foreclose. The bankruptcy court entered an order authorizing the abandonment of the property.
As the debtor feared, the secured creditor conducted the foreclosure sale later that day. Thereafter, the Trustee issued a final "no asset" report, and the case was closed about two weeks later.
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The debtor then filed a motion to reopen the bankruptcy case so that it could set aside the foreclosure sale and commence contempt proceedings for violation of the automatic stay. The bankruptcy court reopened the case, but denied the yet-unfiled motions to set aside the sale and to hold the creditor liable for contempt. It held that upon entry of the abandonment order, the automatic stay no longer enjoined the foreclosure sale of the gas station. The court also ruled that it would annul the automatic stay sua sponte to the extent necessary to validate the foreclosure. The debtor appealed.
The Bankruptcy Appellate Panel ("BAP"):
- Affirmed, holding that the bankruptcy court could simply annul the automatic stay sua sponte.
- Affirmed, holding that abandonment made the collateral no longer property of the estate, so the automatic stay did not apply.
- Reversed, holding that the bankruptcy court erred when it found that the foreclosure did not violate the automatic stay.
- Reversed, holding that the bankruptcy court failed to consider whether it had subject matter jurisdiction since the property was no longer property of the estate and the Chapter 7 trustee filed a "no asset" report.
Explanation of In re Gasprom: Abandonment does not terminate the automatic stay.
The correct answer is C. The BAP reversed, holding that the bankruptcy court erred when it found that the foreclosure did not violate the automatic stay. Although the abandonment made the collateral no longer property of the estate, the automatic stay remained in effect to bar enforcement of liens against "property of the debtor" under section 362(a)(5). The BAP declined to follow the holding of D'Annies, which held that after abandonment of estate property, section 365(a)(5) only protects a debtor from foreclosure of that property if that debtor is an individual. The BAP found that nothing in the statutory language would permit it to read "of an individual" into the statutory language of section 362(a)(5). The BAP found that references in prior Supreme...
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