Macdonald | Fernandez LLP

MACDONALD | FERNANDEZ LLP


221 Sansome Street
San Francisco, CA 94104
Telephone: (415) 362-0449
Facsimile: (415) 394-5544
914 Thirteenth Street
Modesto, CA 95354
Telephone: (209)549-7949
Facsimile: (209) 236-0172

Friday, December 26, 2014

Winding Up and Dissolving a Nonprofit Corporation

This article discusses the basic steps to wind up and dissolve a nonprofit public benefit corporation under California law.  Although this background is helpful, it is not a substitute for retaining competent counsel to assist with the analysis of alternatives and the preparation of the required resolutions, minutes, forms, notices and letters.  This article does not cover mutual benefit corporations, private foundations, freestanding charitable trusts, political action committees or religious corporations, although there are many similarities. 

The Role of the Attorney General

A key distinction from winding up and dissolving an ordinary corporation is that the Attorney General of the State of California (the “AG”) must receive notice and may play a role in the ultimate disposition of assets.  The AG considers public benefit corporations to hold assets in a charitable trust by their very nature, over which the AG has broad powers of supervision.  California Government Code (“Gov’t C.”) Sections 12598 through 12599.7; Holt v. College of Osteopathic Physicians & Surgeons (1964) 61 Cal.2d 7590; People v. Cogswell (1896) 113 Cal. 129, 136.  Certain filing requirements with the Secretary of State of California are triggered upon dissolution, as are certain tax reporting requirements.
 
 Merger Alternative

The option of merging with another nonprofit or for-profit business should be considered.  A public benefit corporation may merge with any type of business entity, including a for-profit entity.  California Corporations Code (“Corp. C.”) § 6010(a).  However, without the prior written consent of the AG, a public benefit corporation may only merge with another public benefit corporation (or a religious corporation or a foreign nonprofit corporation or an unincorporated association), the governing documents of which provide that its assets are irrevocably dedicated to charitable, religious, or public purposes.  Corp. C. § 6010(a).  For more information on the merger alternative, read here.
 
Considerations

If a dissolution is warranted, it should be planned and commenced promptly in order to avoid drifting into insolvency or wasting assets, which course of conduct could expose directors to liability.  Corp. C. §§ 5232, 5233 & 5240.

The assets of a public benefit corporation may be sold for fair value, with the proceeds distributed to another public benefit or religious corporation, or donated directly to another public benefit or religious corporation, and the articles of incorporation can be amended to designate new recipients of the corporation’s assets, subject to the powers of the AG, as applicable.  Corp. C. § 5820.

An election to wind up and dissolve can be revoked at any time before a certificate of dissolution is filed with the Secretary of State.  Corp. C. § 6612.  Likewise, subject to the rights of any affected third parties, the board may abandon a sale at any time.  Corp. C. § 5911(b).
  
Election to Wind Up and Dissolve

The corporation may elect to wind up and dissolve by approval of its board of directors as provided in its governing documents.  Corp. C. § 5032 & 6610(a)(3).   If the number of directors remaining in office is less than a quorum, the corporation may nevertheless elect to wind up and dissolve by unanimous consent of the remaining directors or majority vote of the remaining directors at a meeting held pursuant to a valid waiver of notice of the meeting.  Corp. C. § 6610(c).  Although approval of third parties may be required to amend the articles, there is no requirement that their consent to a dissolution must be obtained unless provided in the governing documents.

Powers and Duties of the Board

The process of winding up and dissolving commences upon the board’s resolution.  The board continues and has full power to wind up and settle the corporation’s affairs.  However, the corporation may only conduct activities necessary to wind up and dissolve.  This includes all tasks necessary for an orderly winding down of operations, including phasing out services, but new activities should not be undertaken.

The board’s powers are the same as prior to electing to dissolve, except that the board may “sell at public or private sale, exchange, convey or otherwise dispose of all or any part of the assets of the corporation for an amount deemed reasonable by the board.”  Specifically, the boards powers and duties in a dissolution are as follows:
The powers and duties of the directors (or other persons appointed by the court pursuant to Section 6515) and officers after commencement of a dissolution proceeding include, but are not limited to, the following acts in the name and on behalf of the corporation:
(a) To elect officers and to employ agents and attorneys to liquidate or wind up its affairs.
(b) To continue the conduct of the affairs of the corporation insofar as necessary for the disposal or winding up thereof.
(c) To carry out contracts and collect, pay, compromise and settle debts and claims for or against the corporation.
(d) To defend suits brought against the corporation.
(e) To sue, in the name of the corporation, for all sums due or owing to the corporation or to recover any of its property.
(f) To collect any amounts remaining unpaid on memberships or to recover unlawful distributions.
(g) Subject to the provisions of Section 5142, to sell at public or private sale, exchange, convey or otherwise dispose of all or any part of the assets of the corporation for an amount deemed reasonable by the board without compliance with the provisions of Section 5911, and to execute bills of sale and deeds of conveyance in the name of the corporation.
(h) In general, to make contracts and to do any and all things in the name of the corporation which may be proper or convenient for the purposes of winding up, settling and liquidating the affairs of the corporation.
Corp. C. § 6710.  Nevertheless, to the extent applicable, assets remain subject to restrictions upon charitable trusts.
  
Sale of Assets

Subject to the terms of any express charitable trusts affecting the corporation's assets, the corporation may sell or otherwise dispose of all or substantially all of its assets.  Corp. C. § 5911.  It is important to determine whether and to what extend the assets are impressed with charitable trusts.

The sale or disposition of all or substantially all of the assets requires approval of the board.  Corp. C. § 5911(a)(1).  A sale or disposition outside of the usual course of business must be approved by any persons specified in the articles of incorporation.  Corp. C. § 5911(a)(2).  Although approval may be obtained after the transaction (Corp. C. § 5911(a)(2)), it is best to proceed carefully pursuant to proper authority.  The AG carries out a heightened review process when assets are sold to a for-profit entity. See the AG's Sales of Charitable Assets to For-Profit Entities - Review Protocol.

An instrument conveying the corporation's property can include a certificate by the corporate secretary attesting that the transaction was properly noticed.  This is prima facie evidence of authorization and conclusive in favor of any food faith purchaser without notice of any trust restrictions or failure to comply with restrictions.  Corp. C. §§ 5912, 7912 & 9632. 
  
Notice to Attorney General

The corporation must give written notice to the AG at least 20 days before it sells or disposes of all or substantially all of its assets outside of the ordinary course of business, unless the AG has given a written waiver of notice of the particular transaction.  Corp. C. § 5913.  If no action by the AG is sought, the notice should include a statement that the documents are delivered only to provide the notice required by the statute.  The notice should include: 

(1)               A letter signed by an attorney for the corporation or a director describing and stating the material facts of the proposed transaction (11 California Code of Regulations (“CCR”) Section 999.1(c));
(2)               A copy of the board’s resolution or minutes discussing or otherwise authorizing the proposed transaction;

(3)               A copy of the corporation’s current financial statement;

(4)               A copy of the corporation’s articles of incorporation and bylaws if not already on file with the Registrar of Charitable Trusts;

(5)               A copy of the articles of incorporation of any other corporation that is a party to the proposed transaction; and

(6)               On request of the AG, independent appraisals or other evidence that the sale price and terms are fair to the corporation.

The notice should be submitted to the nearest AG’s office.  11 CCR § 999.1(a).  The notice is deemed filed when it is received, not when it is mailed.  Id.  A request for waiver will be granted or denied within 30 days after filing.  It is best to give notice well before the 20-day deadline as the AG’s written response can serve as proof of timely notice or waiver of notice.

Special Requirements of Health Facilities

There are additional notice and approval requirements (Corp. C. §§ 5914-5925) for “health facilities” as defined in the California Health and Safety Code Section 1250, which defines a “health facility” in general to be:
[A]ny facility, place, or building that is organized, maintained, and operated for the diagnosis, care, prevention, and treatment of human illness, physical or mental, including convalescence and rehabilitation and including care during and after pregnancy, or for any one or more of these purposes, for one or more persons, to which the persons are admitted for a 24-hour stay or longer….
This definition appears not to apply to facilities licensed as a Residential Care Facility for the Elderly under Health and Safety Code Section 1569, et seq. unless the facilities meet the definition of a "health facility" for other reasons.
  
Distribution

Plans to control the ultimate distribution of assets should be made prior to completion of the corporation’s dissolution.  The AG’s prime concern is the purpose and use to which the assets will be dedicated after distribution.  Assets subject to restrictions under the articles of incorporation, the bylaws or a trust must be distributed for a use that is consistent with the restrictions.  Corp. C. § 6716; Estate of Zahn (1971) 16 Cal.App.3d 106.  Moreover, assets of a nonprofit corporation that is exempt from taxation under Internal Revenue Code 501(c)(3) must be dedicated to the purposes for which the exemption was given
The AG’s waiver of objections is necessary to distribute certain assets of a public benefit corporation, or the distribution may be made pursuant to a court decree.  Corp. C. § 6716(c); 11 CCR 999.1-999.8.  The corporation itself has no vested right to designate the recipients.  In re Veterans’ Indus., Inc. (1970) 8 Cal. App.3d 902.  The AG will often request to review copies of the tax exempt determination letter for each recipient, the minutes authorizing the distribution and other information.  The AG’s waiver of objections must be attached to the certificate of dissolution to be filed with the Secretary of State.
As a practical matter, the AG should waive any objection unless the corporation proposes to distribute assets for a purpose not contemplated by the language of its articles.  If the AG objects to the proposed distribution, there is an opportunity to obtain court approval of a distribution outside of the articles under the doctrine of cy presCy pres is a French phrase translated “as near as,” and in American law it means:  “The equitable doctrine under which a court reforms a written instrument with a gift to charity as closely to the donor's intention as possible, so that the gift does not fail.”  Black’s Law Dictionary (9th ed. 2009), cy pres.
  
Dissolution Procedure

Dissolution is accomplished by taking the following steps:

     1.                  The board adopts resolutions to wind up and dissolve;
     2.                  A certificate of election to wind up and dissolve is filed with the Secretary of State (this step is not necessary if all directors vote to dissolve) (Corp. C. § 6611(c);
     3.                  Notice to the AG is given;
     4.                  Notice to creditors is given;
     5.                  The corporation winds up operations, pays or provides for liabilities and distributes assets (see the requirements for AG or court approval of distributions above);
     6.                  The corporation files a certificate of dissolution with the Secretary of State, signed and verified by a majority of directors (the AG’s waiver of objections must be attached, and it must state that the final tax returns have or will be filed);
     7.                  If assets are held in a charitable trust, notice is given to the Registrar of Charitable Trusts; and
     8.                  Final IRS Form 990 (with Schedule N) and FTB Form 199 tax returns are filed.

Providing for Claims

The debts of the corporation must be provided for.  There is a streamlined notice and claim procedure available to nonprofits in order to clear up any unknown or doubtful claims.  Specifically, the corporation notifies all potential creditors that can be identified, following which creditors will have 120 days to submit a proof of claim.  A creditor who fails to submit a claim or whose claim is rejected and fails to initiate a proceeding to enforce the claim within 90 days will be forever barred.  Corp. C. § 6618.
  
Taxes

The final Form 990 return must be filed four months and 15 days after the date of the organization's termination.  The corporation must also file Schedule N, which includes:

     1.                   A description of the assets and any transaction fee, the date of distribution, the fair market value of the assets and information about the recipients of the assets;

     2.                  A disclosure of whether an officer, director, trustee or key employee is or is expected to be involved in the successor entity; and

     3.                   A certified copy of the articles of dissolution or merger, resolutions and plans of liquidation or merger.

Unless otherwise exempt, the corporation must also file Form 199 with the Franchise Tax Board.  California Revenue & Taxation Code § 23332.
  
Post-Dissolution Activities

The existence of a nonprofit corporation continues for certain limited purposes after dissolution.  Specifically, the corporation may continue to wind up it affairs, file final tax returns and handle administrative matters.  The corporation may also continue as plaintiff or defendant in any pre-existing litigation, and it may bring new actions necessary to wind up.  Corp. C. § 6720.  The AG and third parties may sue the dissolved corporation as a nominal defendant in order to recover any improper distributions from third parties.  Corp. C. § 6721.

Thursday, December 25, 2014

Mergers with California Nonprofit Corporations

This article discusses the basic steps and considerations in mergers involving California nonprofit public benefit corporations.  Although this background is helpful, it is not a substitute for retaining competent counsel to assist with the analysis of alternatives and the preparation of the required resolutions, minutes, forms, notices and letters.  This article does not cover mutual benefit corporations, private foundations, freestanding charitable trusts, political action committees or religious corporations, although there are many similarities. 

Dissolution Alternative

If financial distress is a motivating factor, consider winding up and dissolving the entity.  If a dissolution is warranted, it should be planned and commenced promptly in order to avoid drifting into insolvency or wasting assets, which course of conduct could expose directors to liability.  California Corporations Code (“Corp. C.”) §§ 5232, 5233 & 5240.


The Role of the Attorney General

A key distinction from mergers involving an ordinary corporation is that the Attorney General of the State of California (the “AG”) must receive notice and may play a role.  The AG considers public benefit corporations to hold assets in a charitable trust by their very nature, over which the AG has broad powers of supervision.  California Government Code (“Gov’t C.”) Sections 12598 through 12599.7; Holt v. College of Osteopathic Physicians & Surgeons (1964) 61 Cal.2d 7590; People v. Cogswell (1896) 113 Cal. 129, 136
 
Forms of Entity

A public benefit corporation may merge with any type of business entity, including a for-profit entity.  Corp. C. § 6010(a).  However, without the prior written consent of the AG, a public benefit corporation may only merge with another public benefit corporation (or a religious corporation or a foreign nonprofit corporation or an unincorporated association), the governing documents of which provide that its assets are irrevocably dedicated to charitable, religious, or public purposes.  Corp. C. § 6010(a).

Factors to Consider

Among other things, the following factors particular to the merger of a public benefit corporation should be considered before undertaking a merger.

     1.  Bequests.  The surviving entity will succeed to and receive the bequests, devises, gifts, grants and other promises in a will or other instrument of donation, subscription or conveyance of the disappearing entity.  Corp. C. §§ 6022, 8022 & 9640(a).  If the subject entity has significant pending bequests, a merger presents an advantage because such bequests will not be received after a dissolution.

     2.  Continued OversightSome of the existing directors may serve in the resulting new corporation and continue their oversight of the assets of the original enterprise.  If the subject nonprofit elects to merge with another entity, consider requiring seats on the surviving entity's board of directors and discuss the terms of maintaining the seats.

     3.  Effect of MergerThe surviving entity succeeds to all rights and property, and is subject to all debts, liabilities and trust obligations, of the disappearing entity.  Corp. C. §§ 6020(a), 8020(a) & 9040(a).  The surviving entity assumes the California tax liability of the disappearing entity.  All creditors’ rights, liens and trusts on the merging entities’ property (only to the extent of property subject to the lien immediately before the merger is effective) are preserved unimpaired as if the surviving party had incurred them itself.  Corp. C. §§ 6020(b), 8020(b) & 96540(a).  The surviving party’s record ownership of the disappearing party’s real property may be evidenced by recording  a certified copy of the merger agreement, or a certificate in the form prescribed by the Secretary of State, in the appropriate county recorder’s office.

     4.  Choice of Entity  The choice of which entity will be the surviving entity should be made carefully.  The board should obtain information on, and consider, the tax exempt status of each entity, the history of each entity, the employees and existing employment benefits as well as the preservation of bequests and opportunities for continuing oversight.

Notice to Attorney General

The AG must be provided with a copy of the proposed merger agreement at least 20 days prior to consummation of the merger.  Corp. C. § 6010(b).  However, the AG’s affirmative consent is not required unless members receive consideration other than membership in the surviving entity.  Corp. C. § 6010(c).  Many public benefit corporations have no members, in which case a merger appears not to require the consent of the AG.

Note that a merger of two California public benefit corporations does not require a determination of fairness by the Corporations Commissioner.  A tax clearance certificate from the Franchise Tax Board was once required, but it is no longer required.

Approval of Boards
 
A merger must be approved by each entity’s board of directors, members (if any), any other person entitled to approve amendments to the entity’s articles and anyone authorized or required to approve the merger according to the laws under which each entity is organized.  Corp. C. §§ 6011-6012 & 6019.1.  Member approval (if the other entity has members) may be obtained before or after board approval.
  
Merger Agreement

The merger agreement document itself, and not just its terms, must be approved by the board and signed by authorized officers of each corporation.  Corp. C. §§ 6011, 6013, 6019.1(e), 8011, 8013, 8019.1(f) & 9640.  The merger agreement must contain:

     (1)     the terms of the merger;

     (2)     any amendments to the articles or bylaws of the surviving corporation required by the merger;

     (3)     the name, place of incorporation and status of each party;

     (4)     the identity of the surviving party;

     (5)     the manner of converting memberships of one entity into the other (if applicable);

     (6)     any other desirable provisions; and

     (7)     any provisions or details required by the laws under which any party to the merger is organized
  
Taxes

The surviving entity is deemed to have assumed the California tax liability of the disappearing entity.  After filing the aforesaid certificates, the Secretary of State will notify the Franchise Tax Board of the merger.  Corp. C. §§ 6020.5(b), 8020.5(b) & 9640(a).

The final Form 990 return must be filed four months and 15 days after the date of the organization's termination.  The organization must also file Schedule N, which includes:

     (1)     a description of the assets and any transaction fee, the date of distribution, the fair market value of the assets and information about the recipients of the assets;

     (2)     a disclosure of whether an officer, director, trustee or key employee is or is expected to be involved in the successor entity; and

     (3)     a certified copy of the articles of dissolution or merger, resolutions and plans of liquidation or merger.

Only a certified public accountant or other properly licensed tax professional can advise you on the tax implications and reporting requirements of a merger.


Filing with Secretary of State

The merging corporations prepare certificates of approval of the merger, which the surviving entity attaches to a copy of the merger agreement and any amendments to the surviving entity’s articles required by the merger, all of which is filed with the Secretary of State.  The surviving entity files the disappearing corporation’s officers’ certificate with the Secretary of State.

Friday, December 19, 2014

Too Early to Dismiss? BAP Overturns Order Dismissing Chapter 11 Case as Bad Faith Filing

In Sullivan v. Harnisch (In re Sullivan), CC-14-1225-TaDKi (9th Cir. BAP December 9, 2014), the Bankruptcy Appellate Panel of the United States Court of Appeals for the Ninth Circuit (the "BAP") reversed a bankruptcy court order dismissing a chapter 11 bankruptcy case as having been filed in bad faith. 

The case was commenced by filing a skeletal bankruptcy petition.  The debtor filed a status report eight days later.  Six days later, the debtor filed schedules and a statement of financial affairs.  The next day, the creditor (who held judgments and judgment liens) moved to dismiss the case as a bad faith filing, contending that the bankruptcy case amounted to a two-party dispute and was filed solely to delay collection attempts.  The creditor further contended that confirmation of a chapter 11 plan was unlikely because the creditor would vote against it.  

The hearing on dismissal was scheduled simultaneously with a scheduling conference as well as the debtor’s motions to employ counsel and approve a budget.  The bankruptcy court called the motion to dismiss first.  After argument, but without testimony or other evidence, the court took the motion under submission and continued the remaining hearings. Thereafter, the court dismissed the case, finding bad faith and no possibility of confirming a plan.  The debtor appealed.

The BAP ruled that the bankruptcy court abused its discretion by considering to consider the interests of the creditor who moved for dismissal and not the best interests of creditors in general.  It is also important to note the speed of the proceedings and the fact that dismissal came before the first steps of the case.  

Creditors and bankruptcy judges favor early dismissal if a case was clearly files in bad faith as delay causes harm.  However, in future cases, bankruptcy judges and attorneys may ask themselves:  "Is it too soon for dismissal?"

Wednesday, December 17, 2014

Mandatory Subordination Does Not Compel Claim Disalowance and Does Not Apply to Individual Debtors

In Khan v. Barton (In re Khan), CC-14-1021-TaDKi, CC-14-1041-TaDKi, CC-14-1062-TaDKi (9th Cir. BAP Dec. 9, 2014), the Bankruptcy Appellate Panel of the United States Court of Appeals for the Ninth Circuit (the "BAP") held that mandatory subordination of a claim under Bankruptcy Code Section 510(b) does not compel disalowance of the claim and does not apply to individual debtors.

In Khan, a creditor obtained judgment against the debtors and their corporation for conversion, fraud, breach of fiduciary duty and loss of common stock shares.  Thereafter, each of the debtors filed a chapter 13 bankruptcy petition.  The creditor filed proofs of claim in both cases. The creditor also commenced adversary proceedings to render the judgment nondischargeable.  The debtors responded by filing adversary proceedings for mandatory subordination of the creditor's claims under Section 510(b) and for disallowance of the claims.
The bankruptcy court ruled in favor of the creditor and dismissed the debtors' adversary proceedings with prejudice. On appeal, the BAP affirmed.

The court held that subordination of a claim does not compel disallowance because it impacts only the order of distribution among creditors, not the validity of the claim itself.  Moreover,  Section 510(b) does not apply to individual debtors; it applies only to claims against corporate debtors.

Tuesday, December 16, 2014

Bankruptcy Judges Luncheon 2015

Reno Fernandez will introduce Chief Judge Alan Jaroslovsky and Judge Stephen L. Johnson as well as the incoming chair of the Bar Association of San Francisco's Commercial Law and Bankruptcy Section at the annual Bankruptcy Judges Luncheon on Tuesday, January 13, 2015, at noon at the City Club in San Francisco.  We expect an excellent program and discussion, as in past years.  This program ordinarily sells out, and we encourage you to RSVP.




January 13, 2015
Noon to 1:30 pm

City Club of San Francisco
155 Sansome Street
San Francisco, CA 94104


Wednesday, December 10, 2014

Bankruptcy Resources for Financial Educators

On May 27, 2010, Reno Fernandez and two other panelists presented a program on bankruptcy resources for financial educators to the Financial Education Network of San Francisco, hosted by the Federal Reserve Bank of San Francisco.  Check out the video here.

Wednesday, December 3, 2014

If You Are A Spendthrift (Trust), Go To Hawaii

A valid spendthrift trust is entitled to certain protections in bankruptcy, especially in Hawaii.  In In re Zukerkorn, 500 B.R. 598 (9th Cir. BAP 2013), the Bankruptcy Appellate Panel of the United States Court of Appeals for the Ninth Circuit (the "BAP") upheld the decision of California Bankruptcy Judge Alan Jaroslovsky ruling that a Hawaii spendthrift trust was valid and entitled to full protection under Hawaii law.

A spendthrift trust is used to transfer the beneficial interest in assets, often to children or grandchildren, with restrictions on spending.  Because the beneficiary's use of funds is restricted, the trust is entitled to certain protections from execution by creditors.  For example, in California, creditors generally can reach only 25% of distributions to the target beneficiary under California Probate Code Section 15306.5.  Under Hawaii law, by contrast, the distributions are fully protected.

In Zukerkorn, the debtor and his mother lived in Hawaii, and the mother held assets in Hawaii.  The debtor's mother set up a spendthrift trust, with a Hawaii choice of law clause, for the benefit of her two sons.  After the death of his mother and brother, the debtor became the trustee and moved to California with his two children, also beneficiaries under the trust.

The debtor filed bankruptcy in California. The bankruptcy trustee sought turnover of 25% of the debtor's future distributions and raised traditional choice of law arguments, including that California has a more substantial interest in the matter and Hawaii's full protection of spendthrift trusts violates a fundamental policy of California law.

The bankruptcy court ruled that the trust was governed by Hawaii law and fully protected.  The trustee appealed, and the BAP affirmed.

The BAP held that Hawaii has a substantial relationship to the dispute.  Moreover, the BAP held that Hawaii's full protection for spendthrift trusts does not violate a fundamental policy of California law.  Accordingly, the BAP held that Hawaii law applies.

It will be interesting to see whether this opinion encourages foreign choice of law provisions in spendthrift trusts in California and throughout the Ninth Circuit.  The fact that there was a clear, concrete connection to Hawaii in this case, and the fact that this is a decision of the BAP and not the Ninth Circuit, may discourage a mass migration toward foreign choice of law provisions.

Monday, December 1, 2014

Discharging Student Loans

A recent opinion, namely In re Hedlund, 718 F.3d 848 (9th Cir. 2013), may make it easier to discharge student loans.  In Hedlund, the debtor borrowed approximately $85,000 for college and law school.  He failed the bar examination three times and took a job as a youth counselor.  The debtor was 33 years old and married with one child.  The debtor filed bankruptcy and sued for a declaration that his student loan debts were dischargeable.


The court applied the tough "undue hardship" standard for discharging student loans in an unusually lenient way.  The undue hardship standard requires that (1) the borrower and his or her defendants cannot maintain a minimal standard of living, (2) this is likely to be the case for a significant portion of the repayment period, and (3) he or she made a good faith effort to repay the loan.


The bankruptcy court determined that the debtor's family expenses were reasonable - including two cell phones, an automobile lease and cable television - notwithstanding the fact that his wife worked only one day per week and could work three and the debtor turned down a repayment plan he contended was itself unaffordable.  Accordingly, the court entered a partial discharge, discharging all but $32,080 of the student loans.

On appeal, the district court reversed.  However, the United States Court of Appeals for the Ninth Circuit reversed the district court and affirmed the bankruptcy court's original ruling.



The Ninth Circuit held that the district court erred by reviewing the bankruptcy court's finding of good faith de novo rather than under the "clear error" standard.  This gives bankruptcy courts significant leeway in determining whether the facts at hand support a finding of good faith, but it may be a double edged sword for debtors with unsympathetic facts.

The Ninth Circuit also held that bankruptcy court's application of the undue hardship standard was supported by substantial evidence that the debtor had maximized income, minimized expenses and attempted to negotiate repayments.  This holding is likely to provide significant help to former students attempting to discharge student loans.



Also seen on Legal By the Bay, the blog of the Bar Association of San Francisco.