Information Released on “State Law Cause of Action” Student Loan Discharge

On June 9, 2015, as reported by Insider Higher Ed and the The Chronicle of Higher Education, the US Department of Education (“Department”) released information related to the loan discharge options of students at schools formerly owned by Corinthian Colleges Inc. (“CCI”). The fact sheet released by the Department (and a related blog post by Department Undersecretary Ted Mitchell, and the transcript of a call with the press) describes a number of efforts to discharge loans owed by students at CCI’s Heald College, WyoTech and Everest College.  In addition, on June 10, the Department published a notice in the Federal Register seeking comment on a proposed “emergency collection” that would “facilitate the collection of information for borrowers who believe they have cause to invoke the borrower defenses against repayment of a loan.”  (It does not look like there is a comment period specified). [JUNE 23, 2015 UPDATE: The Department published a Federal Register notice providing a 60-day comment period]

The fact sheet describes how students of Heald College — which the Department fined nearly $30 million for alleged misrepresentations made related to job placement statistics — “who relied on misrepresentations found in published job placement rates for many Heald programs qualify to have their federal direct student loans discharged.”  While students at other CCI schools may be eligible for discharge due to state law violations, Heald College students can rely on the Department’s finding as a finding that the Heald committed an “act or omission” “that would give rise to a cause of action against the school” which, in turn, serves as a defense to the repayment of the student loan pursuant to 34 C.F.R. § 685.206(c)(1).  The Department will also appoint a Special Master to review the claims.

For those unfamiliar with the concept of student loan discharge under 34 C.F.R. § 685.206(c)(1), you are not alone.  This defense to repayment of a student loan has only been used five times in over a twenty years.  Specifically, the regulation provides:

In any proceeding to collect on a Direct Loan, the borrower may assert as a defense against repayment, any act or omission of the school attended by the student that would give rise to a cause of action against the school under applicable State law.

Importantly, the Special Master appointed by the Department “will help develop a broader system that will support students at other institutions who believe they have a defense to repayment.”  Given the Department can seek recoupment of any discharged loan funds from an institution, this is a very serious development that could impact every institution of higher education.

As provided for in section 34 C.F.R. § 685.206(c)(3), the Secretary:

may initiate an appropriate proceeding to require the school whose act or omission resulted in the borrower’s successful defense against repayment of a Direct Loan to pay to the Secretary the amount of the loan to which the defense applies.

To be sure there are some limitations on the ability of the Department to seek recoupment.  For example, the regulation makes clear that the Secretary cannot “initiate such a proceeding [for recoupment] after the period for the retention of records described in § 685.309(c) unless the school received actual notice of the claim during that period, resulting in a three year statute of limitations on recoupment claims” (§ 685.309(c) cites 34 C.F.R. § 668.24, the records retention regulation, which establishes a three-year record retention requirement). In addition, as noted in the preamble to the final rule:

The Secretary notes that the regulations identify formal proceedings in which borrowers may raise the acts or omissions of the school as a defense against collection of the loan. . . . . Moreover, schools are further protected from frivolous claims by the requirement that the Secretary initiate a second proceeding to enforce a liability against the school.

Thus, it appears schools will have the opportunity to mount a defense in a “second proceeding.” Nonetheless, given the amount of money that could be lost due to the loan forgiveness, I have to believe the Department will seek recoupment whenever and wherever possible. It seems this may be the only way to justify this to the Office of Management and Budget and others concerned about the budget.

There are a number of unresolved issues with the Department’s intended use of the loan discharge that will determine just how big an issue this is. First, the regulations describe a defense to collection, not a proactive application, which makes the Department’s move. Next, it’s not clear what actions will give rise to the state cause of action suitable for the defense. In addition, putting aside the Heald matter (and use of a Special Master) it’s not clear what type of “proceeding” will be used in either the initial determination with the student or in any recoupment action.

It is very strange to have a proactive use of this section, given the regulation requires that the defense to payment be raised in a “proceeding to collect on a Direct Loan” (such as wage garnishment). Indeed, when a student has defaulted on a loan (which, pursuant to 34 C.F.R. § 685.211(d), would permit the Department to bring such a collection action), there is at least a presumption that the education provided by the school hasn’t necessarily worked out for the student – the job outcomes were not realized and the student cannot repay the loan. A student would not be in this situation – and suffer the collection calls and negative notations to the student’s credit rating – needlessly. This is an important check on frivolous claims for discharge; by allowing a proactive use of the “defense,” students that have graduated, have jobs, and have the ability to pay back the loan may assert request loan discharge.

This makes it all the more important the nature of the state law cause of action that would support the discharge. As explained in July 21, 1995 notice of interpretation, a defense to repayment based on acts or omissions that provide a student with a state law cause of action will be recognized “only if the cause of action directly relates to the loan or to the school’s provision of educational services for which the loan was provided.” (The NPRM and Final Rule are largely silent on this issue). So, while it appears zoning violations or causes of action for slips and falls may not make the cut, it is still unclear what would be an act or omission that would give rise to a cause of action for the student. For example, while job placement services arguably do not “directly relate” to the provision of educational services, the Department has already, in the case of Heald, found that misrepresentations about job placement can support a discharge. Moreover, here are just a few of the questions that need to be addressed:

• is a breach of contract related to the education services a a cause of action (with the act or omission giving rise to the breach)?
• does the student have to be able to bring the action?  Are jurisdictional or procedural defenses to the cause of action relevant?
• would causes of action under consumer statutes – such as, for unfair business practices – support a discharge if the underlying violation of the law (such as failure to have a complete student file, or if a faculty member’s license briefly lapses prior to renewal) does not provide a cause of action to the student?
• are any misrepresentations enough to support a cause of action?  Would misrepresentations to US News and World Report that improve a school’s ranking be actionable?

In the Heald mater, the Department intends to use a special master to review claims of students for loan discharge. As a result, it appears the “formal proceeding” required under the regulation can take the form of the other types of proceedings identified in the regulation as examples (tax refund garnishment, wage offset, etc.) that are handled by the agency (34 CFR Part 30 describes the process), rather than a proceeding before a judge.  Hopefully Heald is a special case. Continued use of a Special Master is concerning, as having a federal judge, or an administrative judge review the facts would have served as a strong check on abusive claims for discharge and the influence of politics in the process. Moreover, in providing the “second proceeding” described in the preamble to the Final Rule, the Department could employ administrative judges to review the matter de novo, give no deference to a decision of the Special Master, and hear the evidence from the institution. This may ultimately protect institutions from recoupment related to frivolous claims – even if the Department uses a Special Master for resolving the underlying student claims (although the discrepancies in the law produced will need to be rectified somehow.

The Department has made clear that it will utilize the special master appointed to deal with the Corinthian students to review a process to be applied to other schools.   While it’s not clear that the Department would have to draft new regulations for this purpose (it could be guidance to the special master), the Department has said it “will develop new regulations to clarify and streamline loan forgiveness under the defense to repayment provision, while maintaining or enhancing current consumer protection standards and strengthening those provisions that hold colleges accountable for actions that result in loan discharges”  I think this is the wiser course, but seeking regulatory cover suggests to me that the Department is more likely to be aggressive in these regulations — institutions beware.