New student debt rule could harm taxpayers and spur speculative litigation

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President Obama often cites escalating college costs and student debt burdens as major obstacles to upward mobility for many young Americans. He is right, but the White House just proposed a new rule that, rather than make college more affordable, makes it too easy for students to get out of paying back their student loans. The problem is that it could stick American taxpayers with the bills, lead to speculative litigation against colleges, and deprive students of valuable courses.

What triggered the new rule was last year’s collapse of Corinthian College, a for-profit college with more than 100 campuses. After it closed, thousands of Corinthian students asked the Department of Education to discharge their loans. Among other things, they alleged that Corinthian had misrepresented job placement rates. A special master has been appointed to discharge the debt of any student illegally duped into attending Corinthian.

{mosads}This loan discharge program, first adopted in 1995, has worked fairly well. It provides a legal backstop for vulnerable students when a college commits fraud or otherwise violates state law related to the loan or services for which the student paid. The government forgives the loan and tries to recoup the costs from the college, but taxpayers generally pay the tab. The program had been sparingly used, and the recent mass of claims exposed some procedural inefficiencies.

Rather than just address process issues, the Education Department is fundamentally changing the program substantively. First, it is reducing the standards for when loans can be discharged. No longer will a student have to show fraud or prove the college broke a state or federal law. The Department could discharge a loan whenever it concludes a college made a “statement that has the likelihood or tendency to mislead under the circumstances” or “omits information” on which a person “could reasonably be expected to rely, or has reasonably relied” to his or her detriment.

Under this reform, it would not matter whether the college even intended to deceive a student – a key element of fraud. Claims could be based on a good faith mistake or information that later turned out not to be fully true. There is no question that students who are defrauded should be protected. The rule’s current requirement to show that the school acted illegally provides a sound, objective measure for when the government needs to protect students from bad actors.

Second, the proposed rule puts too much power in the hands of the Education Department. In addition to giving the agency full discretion over when to discharge a loan, it sets up an inherent conflict of interest. The Department represents the borrowers and makes all determinations over whether to discharge the loans. The proposed rule also gives the Department the unprecedented ability to order large-scale student debt relief, even when many students in that group have not filed claims. When claims are aggregated in court, there are safeguards to assure aggregate or class treatment is appropriate. The lack of protections here raises major due process concerns.

Finally, the proposed rule fosters speculative lawsuits. It bars colleges from including in enrollment agreements clauses requiring disputes to go to arbitration, rather than litigation. These clauses have grown in popularity across economic sectors because arbitration is much less expensive for both sides than litigation. Getting rid of these clauses has been the plaintiff-bar’s top priority, and they have set about to bar these clauses through friendly federal regulations. As a result, any Department determination to discharge a loan under this program will undoubtedly be followed by individual and class actions, even when no law was violated.

There has been speculation that the Department wants to use this new rule to go after for-profit schools. But, these changes do not appear limited to for-profits alone. A few years ago, more than a dozen law schools faced lawsuits over their job and salary statistics. The judge dismissed the case because no laws were broken and job prospects for graduates are always uncertain. Under the proposed rule, the Department could nonetheless free these students from their loans, giving a benefit that is neither supported by law nor available to students who paid their tuition.

Discharging these loans is not free or without consequences. The Department estimates the cost to taxpayers alone at $43 billion over the next 10 years. The Office of Management and Budget concluded that, when considering the impact on the education system as a whole, the proposed rule is “economically significant,” meaning it will have an annual effect of at least $100 million. Schools will likely have to raise tuition to offset losses, and if for-profit colleges are unfairly targeted, they may cut back on programming that help people develop needed practical skills.

If any college – public, non-profit or for-profit – defrauds students, the school should be held accountable. But, expanding public and private litigation absent a violation of law does not advance sound legal principles. The objectivity and due process protections in the current rule help ensure that the extraordinary measure of discharging contractual obligations is available only when unquestionably appropriate. The Department should pull back this proposed rule and look for other ways to address the student debt crisis.

Phil Goldberg is the Director of the Progressive Policy Institute’s Center for Civil Justice and a partner in the Washington, D.C. office of Shook Hardy & Bacon, LLP.

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