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The "Overwhelming Incentives" to Avoid Bankruptcy

posted by Matthew Bruckner

Shutterstock_118095742In an earlier post, I claimed that Thomas Jefferson School of Law’s recent debt restructuring was the rational response to its recent financial difficulties. I closed that post by suggesting that bankruptcy was not a viable option for Thomas Jefferson’s creditors because of U.S. Department of Education (“E.D.”) regulations. Those regulations provide that a voluntarily bankruptcy filing terminates an institution’s eligibility to participate in Title IV loan programs (e.g., Stafford, Perkins and Plus loans). As a result, law schools and their creditors ordinarily share “overwhelming incentives . . . in avoiding bankruptcy”. See Marblegate Asset Mgmt. v. Education Mgmt. Corp., 2014 WL 7399041,*11. (S.D.N.Y. Dec. 30, 2014).

A brief discussion of those regulations and their implications follows after the jump.

In order to qualify as an “eligible institution” and participate in Title IV loan programs, a school must meet a number of criteria set forth in 20 U.S.C. § 1002(a)(4)(A) and 34 C.F.R. § 600.1 et. seq. Most relevant to this post is that the school shall not have filed for relief (or had an order entered against it) in bankruptcy. See 34 C.F.R. § 600.7. For schools that are heavily dependent on student loans (as many are), losing access to federal student loan dollars can be devastating. Consider, for example, that Corinthian Colleges, one of the nation’s largest for-profit, post-secondary education companies, recently collapsed and filed for bankruptcy after the E.D. imposed only a 21-day waiting period on the school’s ability to access student loan dollars. This slight delay appears to have been the precipitating cause of the college's collapse. Given that some law schools’ business models—including Thomas Jefferson's—are based primarily on earning revenue from federal, student-loan funded tuition dollars, and that a voluntary bankruptcy filing would likely cause that revenue stream to evaporate, it seems clear that avoiding bankruptcy would have been one of the highest priorities for Thomas Jefferson School of Law’s creditors.

Still, colleges declare bankruptcy with some regularity, and the same forces that act on those colleges could precipitate a law school’s bankruptcy filing. One of the primary benefits of a bankruptcy filing might be to facilitate the sale of some or all of an institution’s assets. Given the ED regulations, however, this strategy depends on finding a buyer who is itself an “eligible institution” under Title IV, and therefore capable of independently participating in Title IV loan programs. For example, this seems to be the strategy followed by Education Training Corp. (operating the Anthem Colleges and Florida Career College brands), according to its first day papers. For a law school to successfully execute this strategy, it would require the existence of a willing (and Title IV eligible) buyer for a failing law school. In this market, that seems like it could be hard to find.

Image from Shutterstock


A very interesting piece. It is indeed a matter of considerable concern that one of the very few places where bankruptcy protection is denied is higher education. The draconian sanction applied to an institution that files for bankruptcy protection is a double-edged sword: it is a very strong disincentive to a forced bankruptcy (which has the same effect as a voluntary, except the sanction goes into effect when the petition is granted rather than, in the case of a voluntary, when it is filed), and therefore encourages voluntary work-outs, but where the only solution is the mitigation of debt it has caused many otherwise viable institutions to shutter their doors. Nor it is easy to transition to another, existing institution: in the case of Anthem what should have been an easy solution that would have been protective of a large number of students was rejected by the Department of Education. There are solutions, but as Prof. Bruckner notes, they are difficult to execute.

The anti-bankruptcy rules were enacted to prevent an unscrupulous school owner from continuing to access Federal student aid while milking the institution. A classic example of the use of a blunt object where a scalpel was in order. There is a growing body of opinion that the anti-bankruptcy provisions of the Higher Education Act (and the companion language in the Code itself) are contrary to the public interest, and should be replaced by a more rational approach that allows financially troubled institutions to rehabilitate themselves.

Michael B. Goldstein
Co-Chair • Higher Education Practice
Cooley LLP
1299 Pennsylvania Avenue, NW • Suite 700
Washington, DC 20004-2400
Direct: +1 202 776 2569
Fax: +1 202 842 7899 • Cell: +1 202 215 9606
Email: [email protected]

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