Allow universities to restructure themselves through bankruptcy

Despite, or perhaps, because of, the higher education boom in the years immediately following the Great Recession, colleges and universities are now facing increased financial pressures.  Enrollments are down by nearly one million students from 2012 levels.  These decreases in enrollment have not only hurt everyone’s bottom line, but institutions are now subsidizing students that do enroll at exceedingly high levels.  Add in the disruptions caused by innovations in the delivery of education and the financial constraints accompanying capital projects undertaken when times were good, it is unsurprising that analysts such as Bain & Company report that, over 60 percent of institutions are on an “unsustainable financial path” or at financial risk.

Unfortunately, institutions of higher education have a significant limitation on their ability to restructure debt. Practically speaking, they can’t declare bankruptcy.  Despite the general nondiscrimination provision in the bankruptcy code, changes to the Higher Education Act in 1992 require that a college filing for bankruptcy immediately and irrevocably loses access to the federal loans and grants authorized under Title IV of the HEA.  Considering that approximately 85 percent of students utilize Title IV programs to pay for tuition, this restriction makes filing for bankruptcy a nonstarter.

{mosads}This has the effect of making debt restructuring in higher education exceedingly difficult. Schools know lenders won’t force them into bankruptcy because doing so will greatly reduce the value of the institutions and make collecting on their debts nearly impossible.  Debt holders are thus forced into the position of equity – owning schools – which isn’t a risk most debt holders assumed.  Conversely, equity (and management in the non-profit context) is also hampered by having far fewer options to settle debts than in bankruptcy.  As the economics become worse, regulators, rightfully concerned with the financial health of the institution, pile on data requests and various restrictions (including delays on receipt of the very Title IV funds the school is counting on).  As each regulator adds inquiries and data requests, the regulatory “death spiral” only makes it harder to keep the institution a viable going concern.

The result of this is schools must either declare bankruptcy and implode (like the non-profit Lon Morris College in 2013 or the for-profit Anthem College in 2014) or, in many cases, go through a protracted consensual foreclosure process to accomplish, in essence, a debt-for-equity swap (as was done with the for-profit ATI Enterprises in 2013).  Not only is this bad for institutions and their lenders, but this situation also places students and the taxpayers at great risk.  When institutions close unexpectedly, the students will have wasted time, money and effort in moving toward an education credential that will never come to fruition.  Taxpayers also suffer losses because students are able to extinguish their federal student loan debt associated with attendance at the now closed school.  Thus, the taxpayer is out not only the grant funds already provided for an incomplete education, but also on the expected student loan repayments as well.

As a nation, we have a strong interest in preserving our system of higher education.  Indeed, despite talk of the “higher education bubble” and cries about quality and cost, America’s colleges and universities are still the envy of the world.  There is a reason, as the Brookings Institute highlighted, that the number of foreign students on F-1 visas in U.S. colleges and universities grew from 110,000 in 2001 to 524,000 in 2012.  Further, studies have shown that college graduates are likely to earn dramatically more money than those without a college degree, are less likely to be unemployed, and are less likely to live with their parents.  Thus, it is in everyone’s interest to responsibly allow institutions of higher education to restructure their debt so they may continue to fulfill their educational missions.

I propose that bankruptcy reform in this area be guided by four principles.  First, given that most institutions are largely funded by tuition revenues from the Title IV programs administered by the Department, institutions cannot be allowed to extinguish debts to the US Department of Education through any bankruptcy process.  Indeed, just as students cannot extinguish student loan debt to the federal government (absent a showing of undue hardship) it doesn’t seem right to let institutions off the hook for liabilities to the Department.  Moreover, this limitation also addresses the original concerns that gave rise to the restriction in the first place, namely allowing institutions to escape regulatory scrutiny and the recovery of liabilities owed to the government.  Thus, we should allow the Department ample time (say thirty days) to establish the liabilities owed to the Department and the institution must find a way to pay back those liabilities.

Second, we cannot allow institutions to continue with the leaderships that led them to their financial conditions.  Given the federal investment in higher education, school owners and board members have an obligation to be careful stewards of taxpayer dollars.  As such, any bankruptcy of a proprietary institution must be occasioned by a sale of assets to a non-affiliated third party.  Similarly, non-profit institutions going through a restructuring (for which a sale doesn’t make sense) would have to have new boards appointed.

Third, any process should utilize pre-existing processes.  There is no need to reinvent the wheel. The bankruptcy process works well. Additionally, the pre-existing procedures applicable to the transfers of ownership and leadership are more than adequate.

Lastly, we must ensure that students have the ability to complete their educations without delay, or significant hardship, occasioned by a school’s restructuring.  As a result, institutions cannot be permitted to relieve themselves of obligations to students as a result of the restricting process and there should be no cessation in the ability of institutions to receive Title IV funds throughout the process. These measures, which promotes student completion, allow the institution and the student to operate as if nothing has happened at all.

While there was a strong case in 1992 for precluding institutions of higher education from utilizing the bankruptcy, it is time to revisit this policy.  With smarter rules aimed at avoiding the abuses used in the past, we can help strengthen our colleges, universities, and the capital markets working with those institutions.  Moreover, we can protect taxpayers from significant losses that would occasion a precipitous closure of a school.  Lastly, we can help ensure students maintain their ability to complete their educations – at financially stronger institutions – which should be the goal of every higher education policy.

Cariello is a lawyer and former deputy general counsel for Postsecondary Education and Regulatory Services in the U.S. Department of Education.  He is currently chair of Regulatory Strategies and Compliance for the Education Group at law firm DLA Piper.