Institutions of Higher Education and Access to Bankruptcy: Are Things as Simple as They Seem?

May 18, 2015

Recently, Corinthian Colleges, Inc., one of the United States' largest for-profit educational conglomerations with 72,000 students across 107 campuses, filed (along with 25 affiliated subsidiaries) a chapter 11 voluntary petition for bankruptcy protection. Corinthian reported $19.2 million of total assets and US$143.1 million of total debts, and plans to liquidate. The general consensus seems to be that federal law makes bankruptcy reorganization all but impossible for educational institutions because, per nonbankruptcy federal statutes and regulations, filing for bankruptcy makes the institutions instantaneously ineligible to receive federal student loan funding. But things may be more complicated—and a little rosier for colleges and universities—than the perceived wisdom assumes. 

Title IV of the Higher Education Act of 1965 (the “HEA”) authorizes a number of important federal financial aid programs, including Pell grants, Perkins loans, and the Federal Work-Study program; it is the primary source of federal student aid. Students depend on these programs and many would not be able to afford post-secondary education without them. Likewise, institutions of higher education depend on the money made available to students by these programs to fund their operations. 

Department of Education regulations set numerous criteria that a school must meet to qualify as an “eligible institution,” a gate keeping requirement necessary to reap the benefits of the Title IV loan programs. One such regulation disqualifies any school that files for relief in bankruptcy from participating in Title IV. 34 C.F.R. 600.7(a)(2)(A); see also 20 U.S.C. § 1002. Per that regulation, once a school files for bankruptcy it is forevermore ineligible to benefit from the loan and grant programs established by the HEA. 

For-profit colleges are often designed specifically to capture federal loan dollars; Title IV is essentially their whole reason for being. As the industry faces continued financial pressure due to, among other things, regulatory scrutiny and decreased enrollment, financial restructurings would be necessary to assure their survival. According the accepted wisdom (that they lose the ability to participate in programs that fund student loan upon bankruptcy filing), however, they will be forced to navigate their dire financial straits without the safety net of bankruptcy reorganization. But two separate aspects of the bankruptcy code may leave the courthouse door open to educational institutions that wish to reorganize under Chapter 11. 

First, the contract-like relationship that the HEA creates between the colleges and the government may prove critical. In most cases, access to Title IV loans and grants is premised on written “program participation agreements” between the institutions and the Secretary of Education. See 34 C.F.R. 668.14. Pursuant to section 365 of the bankruptcy code, these agreements may be assumable as executory contracts. See e.g., In re Bayou Shores SNF, LLC, 525 B.R. 160 (Bankr. M.D. Fla. 2014) (allowing a nursing home to assume Medicare provider agreements notwithstanding limitations similar to the HEA’s). 

Second, the HEA’s scheme of revoking Title IV eligibility status automatically upon bankruptcy filing is inconsistent with the anti-discrimination provision of the bankruptcy code. Section 525, protects against retaliation based solely on the fact that a debtor filed a bankruptcy petition. Notably, while bankruptcy code sections 362 and 541 were amended in 1990 to except the termination of HEA eligibility from the automatic stay and to exclude HEA eligibility from property of the estate, section 525 was not. And section 525, by it explicit terms, applies “except as provided in [specific statutes],” and does not list the HEA as an exception. While two bankruptcy courts held that the revocation of HEA eligibility did not violate Section 525, see In re Betty Owen Sch., Inc., 195 B.R. 23 (Bankr. S.D.N.Y. 1996); In re Lon Morris College, No. 12-60557 (Bankr. E.D.Tex. Aug. 20, 2012), the statutory analysis the courts used to reach this conclusion is not irreproachable, since they did not consider the executory contract aspects of the agreements, or the literal language of section 525 which fails to list the HEA as an exception to its coverage. 

Neither the issue of contract assumability nor the HEA’s inconsistency with section 525 have been litigated fully enough to definitively answer the question of whether educational institutes are barred, for all intents and purposes, from reorganizing under chapter 11.

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