Liability for Collection Costs on Rehabilitated Loans: The July DCL and Related Litigation Shelly...

Liability for Collection Costs on

Rehabilitated Loans:

The July DCL and Related Litigation

Shelly Repp NCHER

Joseph P. Esposito Hunton & Williams LLP

Department of Education:

A guaranty agency cannot charge collection costs to a defaulted borrower who, within the 60-day period following the initial notice, enters into a repayment agreement, including a rehabilition agreement, and honors that agreement

-Amicus brief filed by DOJ in the appeal of the Bible decision (May 21, 2015) Dear Colleague Letter GEN-15-14 (July 10, 2015)

Higher Education Act:

1. General Provision“a borrower who has defaulted on a loan made under this title [title IV] shall be required to pay, in addition to other charges specified in this title, reasonable collection costs;” Section 484A (b)(1)

2. Rehabilitation ProvisionA guaranty agency “may in the case of a sale [of a rehabilitated loan] made on or after July 1, 2014, in order to defer collection costs (aa) charge to the borrower an amount not to exceed 16 percent of the outstanding principal and interest at the time of the loan sale; and (bb) retain such amount from the proceeds of the loan sale;” Section 428F(a)(1)(D)(II)

ED Regulations

1. “the guaranty agency shall charge a borrower an amount equal to reasonable costs incurred by the agency in collecting a loan on which the agency has paid a default or bankruptcy claim” 34 CRR 682.410 (b)(2)

2. “The guaranty agency, after it pays a default claim on a loan but before it reports the default to a credit bureau or assesses collection costs against a borrower shall…provide the borrower with –

a) Written notice that meets the requirements of paragraph (b)(5)(vi)…;b) [an opportunity to inspect records relating to the loan];c) An opportunity for an administrative review of the legal

enforceability or past-due status of the loan obligation; andd) An opportunity to enter into a repayment agreement on terms

satisfactory to the agency. 34 CFR 682.410 (b)(5)(ii)

ED Regulations Continued…

3. “The deadline established by the agency for requesting administrative review under paragraph (b)(5)(ii)(c) of the section must allow the borrower at least 60 days from the date of the notice…” 34 CFR 682.410 (b)(5)(iv)(b)

Dear Colleague Letter GEN-15-14 (July 10, 2015)

• Restates and clarifies the rules• A rehabilitation agreement is a repayment agreement • Nothing in rehabilitation regulations exempts loan rehabilitation

from the general rule that allows a guarantor to charge collection costs only to a borrower who fails to enter into a repayment agreement satisfactory to the agency within the 60-day period following the initial notice

• The loan rehabilitation agreement is an agreement the agency must accept as satisfactory

• Thus, a guaranty agency cannot use the collection activities otherwise required if a borrower in the 60-day period enters into a rehabilitation agreement and then honors the agreement

• 2006 HEA Amendment that provides that a guaranty agency may charge collection costs upon sale of rehabilitated loan merely codified existing permissible costs and did not empower agencies to charge costs not previously permitted

Additional Considerations:• No agency written up during numerous audits and

reviews• July 28, 1997 private letter to TG:

“If the agency obtains a signed repayment agreement from the borrower within the 60-day period, and the borrower begins to make payments, the agency is not required to assess the borrower collection costs.”

• OMB Circular A-133 Audit Guide Compliance Supplement “A guaranty agency may chose not to charge collection costs to a borrower who enters into a voluntary repayment agreement during the 60-day period after [the initial notice].”

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1. Bible v. USA Funds – District Court

• Lawsuit in Southern District of Indiana:– Bible brought a class action on behalf of

100,000 USA Funds borrowers– Asserted breach of contract and RICO

violation– District Court granted USA Funds’ motion to

dismiss

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Bible v. USA Funds – District Court

• 1) Breach of Contract claim: although MPN provided for collection costs if default occurs, MPN also incorporated HEA and associated regulations, which Bible argued do not allow collection costs when a defaulted borrower promptly enters into a Rehabilitation Agreement

• 2) RICO violation: Bible’s Rehabilitation Agreement stated that her current collection costs were $0, but $4,500 in collection costs were later assessed

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Bible v. USA Funds – District Court• District Court’s opinion:

– Bible’s claims are preempted by the HEA– Breach of contract claim is really a claim for a violation of

the HEA, and there is no private right of action under the HEA

– Breach of contract claim fails• MPN expressly allows collection costs, even if it also

incorporates the HEA and its regulations• Rehabilitation Agreement also expressly allows collection costs• The HEA regulations “clearly and explicitly authorized – and

mandated” the imposition of collection costs

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2. Bible v. USA Funds – 7th Circuit

• Bible appealed to the Seventh Circuit: merit briefs were filed in June-August 2014, oral argument was held on October 2, 2014

• In January 2015, Court invited the Department of Education to file an amicus brief stating its position on the correct interpretation of the HEA and its regulations

• Department’s May 2015 amicus brief agreed with Bible’s position: collection costs could not be assessed under these circumstances; and there was no preemption here

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Bible v. USA Funds – 7th Circuit proceedings

• Department of Education Amicus Brief:– HEA calls for “reasonable” collection costs, and left “reasonable” to be

defined by the Department– “The Department interprets its regulations to provide an exception with

regard to collection costs charged when a borrower promptly enters into a loan repayment agreement after the borrower has been notified by the guarantor that it has paid a default claim”

– The Department argued its interpretation of HEA should receive deference under Chevron, and its interpretation of its own regulations should receive deference under Auer

– Important to incentivize borrowers to enter into repayment agreements quickly, because if they don’t, the guarantor must then take steps to collect the debt, and this will be more costly

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• Department of Education Amicus Brief– The Department has always held this position– Purpose of 410(b)(5)(ii) is to allow borrowers to avoid all

adverse consequences if they promptly enter into a repayment agreement

• No default reporting• No collection costs imposed• No enforcement activities

– Similar collection costs must be assessed against borrowers in similar stages of delinquency

• A borrower who promptly enters into a Rehabilitation Agreement is not similarly situated to one who does not

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• USA Funds’ response to the Department’s Brief:– The Department’s interpretation is incorrect:

• It cannot be squared with the regulations or the statute

• It has never been stated before in any form• It is contrary to official guidance and industry

practice• It effectively creates a new regulation

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• USA Funds’ response:– “Rehabilitation Agreements” in 405 are not always and

automatically “satisfactory” repayment agreements under 410• Not all “repayment agreements” are “on terms satisfactory to the

agency” – if they were, this phrase would have no purpose at all• This substitution of “Rehabilitation Agreement” from 405 in place of

“repayment agreement on terms satisfactory to the agency” in 410 is something that has never been done by the Department before, although these regulations have been in place for over 20 years

• Rehabilitation Agreements are strictly defined with mandatory terms – no discretion on the part of guarantors is allowed

• The only mention of collection costs in 405 says that they are allowed for Rehabilitation Agreements

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• USA Funds’ response:– Government’s position is contrary to its prior positions– Department has never issued a Dear Colleague Letter stating this

position– Industry practice has been to the contrary, and the Department

never objected to it– The regulation upheld in the previous Barnes/Black 7th Circuit case

expressly allows collection costs, without exception• The Department in Barnes/Black took the position that guarantors should

asses collection costs under a Rehabilitation Agreement

– Costs associated with the rehabilitation program are quite substantial, whether agreement is entered into “promptly” or not

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• USA Funds’ response:– Department’s own publicly available guidance for

defaulted borrowers says nothing about avoiding collection costs by promptly entering into a Rehabilitation Agreement

• Department’s own website says that collection costs can be added if you enter into loan rehabilitation

– Effect of the Department’s position will be that Rehabilitation Agreements now will not be offered within 60 days of the notice of default

• This won’t help defaulted borrowers

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• NCHER’s proposed amicus brief responding to Department:– Department has never publicly taken this position– Since the statute and regulations are clear, the

Department’s interpretation is not entitled to any deference

– Collection costs are clearly allowed by both the statute and the regulations after a loan has been rehabilitated

– The website of opposing counsel, National Consumer Law Center, acknowledged collection costs can be imposed after rehabilitation

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• NCHER’s proposed Amicus brief:– Guarantors have long assessed collection costs

against defaulted borrowers who enter into Rehabilitation Agreements

– Department’s interpretation would punish guarantors for conduct that the Department has never prohibited

– Department is trying to use this lawsuit to impose a new rule without complying with the rulemaking procedures in the APA

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3. Seventh Circuit’s Decision• On August 8, 2015, 7th Circuit issued split decision, finding in favor of

Bible and reversing the district court• Court held that neither contract nor RICO claim is preempted• Court adopted Bible/Department interpretation of HEA and regulations:

a first-time defaulted borrower merely has to timely enter into and comply with an alternative repayment agreement to avoid collection costs

• RULE: No collection costs may be imposed if– 1) this is the debtor’s first default– 2) debtor enters into a repayment agreement within 60 days of

receiving notice; and– 3) debtor complies with that agreement

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Seventh Circuit’s Decision

• Court: Bible’s MPN expressly incorporated HEA and regulations into the terms of the contract, so USA Funds may only charge collection costs when allowed by the HEA and regulations

• HEA and regulations do not allow collection costs to be assessed in these circumstances

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Seventh Circuit’s Decision• 2-1 decision:

– One judge: the Bible/Department interpretation is the correct interpretation and Court should defer to Department

– One judge: the Court should defer to the Department’s interpretation

– One judge: the Bible/Department interpretation is erroneous and inconsistent with the statute and regulations

• Two judges: Department’s position will be followed because Department’s interpretation is entitled to deference

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• Breakdown of the Court’s holdings:– 3-0: No Preemption– 2-1: RICO claim can proceed– 2-1: Chevron & Auer deference is due to the

Department, so Bible/Department interpretation of the regulations prevails, and breach of contract claim can proceed

• 60 day exemption/safe harbor from collection costs is for any repayment agreement entered into within that time, including Rehabilitation Agreements

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Seventh Circuit’s Decision• Court: two consequences of default – reporting default to credit agencies,

and imposing collection costs– Waiting period in 410(b)(5)(ii) creates a safe harbor to allow

defaulters to cure their default and avoid both of these consequences• “USA Funds has given us no persuasive reason to treat one of the stated

adverse consequences of default (a bad credit report) differently from the other one (collection costs)”

– 60-day time limit for requesting administrative review under 410(b)(5)(ii) also applies to entering into repayment agreements, because borrowers must be allowed to first seek administrative review, then have the opportunity to enter into a repayment agreement

– This safe harbor incentivizes borrowers to enter into rehabilitation and voluntarily repay their loans

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• In a footnote, Court concluded that a Rehabilitation Agreement is one type of authorized repayment agreement

• Court: guarantors still retain discretion to set terms of Rehabilitation Agreement/ repayment agreement

• Guarantor has power to set and reject monthly pay amounts, but not to impose collection costs

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Seventh Circuit’s Decision• Court: even if this isn’t the best interpretation and USA

Funds’ interpretation is better, deference is still due to the Department’s interpretation under Chevron and Auer

• HEA does not define “reasonable collection costs,” so Congress left it up to the Department to define– Department’s interpretation of “reasonable” is

reasonable, so the Court will defer to it• Similar costs should be applied to borrowers at similar states

of delinquency, and a borrower who promptly enters into a repayment agreement is not similarly situated to one who does not

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Seventh Circuit’s Decision• No preemption – state law does not pose an obstacle to or

conflict with HEA and regulations– Federal law provides a standard of compliance, and duties

are enforced under state law– State law claim is complementary to the federal

requirements, not in conflict with them• This is not a disguised claim for violation of HEA

– Just because federal statute does not contain a cause of action does not mean that state law cannot provide a remedy in its stead, or that Congress meant to displace state law remedies

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Seventh Circuit’s Decision• RICO violation was adequately pled

– USA Funds, GRC, and Sallie Mae can collectively form a RICO “enterprise”

• Based on the economic interdependence between the entities, and the way they worked together on the loan rehabilitation process and debt collection activities

– Letters mailed to Bible and others stating that their current collection costs were $0 could have been misleading

• However, it remains to be seen whether Bible can prove fraudulent intent on the part of USA Funds

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Seventh Circuit – Concurrence• In order for Bible to win, “we are necessarily required to infer that

Bible’s rehabilitation agreement qualifies as a ‘repayment agreement on terms satisfactory to the [guarantor] agency,’” which “is no small inferential leap”– There is “a strong case” that these “are separate and distinct”

• Bible’s position is intuitively appealing, however, and both interpretations are plausible readings

• Therefore, deference is due to Department’s interpretation– “Given the regulation’s lack of clarity on this issue” [earlier

described as a “complex and ambiguous regulatory scheme”], I cannot conclude that the Secretary’s interpretation is either plainly erroneous or inconsistent with the regulations”

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Seventh Circuit – Dissent

• Agrees with the majority that there is no preemption• Disagrees with the Bible/Department interpretation• Bible’s whole theory is based on an “erroneous

equivocation,” that the loan Rehabilitation Agreement of 405 is the same as the repayment agreement of 410, a theory created for the first time by Bible in this case– This novel theory would grant Bible a complete

exemption from collection costs, despite the plain language of the statute

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Seventh Circuit – Dissent

• Department’s interpretation is unreasonable; statute and regulations are clear

• Two errors in Bible’s position:– 1) Waiting period for charging collection costs

applies to a different kind of repayment agreement than a Rehabilitation Agreement

– 2) Regulation does not contain a mandatory exception to charging collection costs for any kind of repayment agreement

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Seventh Circuit – Dissent• Under regulations, there are five options for a defaulted borrower:

– 1) She can avoid collection costs by paying her loan upon a demand for payment;

– 2) She can negotiate and enter into a repayment agreement on “terms satisfactory to the agency” that do not include collection costs;

– 3) If she can’t reach such terms, but can still enter into a repayment agreement, she avoids report of her default, but still must pay collection costs;

– 4) If she cannot enter into any repayment agreement, her default is reported and collection costs are assessed; or

– 5) She can enter into loan rehabilitation, which will result in a report of default and collection costs

• The default will be cleared from her record upon completion of rehabilitation

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Seventh Circuit – Dissent• Loan Rehabilitation is a separate program under 405 for borrowers

unable to meet the stricter repayment obligations of 410• Rehabilitation is not a full repayment agreement – the purpose is not to

repay the loan, but to make 9 out of 10 reduced monthly payments• Just because a guarantor accepts a Rehabilitation Agreement, that does

not make it on terms satisfactory to the agency – guarantors are required to accept a Rehabilitation Agreement

• If a Rehabilitation Agreement were a “satisfactory repayment agreement,” prompt acceptance would prevent both a report of default and the assessment of collection costs– But no one argues that timely acceptance of a loan rehabilitation

program prevents a report of default – that would be absurd, because it is required by 405

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Seventh Circuit – Dissent• Bible/Department interpretation turns loan rehabilitation into at-will

deferment:– A borrower makes no payments for 9 months, then goes into default– She then enters into rehabilitation within 60 days, where she only has

to make token payments (as small as $5) for 9 out of the next 10 months, without collection costs being imposed

– She receives a new lender at the end of this period and has the default erased

• Effectively a 21-month deferral with no collection costs imposed and report of default erased from her record at the end

• No fair warning was provided to USA Funds and other guarantors, as the Department’s position is new and inconsistent with its prior interpretations

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4. Seventh Circuit Case – Motion for En Banc Reconsideration

• Motion filed September 1, 2015• Bible’s answer filed September 17, 2015

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5. USA Funds v. Duncan (District of Columbia)

• Filed by USA Funds in United States District Court for the District of Columbia on July 16, 2015

• USA Funds seeks order declaring new rule announced in DCL to be invalid, unenforceable, and contrary to law

• HEA instructs guarantors to charge collection costs to all defaulted borrowers without exception, and allows guarantors to charge collection costs in relation to a loan Rehabilitation Agreement without exception

• Department’s interpretation is a new rule, which is contrary to the text of the statute and regulations, is improper legislative rulemaking without notice and comment, is impermissible retroactive rulemaking, and is unlawful, arbitrary, capricious, and irrational

• New rule will harm student loan borrowers by discouraging timely loan rehabilitation, contrary to intent of Congress

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USA Funds v. Duncan (District of Columbia)

• Count 1: New rule is in violation of, and not authorized by, the HEA– Exceeds the Department’s statutory jurisdiction and authority– Violates 5 U.S.C. § 706(2)(C)&(A), is arbitrary and capricious, an

abuse of discretion, and illegal• Count 2: New rule is in violation of existing regulations• Count 3: New rule failed to follow notice and comment rulemaking

– It is so different from the statute and current regulations that it amounts to a substantive regulation

• Count 4: Department’s action is arbitrary and capricious – they did not consider relevant factors

• Count 5: New rule constitutes impermissible retroactive rulemaking

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• Department’s own regulations, 405 and 410, do not contain any exceptions, exclusions, or carve-outs for charging collection costs to borrowers who enter into Rehabilitation Agreements

• There is no time period, 60 days or otherwise, in which Rehabilitation Agreements must be offered

• Guaranty agencies have long assessed collection costs against defaulters who have Rehabilitation Agreements– Department has been aware of this and has acquiesced and done

nothing about it• Costs associated with rehabilitation program are substantial, no matter

when agreement entered into• Department’s own guidelines and website acknowledge that collection

costs can be assessed here

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• USA Funds and other guarantors reasonably relied on Department’s public statements, actions, and inactions

• New rule is effectively an amendment to 410(b)(2), issued without notice or comment

• Department’s interpretation reads “on terms satisfactory to the agency” out of the regulation

• Under the new rule, a guarantor must accept as “satisfactory to the agency” non-discretionary, required Rehabilitation Agreements; and now under the DCL, any repayment agreement entered into at all

• New rule is a new legislative rule, for which APA notice-and-comment procedures were required, and not followed

• New rule is impermissibly retroactive

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• Joseph P. Esposito, Partner– [email protected]– 202.419.2155

mailto:[email protected]

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