Developments in Student Lending Litigation

Introduction

Legal issues surrounding student loan debt, which now consists of the second highest consumer debt category in the United States, was litigated in several notable circuit court and district court decisions this past year. Federal courts of appeals have largely ruled consistently with previous decisions on issues in this context, providing industry members with clearer lines of demarcation for maintaining compliance with existing legal frameworks. Likewise, a recent federal district court decision upheld longstanding principles in the arbitration context. This survey highlights these developments.

Sixth Circuit Holds Student Loan Rehabilitation Company Not Subject to FDCPA as a Debt Collector

In a decision affecting the potential liability of student loan servicers, the Sixth Circuit confirmed in Willison v. Nelnet, Inc. that student loan servicers that begin servicing student loan debt after events of default and resale are not liable to student-borrowers under the Fair Debt Collection Practices Act (“FDCPA”). In Willison, the plaintiff brought an action alleging that Nelnet, Inc., a financial services company that facilitates the repayment of student loans, violated the FDCPA by “directly contacting [plaintiff] regarding her [student] loan after counsel had given Nelnet notice of the fact that he was representing her with regard to the amount due under the loan.” The plaintiff had taken out two student loans and defaulted on them. She then entered into a rehabilitation agreement with non-party Performant Recovery Inc. in which she agreed to make nine micro payments over a ten-month period, until she received notification that her loans were sold to a rehabilitation lender. After successfully making her final payment on the agreement, she received notification that the lender, Deutsche Bank, sold the loans to SunTrust Bank. On the same day, Nelnet acquired the loans from SunTrust for servicing, and it provided the plaintiff with her account balance and a new repayment schedule. Believing that her account balance “looked off,” she contacted an attorney, who in turn instructed Nelnet to direct all correspondence to him. When Nelnet subsequently instead directed a response to the plaintiff, she filed suit under the FDCPA.

Nelnet moved to dismiss, arguing that it was not a “debt collector,” and therefore was not subject to the FDCPA. The district court found that, in order for the plaintiff to establish that Nelnet was a debt collector, she needed to show that her loans were either in default at the time Nelnet acquired them, or that Nelnet treated her loans as if they were in default. The plaintiff failed to meet this burden because the contractual language contained in the rehabilitation agreement stated that once the loans were sold, they would no longer be in default. Nor did Nelnet treat the loans as if they were in default because it sent the plaintiff a letter regarding a “change in the status of [her] federal student loans,” explicitly stating that the letter was not a billing statement. The district court granted Nelnet’s motion.

On appeal to the Sixth Circuit, the plaintiff argued that Nelnet “is part of a default washing operation which purports to restore a defaulted loan to a non-defaulted status” and that “[t]here is no provision in the FDCPA wherein a loan can be ‘undefaulted . . . such that the entity acquiring this defaulted loan becomes a creditor” rather than a debt collector. She further argued that “when SunTrust received the loan, it was still in default. SunTrust then is a ‘debt collector’ under the FDCPA” and “[t]he fact that SunTrust asked [Nelnet] to collect on the debt as its servicer, does not make [Nelnet] a creditor.”

The Sixth Circuit affirmed the district court’s decision in favor of Nelnet, holding that Nelnet was not a debt collector and therefore was not subject to the FDCPA. It rejected the plaintiff ’s argument that Nelnet engaged in a “default washing operation,” finding that the U.S. Department of Education requires loan rehabilitation programs for loans like the plaintiff ’s that are held under the Federal Family Education Loan Program (“FFELP”). The Sixth Circuit found that once the plaintiff met the terms of the rehabilitation agreement and the loans were sold, her loans “exited default through rehabilitation.” When SunTrust then assigned the loans to Nelnet for servicing, “neither the Department of Education, the guaranty agency, nor the lender considered the loans to be in default.” Thus, “[a]s fortuitous as the timing may be, the result of the rehabilitation is that Nelnet does not fall within the definition of a ‘debt collector’ under the FDCPA.”

The Sixth Circuit’s decision in Willison demonstrates the importance of timing loan services or activities for purposes of FDCPA liability against companies that purchase or are assigned loans. This is particularly true in the student lending industry, where the Department of Education has required all guarantors of loans held under the FFELP to establish rehabilitation programs for student borrowers whose loans are in default. Because Nelnet only began servicing the loans after rehabilitation, the timing of the start of its services was such that it could avoid FDCPA liability. The decision also demonstrates how FDCPA obligations change based on the status of the loan itself. The status of the student loan will affect whether a student loan servicer may be treated as a debt collector, thereby imposing obligations on the servicer under the FDCPA.

Third Circuit Finds in Favor of Parallel Enforcement Litigation Against Student Loan Servicers

The Third Circuit held in Pennsylvania v. Navient Corp. that the plain language of the Consumer Financial Protection Act of 2010 (“CFPA”) permits states to bring parallel enforcement actions against student loan servicers under the Act even when the Consumer Financial Protection Bureau (“CFPB”) has already filed suit. The Navient court also held that, while the preemption provision of the federal Higher Education Act of 1965 (“HEA”) preempts state claims based on failures to disclose required statutory information, it does not preempt state claims of affirmative misrepresentations based on the statute.

In Navient, the Pennsylvania attorney general filed a complaint against Navient Corporation and Navient Solutions, LLC (“Navient”), alleging that Navient’s actions in originating and servicing student loans made under the Direct Loan Program and under the FFELP constituted unfair, deceptive, and abusive practices in violation of the CFPA and state law. The attorney general alleged that Navient misled student-borrowers by steering them into forbearance programs, rather than informing them about affordable alternatives, such as Income Driven Repayment (“IDR”) plans.

Nine months before the attorney general filed suit, the CFPB had also filed suit against Navient for similar claims, including Navient’s alleged failure to “disclose adequately the availability of IDR programs to federal student loan borrowers.” Navient moved to dismiss on the ground that the CFPA precluded the Commonwealth from bringing a concurrent lawsuit. The district court denied the motion, finding that section 5552(a)(1) of the CFPA unambiguously confers a right on state attorneys general to file suit to enforce the CFPA. Likewise, it rejected Navient’s argument that the HEA preempted the state law claims, finding that those claims survived both express- and conflict-preemption principles.

The Third Circuit affirmed. First, it held that the “clear statutory language of the [CFPA] permits concurrent state claims, for nothing in the statutory framework suggests otherwise.” Looking to the plain meaning of the statute, the Navient court found that, while other provisions of the CFPA expressly prohibit concurrent claims, section 5552(a)(1) had no such language, indicating that concurrent claims are permissible. The court also rejected Navient’s argument that the CFPA’s pre-suit notice requirement, which requires state attorneys general to address whether there is a need to coordinate the prosecution of the proceeding so as not to interfere with “any action, including any rulemaking” that the CFPB undertakes, is only intended to address claims of which the CFPB is not aware. It found that Navient “stretch[ed] too far the meaning of this pre-suit notice requirement” because, if Congress had intended to provide this limitation, it could have drafted a “simpler provision.” The court further rejected Navient’s argument that the CFPB’s authority to intervene as a party-plaintiff in any state-filed CFPA litigation demonstrates that Congress intended to prevent concurrent claims, because Congress did not limit concurrent claims in the statute as it has done in other statutes that authorize state enforcement.

Next, following other circuits, the Navient court held that the preemption provision contained in the HEA does not expressly or impliedly preempt state claims based on affirmative misrepresentations. The court “adopt[ed] the distinction between affirmative misrepresentation and failure to disclos[e] information as required by the [HEA]. [The preemption provision] does not expressly preempt claims to the extent they are alleging affirmative misrepresentations rather than failures of disclosure.” Navient argued that the attorney general’s state claims specifically targeted the sufficiency of the disclosures made to borrowers, and the court entertained the possibility that not all of the attorney general’s allegations constituted affirmative misrepresentations and would be ultimately preempted: “[t]he Commonwealth cannot fault Navient for failing to provide consumers with more information about IDR plans or recertification, but it can fault Navient for providing misinformation.”

With respect to Navient’s argument that the attorney general’s claims were impliedly preempted by the HEA, the Third Circuit found that section 1098g of the HEA does not impliedly preempt state law claims, as it agreed with other circuits that it need not infer congressional intent to preempt state laws. The HEA includes several provisions where state preemption of specific areas of state law is expressly contemplated, indicating that Congress did not intend to preempt other areas of state law. It reasoned that “[t]here is no indication that Congress had the sweeping goal of regulating all misconduct that could possibly occur in student-loan financing and requiring uniformity of all claims tangentially related to the [HEA].”

The Navient court also found that the HEA does not preempt the field of regulation of student loans, as every circuit to consider the issue has rejected that argument. Even looking from a “practical standpoint,” the Third Circuit reasoned that field preemption in this context would result in consumers being left “with no protection against unfair or deceptive acts or practices by loan servicers because the [HEA] contains no general prohibition against those practices.” Thus, field preemption in this context would be “untenable.”

The Third Circuit’s decision in Navient allows state and federal actors to separately seek protections for student borrowers based on conduct that may arise from the same set of facts. In its opening brief, Navient argued that permitting state attorneys general to enforce provisions under the HEA would infringe on the President’s executive power under the Take Care Clause and violate the Appointments Clause because state attorneys general have not been appointed by the President and lack power to fully independently enforce broad federal laws. However, the Third Circuit did not address the prosecution of concurrent actions, or “copycat suits,” in that context, as those issues were not part of the interlocutory appeal. Because this issue was not addressed, the decision leaves a door open for student loan industry members to challenge copycat suits in this context.

The Third Circuit also affirmed that the HEA establishes the disclosure requirements for the servicing of certain federal student loan programs, and that it preempts any state law claim violations of those disclosure requirements. Importantly, in addressing Navient’s argument that the attorney general targeted the sufficiency of borrower disclosures, the Third Circuit acknowledged the possibility that a closer allegation-by-allegation analysis of the Commonwealth’s claims might reveal that certain claims were based on failures of disclosure, which the HEA would preempt.

Developments in Student Lending Class Action Arbitration

A New Jersey federal district court agreed to compel arbitration in Vasquez v. National Enterprise Systems, Inc., a proposed class action in which the court found that the arbitration agreement in the plaintiff-debtor’s student loan agreement extended to the loan servicer’s affiliates and agents. In Vasquez, the plaintiff signed a promissory note to obtain a private student loan. The note provided that it governed the plaintiff ’s student loan, and it contained an arbitration provision that encompassed the private student loan provider Sallie Mae Inc. and “any other subsequent holder of the note,” “any Sallie Mae affiliate or subsidiary,” and “all of their parents . . . and affiliates.” Furthermore, the arbitration provision subjected to arbitration “any claim, dispute or controversy . . . that arises from or relates in any way to the Note.” After the plaintiff had obtained her student loan, Sallie Mae created the entity Navient Solutions, LLC (“Navient”) to handle student loan servicing issues. Subsequently, the plaintiff defaulted on her student loan, and Navient assigned the loan to the defendant, a debt collection agency. The plaintiff then filed the putative class action, alleging that defendant debt collector’s attempts to collect on the student loan violated the FDCPA, and the defendant moved to compel arbitration pursuant to the arbitration provision of the promissory note.

The Vasquez court rejected the plaintiff ’s argument that as a third-party debt collector, the defendant could not enforce the arbitration provision. The court held that the note’s “plain language” permitted affiliates of Sallie Mae’s affiliates to compel arbitration, and that encompassed the defendant. The court further found that the defendant would be entitled to compel arbitration “[e]ven without such express language” because the defendant, as Navient’s agent, was “tasked with collecting Plaintiff ’s debt,” and courts in the Third Circuit permit arbitration via agency principles. The Vasquez court also found the FDCPA claim fell within the scope of the arbitration provision, as the note encompassed “any claim[] . . . that arises from or relates in any way to the [n]ote.” The court therefore granted the motion to compel arbitration and dismissed the case.

Student loan servicers should carefully analyze their relationships with third-party debt collectors and other vendors and should consider using an in-house debt collector structure like Sallie Mae in order to enforce arbitration agreements, and to avoid potential liabilities. Notably, in Hunstein v. Preferred Collections & Management Services, Inc., the Eleventh Circuit held as a matter of first impression that consumers may assert an FDCPA claim for a debt collector’s transmittal of a consumer’s personal information to a third-party vendor. But maintaining an in-house structure, and including robust arbitration agreements in terms of both scope and parties bound, may provide added protection to student loan servicers and affiliates seeking to collect on a debt or service a loan.

Developments in Student Lending Bankruptcy Discharge

In Homaidan v. Sallie Mae, Inc., the Second Circuit affirmed a bankruptcy court decision that private educational loans the plaintiff-student borrower took out from defendants Sallie Mae, Inc., Navient Solutions, LLC, and Navient Credit Finance Corporation (collectively, “Navient”) were dischargeable under section 523(a)(8)(A)(ii) of the Bankruptcy Code. In rendering this decision, the Homaidan court joined the Fifth and Tenth Circuits, which previously issued rulings that private student loans are dischargeable in bankruptcy.

In Homaidan, the plaintiff received student loans from Navient, and, after graduation, he filed for a Chapter 7 bankruptcy. The bankruptcy discharge order was ambiguous as to whether the Navient student loans were dischargeable, as the discharge order listed “common types of debts” as not subject to discharge, including “[d]ebts for most student loans.” After the discharge order was issued, Navient sought repayment on the loans, and the plaintiff complied, allegedly “under the mistaken belief that he had a legal obligation to do so.” After paying off the Navient loans in full, the plaintiff reopened the bankruptcy case and claimed that Navient had violated the discharge order by seeking to collect on the student loans. Navient moved to dismiss, arguing that section 523(a)(8)(A)(ii) of the Bankruptcy Code prevented the student loans from being subject to discharge because that provision creates an exception for “obligation[s] to repay funds received as an educational benefit, scholarship, or stipend.” Navient argued that the student loans were used for the purpose of an “educational benefit” and were thus covered under the exemption provision. The bankruptcy court disagreed with Navient and denied the motion to dismiss, reasoning that the provision “does not sweep in all education-related debt.”

On appeal, the Second Circuit primarily relied on the plain language of section 523(a)(8)(A) in rendering its decision. That section exempts three categories of education debt from discharge in bankruptcy: “(1) loans and benefit overpayments backed by the government or a nonprofit; (2) obligations to repay funds received as an educational benefit, scholarship, or stipend; and (3) qualified private educational loans.” Navient contended that its loans fell under the second category as funds received for the purpose of educational benefit, but the Second Circuit concluded that Navient’s interpretation violated basic rules of statutory construction. It reasoned that, had Congress intended to exempt all educational loans from discharge under section 523(a)(8)(A)(ii), “it would not have done so in such stilted terms”—especially when there are educational benefits, such as conditional grants, that would more naturally fit the statutory text. It also found that section 523(a)(8)(A)(ii) cannot be interpreted to include the word “loan” in that provision when it is “sandwiched in between two other [provisions] that use the word ‘loan’ expressly,” which signals that its absence is intentional.

The Second Circuit rejected Navient’s broad interpretation of section 523(a)(8)(A)(ii) under which any loan would be nondischargeable if the loan was used to further one’s education on the additional ground that it “would draw virtually all student loans within the scope” of the provision, rendering the three distinct subsections of exemptions contemplated by Congress as superfluous. In this context, the Second Circuit found that the phrase “educational benefit” is limited by the surrounding terms “scholarship” and “stipend,” which are most appropriately understood to encompass conditional grants of payments that are not generally required to be repaid by the recipient. Thus, the Second Circuit affirmed that the private student loans in this case were dischargeable in bankruptcy.

For student borrowers facing financial hardships, the Second Circuit’s decision opens another door for them to seek discharge of their student loans and contributes to the overall national trend of easing the standards on discharging of student loans. Other circuits that have yet to weigh in on the issue now have an opportunity to follow these decisions and close the gap on the ambiguity.