The "Overwhelming Incentives" to Avoid Bankruptcy

In an earlier post, I claimed that Thomas Jefferson School of Law’s recent debt restructuring was the rationale 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-way 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 use section 365 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.

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