[1]A powerful and commonly utilized tool in a restructuring is the commencement by a company of an insolvency proceeding, whether under the Bankruptcy Code or analogous law, in order to achieve desired changes to its capital structure and/or operations. However, there are certain instances where, due to legal or commercial reasons, the use of an insolvency proceeding is not available. Depending on the complexity of a company’s capital structure and the required operational changes, the absence of this option can greatly complicate and/or limit the company’s restructuring.
One sector facing this problem that has been getting significant attention in the market is the title IV-funded education sector. This sector is comprised of educational institutions that derive a portion of their revenue under title IV of the Higher Education Act of 1965.[2] Title IV authorizes federal student aid programs that collectively “provide grants, loans and work-study funds from the federal government to eligible students enrolled in college or career school.”[3]
Title IV was amended in 1992 to expressly provide that any entity that filed for bankruptcy would lose its eligibility to draw funds under title IV.[4] To the extent that an institution derives much of its revenue from title IV,[5] as many of them do, elimination of this source of revenue can have a significant and very sudden impact on a school’s revenue and liquidity. Although these amendments appear to violate the anti-discrimination provision of § 525(a) of the Bankruptcy Code,[6] the only two reported decisions on point have held otherwise, and determined that the subject companies’ bankruptcy filings stripped them of title IV eligibility.
In re Betty Owen Schools Inc.
In In re Betty Owen Schools Inc., the U.S. Department of Education withdrew the eligibility of the Betty Owen School Inc. to participate in title IV, including prohibiting it from continuing to access title IV funds, shortly after commencement of its bankruptcy proceeding. This decision by the Department of Education had two consequences. First, newly enrolled students were not eligible for student loans under title IV.[7] Second, the purchaser of Betty Owen Schools’ assets could not immediately reapply for title IV eligibility (as is permitted outside of bankruptcy). Instead, the purchaser was required to comply with the statutory two-year waiting period applicable to new institutions.[8]
In response, Betty Owen Schools and the purchaser filed motions for relief with the bankruptcy court asserting that the Department of Education’s revocation of Betty Owen Schools’ title IV eligibility violated § 525(a). In an attempt to reconcile the conflicting statutes, the court undertook a statutory interpretation analysis and ultimately concluded that the amendments to title IV trumped § 525(a).[9] Among other rationales, the court determined that a ruling in the Department of Education’s favor would better promote the “general policy goals” of both the Bankruptcy Code and the Higher Education Act:
First, [Congress’s] desire to conserve scarce resources under [Higher Education Act] programs will be furthered. Second, conflicting provisions of the Bankruptcy Code will be reconciled. If Congress amended the Bankruptcy Code to allow the accrediting agencies to take appropriate action free of the protection of the ‘automatic stay’ and ‘property of the estate’, to hold that the Department violated section 525 would only inhibit the agencies from taking the very action Congress had, in its wisdom, permitted.[10]
The court also noted that “section 525 was enacted prior to the amendment of section 1088 [now 1002] of the [Higher Education Act], and the ‘more recent expression of legislative intent prevails.’”[11]
In re Lon Morris College
Like Betty Owen Schools, Lon Morris College was an institution of higher education that, prior to filing for chapter 11, qualified for title IV. Also similar to Betty Owen Schools, shortly after the bankruptcy filing, the Department of Education revoked Lon Morris College’s eligibility to receive title IV funding solely as a result of its bankruptcy.[12] Although the court disliked the action taken by the Department of Education as a policy matter, it agreed with the analysis in the Betty Owen decision and overruled the debtor’s request for relief under § 525(a) to block the Department of Education’s action.[13]
Conclusion
Based on these decisions and the potentially catastrophic consequences that can result from a bankruptcy filing, companies that derive revenue from title IV, as well as their creditors and equityholders, need to develop alternative options for the restructuring of a title IV eligible institution. The viability of such options will be dependent on the level of flexibility available to the parties under any applicable debt or equity documents and may require a significantly longer runway and a greater level of cooperation and willingness to compromise from the various creditor and equity constituencies than would be necessary if bankruptcy were an option.
[1] The author wishes to thank Odelia Lee, an associate with the Financial Restructuring Group at Stroock & Stroock & Lavan LLP, for her assistance in the preparation of this article.
[2] 20 U.S.C. § 1001, et seq.
[3] “Types of Aid,” Federal Student Aid: An Office of the U.S. Department of Education, (June 19, 2014), available at https://studentaid.ed.gov/glossary#Federal_Student_Aid_Programs (last visited Sept. 22, 2014).
[4] See 20 U.S.C. § 1002(a)(4)(A).
[5] Pursuant to § 1094 of the Higher Education Act, institutions can derive up to 90 percent of their revenue from title IV. 20 U.S.C. § 1094(a)(24).
[6] Section 525(a) provides that “a governmental unit may not deny, revoke, suspend, or refuse to renew a license, permit, charter, franchise, or other similar grant to ... a person that is or has been a debtor under [chapter 11].” 11 U.S.C. § 525(a).
[7] Betty Owen Sch. Inc. v. United States Dep’t of Educ. (In re Betty Owen Sch. Inc.), 195 B.R. 23, 26 (Bankr. S.D.N.Y. 1996).
[8] Id. at 26-28.
[9] Id. at 34.
[10] Id. at 33.
[11] Id.
[12] Transcript of Proceedings at 24, In re Lon Morris College (Bankr. E.D. Tex. Aug. 20, 2012) (No. 12-60557-BP-11).
[13] Id. at 35-44.