Chapter 11 for colleges and universities: The time is now to remove the ban

In a recent article in The Hill, Dennis Cariello, former deputy counsel for Postsecondary Education and Regulatory Services in the U.S. Department of Education, joined the growing number of commentators advocating for permitting colleges and universities to use formal bankruptcy procedures to address their current dire financial condition.

As previously noted, both the majority of university business officers and the National Commission on College and University Governance have indicated that institutions face risks to sustainability. While I have discussed numerous operational strategies that can be utilized, higher education institutions are extremely limited in their ability to restructure debt due to the 1992 amendments to the Higher Education Act that strip any institution of its Title IV eligibility if it files for bankruptcy protection. Because the vast majority of tuition is funded by Title IV programs, this precludes universities from using the tools of bankruptcy, and perhaps more importantly the threat of bankruptcy, to restructure debt, reject burdensome leases and contracts, sell assets, and transfer control or ownership without the unanimous support of creditors and other constituencies.

While it is now frequently questioned due to the increasing cost, studies uniformly demonstrate that college graduates are likely to earn more than those without degrees. Consequently, as a nation we have an interest in both continuing to make higher education available and to reduce the cost. Bankruptcy has worked in other highly regulated industries, such as airlines and healthcare, where the special needs of consumers of the service must be protected. Permitting universities the ability to reduce debt while protecting the interests of their students can be accomplished in bankruptcy, albeit with a few special provisions tailored to the industry.

In his article, Mr. Cariello notes first that there is no need to reinvent the wheel. The U.S. bankruptcy system, while not perfect, remains the best legal means to preserve asset and business value, which is why it has become the model for insolvency laws throughout the world. As such, only a few special provisions should be added to chapter 11 for application to universities.

Second, I concur with Mr. Cariello that a change in control is necessary for universities that avail themselves of bankruptcy. Like the railroads that gave birth to the concept of reorganization in bankruptcy, the board (and the owners in a for profit situation) have demonstrated an inability to respond to their institution’s financial situation. However, this change should be immediate and, at filing, control of the institution should be vested in a Chief Restructuring Officer (CRO) – a disinterested professional with expertise in restructuring and higher education (selected by the university subject to court approval). The CRO would be required to consult with constituencies such as faculty, but would have the authority to take action only subject to the approval of the Bankruptcy Court. Given the institutional inertia in higher education, this will facilitate that necessary actions be undertaken immediately without depriving parties in interest of a seat at the table and the ability to object in court if necessary. The ultimate disposition and exit from the process can be proposed by the CRO subject to the existing sale or confirmation processes.

Of course, the needs of students at the institution are paramount and they must be permitted to complete their educations. Consequently, any proposed operational changes must not cause students undue hardship.

Although most institutions are funded by tuition revenues from Title IV programs administered by the U. S. Department of Education, I cannot agree with Mr. Cariello that it necessarily follows that this should preclude them from restructuring debts to this creditor. The tuition funding represents loans to the students, not to the universities. Also, even student loans can be discharged in cases of undue hardship. More importantly, the economic reality is that there may be situations where an institution is not viable without restricting or discharging its obligations to the U.S. Department of Education. Accordingly, universities should be permitted to restructure or discharge obligations to the U.S. Department of Education but only if they can establish that without the proposed restructuring or discharge they are:

1. Not able to meet their students’ continuing educational needs, which are the paramount concern now and in the future, while remaining economically viable;
2. There is no viable alternative to the proposed restructuring or discharge; and
3. The institution serves a unique need, whether as a result of its location, programs, student body, or other factors, that cannot realistically be met by other institutions.

In other words, if the institution is needed and cannot survive if it has to repay the U.S. Department of Education, then it should be permitted to restructure or even discharge the debt.

The world has changed since the 1992 amendment and Title IV needs to change to reflect the new realities. Like entities in other regulated industries that serve the common good, institutions of higher education need to be able to access bankruptcy to restructure so that they can continue to provide the college education that provides our youth and our country with a path to a better future.