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When the University is a Fraud What Becomes of the Student Loans?

Should student loans be forgiven when the university turns out to be a fraud? This is what a small group of students of the now-defunct ITT Education Services and the Corinthian Colleges have asserted.

ITT shut its doors when the U.S. Department of Education denied access to federal student loan and financial aid programs on which most of the schools' students depend to assist with tuition. The school was subject to numerous long-standing complaints that it conducted predatory lending to students, overstated the quality of its programs and overstated employment prospects for its graduates.

Upon its nearly instantaneous disintegration, ITT placed just under $100 million dollars into escrow. The tuition owed by the students was among the bankruptcy petitioner's $389 million asset disclosure, against debts of over a billion dollars.

With the assistance of a Harvard Law School clinic, about 800 students seek to intervene in the federal bankruptcy case the school filed in the Southern District of Indiana. Normally, only creditors of the petitioner are allowed to participate in a bankruptcy case thus, this situation presents a procedural novelty.

Lawyers for ITT will challenge the students' attempt to intervene on the basis they have no standing because they are not creditors of the school but rather, indebted to the school. Prior to filing in the bankruptcy case, each of the students filed complaints with the Department of Education; those complaints, however, have gone nowhere.

The legal argument by the students' lawyers is that ITT violated state consumer protection laws. Therefore, the students argue that their loans should be forgiven and that collection practices against the students should cease.

Bankruptcy Trustee Deborah J. Caruso will have these and other more traditional creditors' claims to contend with in the case. Her job will be difficult to the extent that the students' claims will compete for a very finite pile of escrowed funds with banks and other creditors of the shuttered schools.

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