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Court rules student loan companies are subject to state consumer laws, contrary to Trump administration’s stance

A federal appeals court ruling Thursday could stymie the Education Department’s efforts to shield from state regulation companies that manage the department’s $1.5 trillion portfolio of student loans.

The 24-page opinion from the U.S. Court of Appeals for the 7th Circuit challenges a decision in October barring Nicole Nelson from suing Great Lakes Educational Loan Services, the company servicing her federal student loans, for allegedly violating Illinois’s consumer fraud laws. Nelson alleges Great Lakes touted its expertise as a student loan adviser, yet steered her into an expensive repayment option.

Nelnet, another student loan servicer that recently acquired Great Lakes, declined to comment on the lawsuit.

A lower court in the Southern District of Illinois had granted Great Lakes’s motion to dismiss the case on the grounds that Nelson’s claims were preempted by federal law. The Higher Education Act says federal loans are not subject to state disclosure requirements, and the court reasoned that Great Lakes was accused only of failing to disclose certain information. But the appellate court took issue with that rationale.

“When a loan servicer holds itself out to a borrower as having experts who work for her, tells her that she does not need to look elsewhere for advice, and tells her that its experts know what options are in her best interest, those statements, when untrue, cannot be treated by courts as mere failures to disclose information,” U.S. Circuit Judge David F. Hamilton wrote.

He added: “Those are affirmative misrepresentations, not failures to disclose. Great Lakes chose to make them. A borrower who reasonably relied on them to her detriment is not barred from bringing state‐law consumer protection and tort claims against the loan servicer.”

The case, which will go back to the district court, could play a critical role in the battle between the Trump administration and states over supervision of federal student loan servicers.

Six state attorneys general have sued the companies for allegedly flouting state consumer protections. Meanwhile, several states have enacted laws to fill what many see as a void in the federal oversight of companies the Education Department pays nearly $1 billion to handle debt payments.

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California, Connecticut, Illinois, New Jersey and the District of Columbia require servicers to obtain a license to operate within their borders as a way to bring the companies under their regulatory purview. Their local agencies have the authority to monitor loan servicers’ compliance with federal laws, investigate their behavior and refer cases to the attorney general.

In the face of mounting regulatory and legal pressure, industry groups lobbied Education Secretary Betsy DeVos and Congress to take action.

In March 2018, the Education Department issued guidance arguing that state regulation of federal student loans “impedes uniquely federal interests.” The department said state efforts to impose more consumer protections undermine “the goal of simplifying the delivery of student loans to borrowers, eliminating borrower confusion, avoiding unnecessary costs to taxpayers and creating a more streamlined student loan program that could be managed more effectively at the federal level.”

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In Thursday’s appellate opinion, Judge Hamilton said the panel refused to “give special deference” to the Education Department’s guidance, saying it was not “persuasive because it is not particularly thorough.”

Education Department spokeswoman Liz Hill said the federal agency is reviewing the decision and will continue to follow the case.

“This decision is a victory for student loan borrowers and a powerful rebuke to the attempts by Betsy DeVos to shield student loan servicers from oversight,” said Dan Zibel, who argued Nelson’s case before the appellate court. Zibel is chief counsel at the National Student Legal Defense Network, an organization founded by attorneys who worked in the Education Department during President Barack Obama’s administration.

“You’ve now had three federal courts rebuke DeVos’s position,” Zibel said. “Federal courts seem unwilling to defer to that interpretation.”

Scott Buchanan, executive director of the trade group Student Loan Servicing Alliance, said Thursday’s ruling is inconsistent with precedent established by other courts. His group waged a legal battle with the District over its licensing requirements. The courts limited the city’s oversight to companies servicing commercially owned, but government-backed student loans, exempting the vast majority of federal education debt.

“While servicers are again caught in the middle of the conflicting interpretations, our members continue to be focused on helping each and every borrower manage their federal student loans,” Buchanan said.

This week’s opinion took aim at the department’s management of its servicers, saying Nelson’s allegations echo the findings of an inspector general report on loan servicers. According to the report, the Education Department’s “oversight activities regularly identified instances of servicers not servicing federally held student loans in accordance with federal requirements,” yet the department “rarely used available contract accountability provisions to hold servicers accountable.”

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Nelson claims that when she lost her job, representatives at Great Lakes told her to postpone her student loan payments through forbearance, an option in which interest continues to accrue. No one, she alleges, informed her about enrolling in an income-driven repayment plan that would avoid fees.

Advocacy groups say income-driven repayment plans are better suited to borrowers facing long-term financial hardship. Because the enrollment process can be time-consuming for servicers, advocates say, companies take the easier route of forbearance. Servicing companies deny the allegation and say they have helped increase the number of people in income-driven repayment plans.

Because loan servicing has such a significant effect on borrowers, state authorities and other regulatory bodies, in addition to the Education Department, must play a role in holding loan companies accountable, said Seth Frotman, a former senior student loan official at the Consumer Financial Protection Bureau. Despite the Trump administration’s efforts to have sole responsibility for loan-servicing contractors, he said the courts see it otherwise.

“The decision is an enormous victory for student loan borrowers, state attorneys general and every American who rejects the idea that big companies should be able to trample on borrowers’ rights with impunity,” said Frotman, who now runs the Student Borrower Protection Center.