In response to the wave of new state student loan servicing laws and enforcement activity, the U.S. Department of Education has published an interpretation emphasizing that the Higher Education Act (HEA) preempts state regulation of federal student loan servicers.
Citing Supreme Court and appellate court precedent, ED stresses that the servicing of loans made by the federal government under the Direct Loan Program is an area involving “uniquely federal interests” and that state regulation of servicers of Direct Loans impermissibly conflicts with federal law and is entirely preempted. Further, state regulation of servicers of Federal Family Education Loan (FFEL) Program loans is preempted to the extent that it conflicts with, impedes, or otherwise undermines uniform administration of the program.
The interpretation also reaffirms the preemption of state laws that prohibit (1) misrepresentation or the omission of material information, because the HEA expressly preempts state disclosure requirements; and (2) unfair or deceptive acts or practices, to the extent such laws “proscribe conduct Federal law requires” or “require conduct Federal law prohibits.”
Direct Loan Program Servicers
In the interpretation, ED identifies the following conflicts between state laws that regulate Direct Loan servicers and federal law:
- The licensing requirements interfere with ED’s power to select contractors for Direct Loan servicing. For example, states require servicers to satisfy certain financial requirements, secure a surety bond, and undergo background checks as a condition of licensure. Such requirements add to, and thereby conflict with, the “responsibility determinations” ED makes in accordance with federal contracting law.
- State-imposed servicing standards pertaining to loan transfers, payment application, and borrower disputes, for example, would conflict with federal law and regulations and ED’s servicing contracts and “skew the balance the Department has sought in calibrating its enforcement decisions to the objectives of the [Direct Loan] program.”
- State licensing fees, assessments, minimum net worth requirements, surety bonds, data disclosure requirements, and annual reporting requirements will increase the costs of student loan servicing, “distorting the balance the Department has sought to achieve between costs to servicers and taxpayers and the benefits of services delivered to borrowers.”
- State laws that restrict the actions a servicer may take to collect on a loan impede ED’s ability to protect federal taxpayers by obtaining repayment of federal loans.
- State-level regulation cuts against the HEA’s goal of creating a uniform set of rules to govern the federal student loan program and “subjects borrowers to different loan servicing deadlines and processes depending on where the borrower happens to live, and at what point in time.”
As ED correctly notes, U.S. Supreme Court precedent involving federal contractors compels the conclusion that the potential civil liability of student loan servicing contractors for non-compliance with state law is an area of unique federal concern because it would raise the price of servicing contracts and because “servicers stand in the shoes of the Federal government in performing required actions under the Direct Loan Program.” Moreover, federal student loan servicing “requires uniformity because State intervention harms the Federal fisc.”
FFEL Program Servicers
As for the servicing of loans made by private lenders and guaranteed by the federal government through the Federal Family Education Loan (FFEL) Program (which Congress discontinued and replaced with the Direct Loan Program in 2010), ED says that state regulation is preempted “to the extent that it undermines uniform administration of the program.” ED provides several examples of the kinds of state laws that invariably conflict with federal FFEL Program regulations, including deadlines for borrower communications and requirements around the resolution of disputes raised by borrowers. ED also notes that state servicing laws appear to conflict with express preemption provisions applicable to guaranty agencies (34 C.F.R. 682.410(b)(8)) and lender due diligence in collecting guaranty agency loans (34 C.F.R. 682.411(o)(1)).
State Disclosure Requirements
ED also stresses that Section 1098g of the HEA expressly preempts state disclosure requirements for federal student loans. ED interprets this to “encompass informal or non-written communications to borrowers as well as reporting to third parties such as credit reporting bureaus.” ED points out that state servicing laws that attempt to impose new prohibitions on misrepresentation or the omission of material information would likewise be preempted by Section 1098g.
Consistency with Earlier Pronouncements
As ED emphasizes, it is not breaking new ground here. Its interpretation is consistent with earlier U.S. responses to state laws that conflict with ED’s administration of federal student loan programs. For example, in 2009, it intervened in litigation in the Ninth Circuit to demonstrate to the Court that the state consumer protection laws on which the plaintiff relied were preempted by the HEA.
Most recently, the U.S. Department of Justice filed a Statement of Interest in litigation brought by the Commonwealth of Massachusetts against the Pennsylvania Higher Education Assistance Agency (PHEAA) alleging violations of Massachusetts law for allegedly unfair or deceptive acts related to the servicing of Federal student loans and administration of programs under the HEA. That Statement of Interest made clear that Massachusetts “is improperly seeking to impose requirements … that conflict with the HEA, Federal regulations, and Federal contracts that govern the Federal loan programs.” (Ballard Spahr LLP represents PHEAA in that matter.)
In its interpretation, ED reaffirms that such claims are preempted because they seek to “proscribe conduct Federal law requires and to require conduct Federal law prohibits.” ED continues, “We believe that attempts by other States to impose similar requirements will create additional conflicts with Federal law.”
ED concludes by describing its efforts to “ensure that borrowers receive exemplary customer service and are protected from substandard practices,” including:
- Monitoring compliance with regulatory and contractual obligations, including call monitoring, account-level review and remote and on-site auditing;
- Allocating more loans to servicers with better customer service performance metrics and paying servicers higher rates for loans that are in a non-delinquent status such as income-driven repayment; and
- Maintaining processes for borrowers to report issues or file complaints about servicers.
We encourage servicers of federal and private student loans to consult with counsel regarding the interpretation as well as other defenses to the application of state student loan servicing laws and state enforcement actions.