()

Former beauty school students may pursue claims that the U.S. Department of Education defied federal law by collecting student loans it knew may have been obtained fraudulently, a federal appeals court determined.

The U.S. Court of Appeals for the Second Circuit revived a suit by former students of Wilfred Academy over the Department of Education’s alleged failure to abide by two federal laws requiring student loan holders to be told that their loans could be discharged if issued under fraudulent premises.

Plaintiffs in Salazar v. King, 15-832-cv, said the agency had that very knowledge, as evidenced by its conclusion in 1996 that misconduct at Wilfred Academy was widespread and that students enrolled improperly. As early as 1988, the U.S. Justice Department had brought charges against Wilfred employees for misuse of federal funds and falsifying loan applications.

The plaintiffs argue that they are still saddled with loans from education and job training that did not prepare them for a profession.

Judge Gerard Lynch, writing for the panel that included Judge Peter Hall and Southern District Judge Jed Rakoff, sitting by designation, found Thursday that the Department of Education did not provide notice about the possibility of discharge that is required by the Federal Family Education Loans and Direct Loans statutes.

“Plaintiffs plausibly argue that the fact that the DOE has already determined that any Wilfred borrower who presents a facially valid application alleging false certification will automatically receive a discharge is powerful evidence that the DOE has in its possession reliable information all such Wilfred borrowers ‘may’ be eligible for discharge,” Lynch wrote.

The ruling reinstated the putative class action suit that Southern District Judge Robert Sweet had dismissed on the Department of Education’s motion.

Sweet had ruled that the agency’s actions were not reviewable because they were not final and were taken within the government’s discretionary powers.

But Lynch wrote that the plaintiffs are asking the court to compel the department to do something that is not a discretionary function of the agency: comply with the two loan laws and stop collecting loans from the students.

“The presumption in favor of judicial review applies to this case, because plaintiffs challenge what they contend are unlawful actions that the agency has taken, and continues to take, against the plaintiffs themselves,” Lynch wrote. “Such challenges are at the core of the judicial review function.”

The judges said their ruling directs a district court to consider the plaintiffs’ contention that, as regulations governing the Direct Loans statute says, the Department of Education must mail “the borrower a disclosure application and an explanation of the qualifications and procedures for obtaining a discharge” where applicable.

The regulations also direct that the secretary of education “promptly suspends any efforts to collect from the borrower on any affected loan.”

Lynch wrote that when the case returns to a lower court, the Department of Education “may be able to provide good reasons why it does not have reliable information about Wilfred borrowers, or some subgroup of Wilfred borrowers,” showing that the agency’s legal obligations to suspend collection efforts have not yet been triggered.

Judge Lynch

“But we do hold that a court has sufficient law to apply to decide whether [the] agency was arbitrary and capricious in failing to follow the mandatory direction of the statute and regulations to suspend and notify,” Lynch wrote.

According to the Department of Education’s investigation of Wilfred Academy in the 1990s and to the circuit’s ruling, the question of fraud surrounding the student loans focused on whether the school ever certified that students who did not graduate high school had an “ability to benefit” from its program. The plaintiffs allege that they were never asked if they had a high school diploma or given any test to determine if, in fact, they had an “ability to benefit.”

It was unclear from court papers or the ruling how many former Wilfred students would be involved in the putative class, or how many are still paying loans arranged through Wilfred that could be dischargeable.

At its height in the late 1980s, Wilfred operated 58 outlets and had an annual enrollment of 11,000 students. Its advertisements often used the tag line, while picturing an eager young student, “That Wilfred winner—she knows where she’s going.”

The Wilfred American Educational Corporation filed for Chapter 11 bankruptcy in May 1990 and the last Wilfred school was shuttered in 1994.

Over 61,000 Federal Family Education Loan program loans were issued to Wilfred students between 1986 and 1994. When the action before the Second Circuit was filed in 2014, lawyers for the plaintiffs estimated that there were 40,000 or more students who took out federally guaranteed loans to attend Wilfred campuses.

The Department of Education is involved in the matter because, under law, the agency is responsible for attempting to collect federally guaranteed educational loan debts. It is empowered to do so by charging interest, fees and penalties, garnishing wages or reporting the debts to consumer collection agencies.

Eileen Connor, now with the Legal Services Center at Harvard Law School, was lead attorney for the plaintiffs on behalf of the New York Legal Assistance Group.

Other NYLAG attorneys on the case were special litigation unit staff lawyers Beth Goldman, Jane Greengold Stevens, Danielle Tarantolo and Jason Glick.

Stevens said in a statement Friday that the Second Circuit ruling will ensure that deserving students will get their day in court.

“In doing so, the court rejected the department’s claims that its ‘discretion’ insulated it from having to justify its actions,” Stevens said. “The decision’s legal foundation may also open the courthouse doors to countless other students who attended predatory schools and who are entitled to the department’s protection.”

Assistant Attorney General Christina Poscablo represented the Department of Education.

The action was initially filed in 2014 under the title Salazar v. Duncan, but the name of the lead defendant was changed when John King Jr. succeeded Arne Duncan as U.S. secretary of education.