The U.S. Department of Education recently announced final regulations, effective July 1, 2023, designed to expand and improve the major student loan discharge programs authorized by the Higher Education Act. Among other things, the final regulations prohibit institutions that participate in the Federal Direct Loan program from requiring borrowers to sign mandatory pre-dispute arbitration agreements or class-action waivers that would be applicable to disputes about Direct Loans. The Department’s purported justification for prohibiting arbitration is a federal statute, 20 U.S.C. Section 1087d (a)(6), which authorizes the Secretary of Education to include in the regulations “provisions as the Secretary determines are necessary to protect the interest of the United States and to promote the purposes of” the Direct Loan Program.
The Department’s arbitration ban is based on its “actual experience in the student loan programs administered by the Department” and a miscellany of public policy arguments, including: if class actions are permitted, borrowers can pursue relief directly from the institution rather than relying on recovery from the federal taxpayers through discharge of their loans; class actions are a deterrent to unlawful conduct; arbitration stifles students’ ability to bring complaints to the attention of oversight bodies; class action waivers prevent borrowers from obtaining injunctive relief that would prevent harm to future borrowers; arbitration records are sealed from public view; and “the arbitration process [is] tilted in favor of the industry.”
We commented on the Department’s proposed regulations when they were issued last summer. The final regulations make no changes insofar as arbitration is concerned, so we reiterate the critical point we made then—none of the Department’s rationales in support of the arbitration prohibition authorize it to carve out these student loan agreements from the coverage of the Federal Arbitration Act (FAA). In a landmark 2018 decision, Epic Systems, Inc. v. Lewis, the U.S. Supreme Court held that in order for another federal statute to override the FAA, the other statute must “manifest a clear intention to displace” the FAA. In that case, the Court concluded that the National Labor Relations Act (NLRA) did not preclude the enforcement of arbitration provisions with class action waivers in employment agreements because the NLRA “does not express approval or disapproval of arbitration. It does not mention class or collective action procedures. It does not even hint at a wish to displace the Arbitration Act—let alone accomplish that much clearly and manifestly, as our precedents demand.” As the Court emphasized, “when Congress wants to mandate particular dispute resolution procedures it knows exactly how to do so.”
The Department expressly acknowledges that it “lacks authority … to displace or diminish the effect of the FAA.” But that is precisely what the Department’s final regulations do. Nothing in Section 1087d(a)(6) of the Higher Education Act “manifests a clear intention” by Congress to authorize the Department to prohibit the use of predispute arbitration agreements and class action waivers in student loan agreements. The Department brushes aside the “lack of authority” comments it received on the proposed regulations by stating, “[t]he Department respectfully disagrees with these commentators” and reiterating the text of Section 1087d(a)(6).
The Department has no issue with arbitration itself, as long as it is agreed to after a dispute has arisen, not before: “We recognize that arbitration may provide some potential efficiencies for institutions and consumers and the regulations do not discourage institutions from offering or promoting arbitration to complainants once a grievance is reported.” However, while post-dispute arbitration is a theory that may sound superficially appealing, it fails in real life. Once a dispute has arisen, one side or the other, or both, inevitably use the in terrorem “threat” of expensive and prolonged litigation as a negotiating tool. That tactic is eliminated if the parties have agreed to arbitrate the dispute prior to the dispute arising. An empirical study by researchers at the University of California at Berkeley concluded that the “overriding problem” with post-dispute arbitration is that “it is extremely rare for both the plaintiff’s and defense’s attorneys in a case to select arbitration after the dispute has arisen” and, accordingly, both businesses and individuals “are hurt by a post dispute system.” David Sherwyn, “Because It Takes Two: Why Post-Dispute Voluntary Arbitration Programs Will Fail to Fix the Problems Associated with Employment Discrimination Law Adjudication,” 24 Berkeley Journal of Employment and Labor Law 1, 7, 68 (2003). By contrast, “[p]re-dispute arbitration agreements ensure that both parties are on the ‘same page’ regardless of the particulars of any subsequent dispute.” Victor E. Schwartz and Christopher E. Appel, “Setting the Record Straight About the Benefits of Pre-Dispute Arbitration,” 34 Legal Backgrounder No. 7, Washington Legal Foundation (June 7, 2019).
Ironically, former CFPB Director Richard Cordray is currently the Department of Education’s Chief Operating Officer of Federal Student Aid. He, for one, must recognize that the FAA preempts the arbitration provision ban in the final rule. As CFPB Director, he headed the agency’s empirical study of consumer arbitration and its issuance of a final rule (later disapproved by Congress) that would have prohibited the use of class action waivers in pre-dispute consumer arbitration provisions. But in contrast to the Department of Education’s arbitration rulemaking, the CFPB’s arbitration rulemaking was expressly authorized by Congress in the Dodd-Frank Act. As the CFPB’s final rule explains:
Congress directed the Bureau to study these pre-dispute arbitration agreements in the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank or Dodd-Frank Act). In 2015, the Bureau published and delivered to Congress a study of arbitration (Study). In the Dodd-Frank Act, Congress also authorized the Bureau, after completing the Study, to issue regulations restricting or prohibiting the use of arbitration agreements if the Bureau found that such rules would be in the public interest and for the protection of consumers.
The Department of Education cannot point to any similar congressional authority that would support its arbitration ban, because none exists. The Department may prefer class actions to arbitration—indeed, it lauds them as “a preventative measure” that will “motivate institutions to provide competitive value and treat their student borrowers fairly.” Nevertheless, given the absence of a clear intention by Congress in the Higher Education Act to displace the FAA, it lacks the power to impose its policy choice regarding arbitration on the institutions it regulates by barring them from participating in its Federal Direct Loan program unless they eliminate pre-dispute arbitration provisions in the loan agreements. The bottom line is that a federal program run by a federal agency should abide by federal law.