Silver State Helicopters vocational school, the largest private helicopter flight academy in the country, has parked its last chopper in the hanger.

The school, which operated in 12 states and enrolled over 2,400 students, filed for Chapter 7 bankruptcy protection after closing its doors in February.

Aside from being earthbound with their education plans dashed, many students had bankrolled their training through loans from KeyBank USA N.A., based in Cleveland, Ohio. Since the school required full tuition for its 18-month program to be paid up front, many students borrowed over $50,000. Silver State helped students apply for private loans, providing access to sources such as KeyBank.

Heres the hitch: Ordinarily, students are protected by Federal Trade Commission (FTC) rules from being stuck with a loan for an institution that no longer exists.

Although the money was owed to the school, Silver State and KeyBank worked closely enough that KeyBank could, according to the students class action lawsuit filed in California, be considered a holder in due course of the financing contract.

The FTC Holder Rule protects consumers when their financing contracts are sold to another creditor. In this case, the rule preserves any legal claims or defenses the student had against the school and allows him to use those claims and defenses against the bank.

Federal law requires that consumer credit contracts contain the following language, in bold, 10-point (or larger) type:


Any holder of this consumer credit contract is subject to all claims and defenses which the debtor could assert against the seller of goods or services obtained pursuant hereto or with the proceeds hereof. Recovery hereunder by the debtor shall not exceed amounts paid by the debtor.

Not only did the students' contracts with KeyBank fail to contain this notice, but students allege that KeyBank deliberately incorporated in Ohio because state laws exempt Ohio-domiciled banks from that states consumer protection laws.

Looks like Silver States students were skinned not just once, but perhaps twice. And if a student refuses to pay, the lender can report negative information about him to a credit bureau, ruining that students credit score.

If Key Bank is truly a holder, students should be protected by the FTC rule despite Key Banks end run around that protection.

Ripe for abuse

Author Cathy Lessor Mansfield, writing in the Wake Forest Law Review, highlights a situation ripe for abuse.

When a student needs a loan, his college or vocational school chooses one or two lenders and frequently processes the loan for the student. If (or when) the school bows out of the picture, the financial institution goes after the student, even though the student is the actual victim.

Mansfield argues that the FTC definitely has power over such situations, because student loans qualify as the type of loan (purchase money loans possessing a finance charge) covered by the FTCs Holder Rule.

Unfortunately, the Silver State situation isnt unique. Schools, especially unlicensed vocational schools, have a habit of closing suddenly, leaving students holding the financial bag.

Aggressive lending

Complaints abound against aggressive lenders including Sallie Mae, the formerly government-affiliated lender that is now privately owned.

In one case involving Sallie Mae, Mark Powell of Alexandria, Virginia enrolled in a computer-training school called Ameritrain, which ran seven computer-training facilities in five states. The school awarded certificates at the end of training, aimed at students getting commercial software jobs.

Shortly before Powell finished his course, the school closed and filed for bankruptcy. Students were stunned to learn that Sallie Mae did not consider itself a creditor within the meaning of the FTC rules and planned to collect on the loans.

Powell and other students hired counsel in hopes of pursuing a class action. They found out two disturbing things:

1) promissory notes they signed forbade litigation in favor of mandatory arbitration and

2) Ameritrain wasnt the first unlicensed school Sallie Mae had done business with.

Congressional action

Congress tried to offer students protection by amending the Higher Education Act, giving students with guaranteed loans the same protections as those contained in the FTC holder rule and make sure lenders checked out the legitimacy of schools whose students borrowed money.

To make things more dodgy, private loans (regulated by state and federal consumer protection and banking laws rather than the HEA) have skyrocketed since the late 90s, now representing approx. 20 percent of student loans.

This situation illustrates the crux of the problem: the explosion of private lending, together with partnering of schools and private lenders, most often banks.

Private loans frequently have more restrictive terms than federal student loans and tend to be more expensive. And, contrary to what youd think, a bank loaning money to students at a substandard school doesnt necessarily put itself at risk. Many private loans are sold to investors, who are usually clueless about the defects lurking in the loan.

Federally-sponsored loan programs contain eligibility requirements for schools its students attend, to lessen the chance that a school is understaffed or doesn't meet state licensing requirements. No such vetting takes place among private lenders, and students sometimes find out about their school's inadequacies when the doors close for good.

More protection

While the Silver State students battle it out in California Superior Court, the Project on Student Debt, a project of the Institute for College Access & Success, suggests measures to protect students borrowing through private lenders (approx. 20% of all student loans.) Among them:

• Extend borrower protections and remedies in the FTCs Holder Rule to cover students at all types of colleges and universities (not just private for-profit schools as under current law,) and all types of student loans and loan holders.

• Require colleges to clearly distinguish private from federal loans in financial aid awards and other materials. Require lenders and colleges to tell prospective borrowers about federal loans before they sign for a private loan, and emphasize that private loans are not backed by the federal government and can cost more.

• Require rate quotes for private loans to include full APR and other items required by the Truth in Lending Act (TILA) and make sure borrowers have accurate quotes before they sign a promissory note.

• Require a minimum cooling-off period during which the borrower can cancel the loan with no prepayment penalty.

• Amend current federal bankruptcy law so that private student loans have to meet the same criteria as other forms of consumer debt to be exempted from discharge. Federal student loans come with some borrower protections for economic hardship, unemployment death or disability, whereas private loans do not. Shielding private loans from bankruptcy means that repayment demands can essentially extend forever.

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Joan E. Lisante is an attorney who writes frequently on consumer issues.