United States: Income Share Agreements – What University General Counsel Ought To Know

Amid widespread concern about student debt and calls for higher education institutions to put more "skin in the game," some have looked to income share agreements (ISAs) as part of the solution. In general, under an ISA, a school or investor provides a student funds for education today in exchange for a percentage of the student's income tomorrow. Incentives are theoretically aligned: the better job a student gets, the more money an institution earns. Like other innovations, however, ISAs largely exist in the interstices of existing legal frameworks and therefore can present challenges.

A June 4 letter from Senator Elizabeth Warren and others to the U.S. Department of Education (ED) and to seven institutions that have implemented ISAs brings some of those challenges to life. Senator Warren essentially characterizes ISAs as no different than other forms of debt and worries that ISAs "can be predatory and dangerous for students," can result in violations of the Equal Credit Opportunity Act (ECOA), and have received "little federal oversight." She therefore requests ED and the institutions to provide documents and information about ISAs, presumably as an entrée to potential oversight and legislation.

Even so, it's unlikely ISAs are going away. Many coding bootcamps are already using ISAs to fund up to 100 percent of the cost of the program with apparent success. More and more, traditional institutions of higher education are considering adding ISAs as part of the financial aid menu. Companies have emerged and are emerging to help institutions address financing and servicing. Additional regulation is also likely. Below, we describe what ISAs are, identify some of their promises and perils, and outline the legal framework university general counsel should consider.

What are ISAs?

ISAs trace their roots to the pre-Higher Education Act of 1965 musings of Milton Friedman. Noticing that students need to finance education but lack collateral and credit, he thought a solution could involve trading a student's educational funding for a share in that student's future earnings. In terms of financing instruments, student loans and ISAs may be contrasted accordingly: if student loans are akin to debt-financing where a student borrows a principal amount and is obligated to repay it with interest, ISAs are akin to equity-financing where a student receives funding (or the equivalent) for education with a promise to pay an undefined portion of the student's future earnings (which could be more or less than the initial funding the student receives).

Today, ISAs can and do take many forms, including as initial and ultimate funding source, key payment terms, and caps. For example, some institutions have raised money from donors to create a revolving institutionally managed fund to start an ISA program. Other ISAs involve private investors funding individual students or purchasing ISAs from institutions. ISAs also differ as to when a student's obligation to begin repayment kicks in (for example, after a set period of time or after exceeding a salary threshold); what counts as income (for example, a line from a student's tax return); and how much students must repay (for example, capped at the initial amount of funding received or some other amount or for a certain period of time). ISAs therefore differ in the extent to which they resemble a traditional private education loan, which has regulatory implications that we address below in the section, "What are some of the key legal issues when constructing an ISA program?"

So far, most traditional Title IV-eligible higher education institutions have viewed ISAs as a potential alternative for private education loans or some high-cost federal Parent Loans for Undergraduate Students (PLUS loans), not as a general replacement for Title IV. However, that could change to some degree with interest rates and the regulatory environment. And some programs already permit students to use ISAs to finance practically the entire cost of the program.

What are some potential advantages and challenges?

ISAs have the potential to benefit both institutions and students. Many students seek higher education to improve their careers. In theory, the better an institution's education program prepares a student to succeed, the better an institution's chances of recovering the ISA investment in the student. ISAs are a potentially powerful way for institutions to testify to the quality of their education programs (because the institutions take the downside risk and may need to cap the upside for legal and practical reasons). Students receive the certainty that any payment due will be tied, not purely to the program cost, but to what the students earn.

Yet there are also challenges. For an institution-based ISA program, one challenge is funding: an institution must find ways to bridge the gap between when a student enters into an ISA and when the student begins repayment. Another is defining and confirming a student's income and collecting the required payments. There are also practical problems around adverse selection, modeling whether an ISA program will at least break even, and addressing concerns about how ISAs compare to student loans (including whether students will pay more or less under various alternatives).

Another big challenge is overall lack of legal clarity. For example, Senator Warren's letter seems to characterize ISAs as just another form of consumer credit, but it is far from clear that is correct as a legal matter. True consumer credit transactions are often distinguished by features that are unlike ISAs. For example, ISAs do not typically impose an absolute obligation for students to repay because they generally only pay if their income meets a certain threshold or a percentage for a certain number of years. Other factors may also contribute to the analysis, such as whether the funder maintains a right of recourse under the ISA agreement. Universities are grappling with these legal uncertainties in an effort to provide solutions for their students; Purdue University's President Mitchell Daniels testified before Congress in 2015 that "widespread use of incomeshare agreements is not realistic without legal clarity and adjustments to the regulation of student data."

What are some of the key legal issues when constructing an ISA program?

As institutions construct ISA programs, they need to address a range of potential legal regimes related to general consumer finance and education regulatory requirements. We provide a high- level outline of some of them below. However the puzzle pieces fit together, it is important under unfair and deceptive trade practices law to give students a clear understanding of what the ISA is, how it works, and how it compares to other financing alternatives. Institutions should similarly seek to provide students with information about regulatory rules that may affect students more than institutions (such as income tax and bankruptcy implications).

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