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Banks, E.D. Held Liable for 'Sham' Trade School

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In a preliminary ruling being hailed by consumer advocates, a federal judge has held that banks, loan-guarantee agencies, and the U.S. Education Department potentially may be held liable for the guaranteed student loans of several thousand students at a failed West Virginia trade school.

Most courts in the past have ruled that students must repay their federally guaranteed loans, even when a postsecondary institution goes bankrupt or fails to provide the education it promised.

But in a class action being heard in federal district court in Charleston, W.Va., students who attended Northeastern Business College argue that state and federal consumer-protection laws shield them from having to repay their loans.

The plaintiffs allege that the now-defunct trade school was a "sham'' institution that existed primarily to sign them up for courses and collect their guaranteed loans. Because the school is out of business, the students have no chance of directly recouping any of their money.

In their suit, the students assert that banks, guarantee agencies, and the Education Department should be held liable for making business arrangements with the school to sign up students for loans and for failing to use their oversight abilities to ascertain the poor quality of the school.

In his June 21 ruling, U.S. District Judge John T. Copenhaver Jr. said that the students may press their suit against several banks because of the business relationships that existed between the banks and the school. For example, one bank offered a finder's fee to the school for each student it signed up for a guaranteed loan.

The ruling came on a preliminary motion to dismiss the case. Judge Copenhaver will determine later whether any of the students' claims actually are supported by West Virginia or federal law and, thus, whether the banks, the guarantee agency, or the federal government will be held re8sponsible for their loans.

Banks See Threat

"This is the first significant ruling that says students have a viable claim against lenders when a school fails to provide them an education," said Jonathan Sheldon, a lawyer with the National Consumer Law Center in Boston.

He noted that under existing court rulings, students who are defrauded by trade schools must repay their loans or face being hounded by collection agencies and becoming ineligible for further federal financial aid.

Representatives of the consumer- banking industry say the ruling ultimately could make it harder for disadvantaged students to obtain loans for higher education, since being held liable for shoddy schools could drive many banks from the guaranteed-loan program.

In a brief filed in the case on behalf of Secretary of Education Lamar Alexander, the Education Department said it backed the students' right to sue under state law.

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