New Laws & Challenges in the ISA Market: How to Stay in Legal Compliance

Income Share Agreements (“ISAs”) started out as a way to finance student tuition in higher education. They’ve since expanded to fund attendance at vocational, coding, culinary, and other types of specialty career training schools in marketing, tech, and even venture capital.

As a financial instrument, ISAs occupy a nebulous middle ground – they’re not quite a line of credit, and they’re not quite a loan. Some ISA companies claim they are a financing product or investment vehicle; others, personal loans or a form of capital.

ISAs occupy a specific niche industry; they have helped thousands of members of job training companies and students pivot during the pandemic and graduate, while in government-ordered lockdowns, from coding programs, schools, and employment training programs that many students would not have otherwise been able to attend or afford.

The marketplace did its job and created a product that would help with repayment terms benchmarked to the actual income of the employment obtained after completing vocational or career training programs. The ISA model effectively incentivizes private institutions to do a superior job (over traditional colleges) for their students or members so they can be competitive in the marketplace, while also protecting them from loan payments during downturns.

Available research data from some states indicate ISA graduates wind up borrowing and paying less than peers who use traditional debt models. When a borrower takes out a loan, that borrower pays back a set amount of money over a known (theoretically) length of time. With an ISA, borrowers are paying back for a set amount of time and an unknown amount of money. When factoring in lower paying wages for college graduates, along with interest rates of over 7% for most federal loan programs, ISAs become an extremely competitive alternative. Further, ISA “debt” can be discharged in bankruptcy, whereas the federal government will not allow its loans to be discharged.

The ISA industry has evolved in a legal grey area, without fitting neatly into any of the current regulations governing student lending, student tuition, or disclosures, which has caused much consternation among state and federal regulators. With prominent universities like Purdue University, and significant coding boot camps like Lambda, it has become clear to the federal government that ISAs are here to stay.

Congress had started the process of regulating ISAs with Senate Bill 2114, the ISA Student Protection Act of 2019. The pandemic derailed this effort, and coincidentally, it also fueled the incredible growth of the ISA marketplace due to the sheer volume of students who needed to pivot in their careers and educate themselves remotely – ironically at the insistence of the government.

Congress has picked up the ball again and has taken steps to create a “consumer protection framework” with Senate bill 4551, titled the ISA Student Protection Act of 2022, which is the revised version of its predecessor, Senate Bill 2114, the ISA Student Protection Act of 2019. The ISA Student Protection Act of 2022 hasn’t yet been signed into law, and the push to regulate ISAs is likely to continue escalating. Companies that provide ISAs to their customers must anticipate these new regulations and position themselves to adapt their business practices to these regulations without becoming the target of costly government investigations.

And that’s not all. Some states are also enacting their own rules, some of which potentially conflict with the regulatory regime proposed by the federal government. While New York doesn’t currently have any regulations concerning ISAs, California classified ISAs as a form of student loan last year, making them subject to the state’s student loan regulations.

Read more to learn about how to protect yourself in this rapidly shifting market.

Are Income Share Agreements Legal?

The answer to this question is more than a simple yes or no. Currently, ISAs are unregulated by the federal government, and, in most states, there is no specific statute or regulations. Instead, ISAs have been “regulated through enforcement” by individual State Attorney General’s Offices and State Departments of Financial and Consumer Protection. Hopefully, the unregulated and chaotic patchwork of laws and rules government agencies are using to bring enforcement actions against companies that use ISAs in their business models, such as employment training programs, vocational schools, and even some higher education schools, can be clarified to create certainty for this burgeoning alternative form of tuition financing.

Regulatory uncertainty makes the present and rapidly growing ISA market a bit like the Wild West. Without explicit regulations, almost anything can potentially be done or said about the ISAs being used. Companies offering an ISA may disclose it as a personal loan, debt consolidation, refinancing vehicle, or just capital. Interest rates do not apply because the repayment of an ISA contract varies depending solely on the individual borrower’s income. The government’s failure to promulgate rules can confuse both borrowers and issuers of ISAs. They may not be exactly sure what state statutes or regulations apply to their contractual relationship, even if the borrower and ISA provider are certain there is some kind of contractual relationship.

This uncertainty damages business owners who utilize ISAs to assist their students, as well as the students themselves. Government investigations will almost certainly cause service disruptions to the programs students have invested their time in, and will seriously concern the investors who back ISA financial products but did not realize how risky ISAs may be because of the lack of regulatory guidance. The unintended consequence of the government “regulating by enforcement” investigations is that the government is specifically harming individuals who do not qualify for federal education loans (such as individuals with a criminal record), do not wish to, or can not afford to go to a traditional four-year college (working mothers and fathers, transient workers, gig economy workers, and second career students, to name a few), and therefore, are looking for specific vocational or job training program to improve their career trajectory.

The same regulatory uncertainty also damages the robust market for legitimate ISA companies and the investors of those ISA companies. Without clarity, investors will cease offering funds for education or job training programs that potentially have higher success rates at obtaining jobs for students in the field of their choice, like coding or specialty sales, than traditional higher education schools do.

The government’s inaction in promulgating clear rules and regulating through enforcement ironically harms the type of student who could benefit most from the flexible terms that ISAs offer, for precisely the kinds of specialized and technical programs designed to train students for specific careers they can start within months, not years.

The New Senate Bill on Student ISAs

As soon as Congress passes a bill on the issue, all ISA providers must comply with the new regulations. Preparing for this eventuality as a risk mitigation strategy will help your company avoid any interruptions to your business operations – and any potential losses that will follow if your company becomes the subject of an investigation. Not to mention the loss of investor confidence in your company.

The bipartisan ISA Student Protection Act of 2022 addresses several major concerns about ISAs, including consumer protection issues such as:

  • Misleading borrowers about ISAs with inaccurate marketing
  • Failing to include required disclosures
  • Violating laws against prepayment penalties
  • Including exploitative or predatory terms in their contracts
  • Charging a high percentage of income for an extended period of time

Some of these actions could result in student borrowers paying more for ISAs over time compared to payments on traditional student loans – without the borrowers realizing it.

This type of abusive behavior has led the Consumer Financial Protection Bureau (“CFPB”) to issue consent orders in recent years against ISA providers acting in bad faith. In one order, the CFPB explicitly labeled ISAs as personal loans subject to private student lending rules. With lack of clear guidance, the government is aggregating these bad-faith actors with reputable the ISA companies that provide valuable services to individuals. The result in either scenario is harmful to the consumer.

To address these issues, the new ISA Student Protection Act proposes the following:

  • Caps on how much ISAs can charge
  • Limits on how long students can be required to make payments on ISAs
  • Greater transparency in the borrowing process

Instead of lumping ISAs in with traditional loans, the new law would create a set of regulations that apply specifically to ISAs.

Despite the limited nature of the new bill, most ISA providers seem to welcome these changes. Instead of operating in a risky regulatory gray area with bad actors who take advantage of the lack of guardrails, ISA companies will now stand on much more solid ground. That’s also good news for businesses, investors, venture capitalists, and hedge funds interested in a more secure, stable ISA market.

How to Keep Your ISA Company in Compliance

If the ISA Student Protection Act goes into effect, ISA providers must elect to operate as either:

  • A traditional loan provider, with all the relevant regulations in that space, or
  • An ISA provider, subject to the new regulations and standards outlined in the Act.

If your company chooses the second option, the rules and regulations may differ based on the finalized version of the bill that is enacted into law. Currently, the proposed regulations in the Act provide that:

  • ISA providers cannot charge more than 20% of a student’s future income
  • Providers must alert students if their future payments will total over 20%
  • ISA contract terms cannot be longer than 240 months
  • All ISAs must expire after 360 months no matter how much has been paid
  • Low-income borrowers can defer payments if their earnings are less than 200% of the federal poverty level after the ISA monthly payments are taken out
  • ISA companies cannot charge borrowers earning less than 300% of the poverty line any more than what they’d pay with a traditional 18% APR loan of similar length
  • ISA providers must show borrowers what their monthly payments will look like at different income levels using comparison tables

The proposed bill also details how ISA programs will be treated under bankruptcy and securities laws and programs like the Fair Credit Reporting Act and Fair Debt Collection Practices Act.

The ISA Student Protection Act of 2022 is currently a bipartisan bill with a fair amount of support. Even if it doesn’t pass in its current form, Congress may pick it back up during the next session, or individual state governments could use it as a framework for their own laws.

What this means is that even though this proposed bill and its provisions do not currently affect you and your company, it’s always a good sign when companies are prepared for changes in the market and take proactive steps to mitigate regulatory risk. If you are an ISA provider, or use ISA products in your business model, aligning your policies to reflect the likely regulatory landscape will help investors confirm that your business operations are a better bet than the competitors.

For more information, please contact the attorneys at the Warren Law Group at 866.928.5838 or email info@warren.law.

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Christopher D. Warren

Christopher D. Warren, Managing Partner