B-226121-O.M. February 9, 1988

B-226121-O.M. February 9, 1988

Memorandum

Date: February 9, 1988 To: Group Director, AFMD/SAG - Ernst F. Stockel From: Associate General Counsel, OGC - Rollee H. Efros Subject: Issues Arising Out of the Sale of Government-Held Loans - B-226121-O.M.

In connection with your ongoing review of the Administration's proposal to sell government-held loans to the public, you asked us to examine two issues in relation to certain loan programs administered by five federal agencies.

First, you asked us to determine whether there are any statutory restrictions or requirements governing the use of the proceeds obtained from loan sales. For example, since loan programs often operate through a revolving fund, the question arises as to whether loan sale proceeds must be deposited in the revolving fund or can be returned to the Treasury as miscellaneous receipts. Second, you asked us to determine whether any of the statutes involved contain any "forbearance" programs that might alter or affect the manner in which loans are repaid by borrowers and whether such provisions could be enforced by borrowers after the loans are sold by the government. In this connection, you also asked whether the rights of borrowers would be violated if the loans are sold to an independent third party. Each of these questions will be considered in turn as we examine the five agencies and the loan programs involved.

Issue 1 - Use of Sale Proceeds

1. Rural Electrification Administration (Department of Agriculture) - Rural Electrification and Telephone Revolving Fund Loans.

Under 7 U.S.C. Sec. 904, the Administrator of the Rural Electrification Administration (REA) is authorized to make direct loans to eligible borrowers for the purpose of furnishing electricity to persons in rural areas that are not receiving central station service. Similar authority is contained in 7 U.S.C. Sec. 922, authorizing REA to make direct loans to borrowers to provide and improve telephone service to rural users.

In 1973, the REA Act was amended to establish the Rural Electrification and Telephone Revolving Fund and to authorize REA to use the monies in the Revolving Fund to make insured and guaranteed loans to eligible electric and telephone borrowers. Pub. L. No. 93-32, 87 Stat. 65, codified at 7 U.S.C. Sec.(s) 931-940. Under 7 U.S.C. Sec. 931, the Revolving Fund consists of "all notes . . . mortgages, and property delivered or assigned to the Administrator pursuant to loans heretofore or hereafter made under sections 904, 905, and 922 of this title and under this subchapter . . .. and all proceeds from the sales hereunder of such notes, . . . mortgages and property, which shall be transferred to and be assets of the fund; . . .".

It is our understanding that the REA loans that would be sold under the Administration's proposal are direct electrification and telephone loans authorized by 7 U.S.C. Sec.(s) 904 and 922. The notes representing these loans were transferred to the Revolving Fund after it was established in 1973, in accordance with 7 U.S.C. Sec. 931, and are currently assets of the Revolving Fund. If such notes are sold, the statute specifies that the sale proceeds must be deposited in the Revolving Fund. Furthermore, 7 U.S.C. Sec. 932 provides that the Revolving Fund's assets are only available for certain specific purposes, all of which are related to the operations and activities of the REA loan program.

Under 7 U.S.C. Sec. 933, monies in the Revolving Fund shall remain on deposit in the Treasury until disbursed. The only authority of which we are aware for using any of the assets in the Revolving Fund, including any proceeds derived from the sale of loans, is set forth in 7 U.S.C. Sec. 935 as follows:

"(a) The Administrator is authorized to make insured loans under this subchapter and at the interest rates hereinafter provided to the full extent of the assets available in the fund, subject only to limitations as to amounts authorized for loans and advances as may be from time to time imposed by the Congress of the United States for loans to be made in any one year, which amounts shall remain available until expended: Provided, That the Congress in the annual appropriation Act may also authorize the transfer of any excess cash in the fund for deposit into the Treasury as miscellaneous receipts. . . . "

Thus, it is our view that under the cited provisions, REA must deposit all of the proceeds obtained from the sale of its electric and telephone direct loans into the Revolving Fund. While the Revolving Fund's assets can only be used for program purposes, Congress may authorize, in REA's annual appropriation act, the transfer of any excess cash in the Revolving Fund for deposit into the Treasury as miscellaneous receipts.

2. Department of Education - Guaranteed Student Loans

Unlike many of the other types of government-held loans that the Administration is proposing to sell, these loans were not originally made by the federal government. These loans were made by non-federal lenders with the guarantee of the Department of Education under the authority set forth in part B of Title IV of the Higher Education Act of 1965, as amended, 20 U.S.C. Sec.(s) 1071-87-2.

Under 20 U.S.C. Sec. 1080, the Department is legally obligated to reimburse the beneficiaries of its guarantees for losses suffered as a result of defaults by the borrowers on the guaranteed loans. Upon payment of such amount, the Department becomes "subrogated for all of the rights of the holder of the obligation upon the insured loan and shall be entitled to an assignment of the note or other evidence of the insured loan by the insurance beneficiary."

The Department of Education is authorized to sell these defaulted loans by 20 U.S.C. Sec. 1082(i), which reads as follows: /1/

"In the event that all other collection efforts have failed, the Secretary is authorized to sell defaulted student loans assigned to the United States under this part to collection agencies, eligible lenders, guaranty agencies, or other qualified purchaser on such terms as the Secretary determines are in the best financial interests of the United States. A loan may not be sold pursuant to this subsection if such loan is in repayment status."

In accordance with 20 U.S.C. Sec. 1081(a), the Department uses a revolving fund--the student loan insurance fund--to make payments in connection with insured or guaranteed loans that go into default. Under that provision, all amounts received by the Secretary ". . . as receipts, earnings, or proceeds derived from any claim or other assets acquired by the Secretary in connection with operations under this part . . . and any other moneys, property, or assets derived by the Secretary from operations in connection with this section, shall be deposited in the fund. . . ." That section further provides that moneys in the fund "not needed for current operations under this section may be invested in bonds or other obligations guaranteed as to principal and interest by the United States."

Thus, it is our view that under these provisions, all of the proceeds derived from the sale of defaulted guaranteed loans by the Department of Education must be deposited in the student loan insurance fund. None of the moneys in this revolving fund can be paid into miscellaneous receipts of the Treasury or used for any purpose other than making payments in connection with the guaranteed student loan program. However, moneys in the student loan insurance fund not needed for current operations may be invested in federally guaranteed obligations.

3. Department of Housing and Urban Development Multifamily Housing for Low Income Families; Multifamily Housing for Moderate Income Families; Multifamily Rental Housing; Multifamily Lower Income Rental Assistance

The multifamily housing programs of the Department of Housing and Urban Development (HUD) operate under various statutory authorities. See, for example, 12 U.S.C. Sec.(s) 1713, 17151(d)(3), and 1715Z-1(j). Generally, in these programs HUD Ensures mortgages which finance multifamily housing projects. These programs are funded through the General Insurance Fund established by 12 U.S.C. Sec. 1735c. If the borrower defaults, HUD makes the appropriate payment to the insured mortgagee out of the General Insurance Fund and receives an assignment of all of the rights and interests arising under the defaulted mortgage. See, for example, 12 U.S.C. Sec. 1713(g). All of the receipts derived from the "claims, debts, contracts, property and security assigned to the Secretary" in connection with the mortgage insurance programs are deposited in the General Insurance Fund. See 12 U.S.C. Sec. 1735c(d). Under 12 U.S.C. Sec. 1735c(c), any moneys in the General Insurance Fund that are not needed for HUD's current operations with respect to its mortgage insurance programs "shall be deposited with the Treasurer of the United States to the credit of such Fund, or invested in bonds or other obligations of, or in bonds or other obligations guaranteed as to principal and interest by, the United States or any agency of the United States . . . . n

Thus, the proceeds obtained from the sale of mortgages and loans that are assets of the General Insurance Fund must be deposited in the Fund and used for program-related activities. The Secretary of HUD has no authority of which we are aware that would authorize him to transfer any of the moneys in the Fund to miscellaneous receipts of the Treasury or use such money for any non-program purpose.

4. Small Business Administration - Disaster Home Loans

Under 15 U.S.C. Sec. 636(b)(1)(B), the Small Business Administration (SBA) is authorized to make loans "to refinance any mortgage or other lien against a totally destroyed or substantially damaged home or business concern . . . ." SBA finances the operations of the disaster loan program through the disaster loan revolving fund established by 15 U.S.C. Sec. 633(c)(1). Under 15 U.S.C. Sec. 633(c)(2), all loans and interest payments "and other receipts arising out of transactions heretofore or hereafter entered into by the [Small Business] Administration . . . shall be paid into a disaster loan fund." Any moneys in the disaster loan fund that are "not needed for current operations may be paid into miscellaneous receipts of the Treasury." See 15 U.S.C. Sec. 633(c)(5)(B)(i). Thus, it is our view that if SBA sells disaster loans, as authorized by 15 U.S.C. Sec. 634(b)(2), the sale proceeds must be deposited in the Disaster Loan Revolving Fund, the assets of which can only be used for program purposes. However, if SBA determines that there is more money in the disaster loan revolving fund than it needs for current operations, it may pay such "excess" into miscellaneous receipts of the Treasury.

5. Veterans Administration - Loan Guarantee (Vendee Loans)

Under 38 U.S.C. Sec. 1810, the Veterans Administration (VA) automatically guarantees loans to eligible veterans to purchase or construct houses. After a borrower defaults on such a guaranteed loan, the VA reimburses the lender for its loss in accordance with the terms of the guarantee. At that time, the VA becomes subrogated to the right of the holder of the guaranteed obligation, and receives an assignment of the loan and underlying security. See 38 U.S.C. Sec. 1816. As a result, the VA often acquires title to the real property securing the loans it guarantees after the borrower defaults. Subsequently, the VA may sell some or all of these houses. Under 38 U.S.C. Sec. 1816(d), the VA is authorized to make direct loans to borrowers to finance between 60 and 75 percent of the houses that the VA sells after acquiring them in this manner. The VA is authorized to sell these loans and any other property it owns at public or private sale upon such terms as the Administrator determines to be reasonable. /2/ See 38 U.S.C. Sec. 1820. It is the sale of these so-called "vendee loans" that your submission asks us to evaluate.

The operations of VA's home loan guarantee and insurance program, which includes the vendee loan program, are financed through the Veterans Administration Loan Guaranty Revolving Fund established by 38 U.S.C. Sec. 1824. Under 38 U.S.C. Sec. 1824(c), all amounts received by the Administrator incident to the housing loan guarantee program, including proceeds from the sale of loans and other property by VA, must be deposited in VA's Loan Guaranty Revolving Fund. The statute requires the Administrator to make an annual determination whether any surplus has accumulated in the Revolving Fund which he believes "is more than necessary to meet the needs of the Fund. . . ." If the Administrator determines that such a surplus exists, such amount "shall immediately be transferred into the general fund receipts of the Treasury." See 38 U.S.C. Sec. 1824(d).

Thus, it is our view that when VA sells these vendee loans, the sale proceeds must be deposited in the Revolving Fund and used for authorized program purposes. However, each year the Administrator is required to determine whether there is a surplus in the Revolving Fund which should be transferred to miscellaneous receipts of the Treasury.

Issue 2 - Statutory Forbearance Provisions and their Relationship to Loan Sales

This issue has two parts. First, for each of the five loan programs, we have to identify those statutory provisions that authorize the agency involved to waive its right under a loan or to modify the terms of the loan and the borrower's obligation thereunder in a manner that benefits the borrower. Such forbearance provisions are not unusual since federal loan programs are designed and established by Congress in order to achieve various social and policy goals rather than to maximize a profit as is generally true of commercial lending. Second, after identifying specific forbearance provisions on an agency-by-agency basis, the memorandum will discuss in general terms the effect, if any, such provisions might have on the proposed sale of government-held loans to private parties.

1. REA - Electrification and Telephone Revolving Fund Loans

The only statutory provisions of which we are aware that authorize REA to modify the terms of a loan to benefit the borrower, are set forth in 7 U.S.C. Sec.(s) 912 and 912a. Under 7 U.S.C. Sec. 912, the Administrator of REA "is authorized and empowered to extend the time of payment of interest or principal of any loans made by the Administrator" under 7 U.S.C. Sec. 904 (electrification loans) and 7 U.S.C. Sec. 922 (telephone loans) for up to 5 years beyond the due date. In addition, 7 U.S.C. Sec. 912a authorizes the Secretary of Agriculture "to adjust and readjust the schedules for payment of principal and interest on loans to borrowers" under REA programs, and to extend the maturity date of such loans to a date not more than 40 years from the date of the loan "where he determines such action is necessary because of the impairment of the economic feasibility of the system, or the loss, destruction, or damage of the property of such borrowers as a result of a major disaster."

2. Department of Education - Guaranteed Student Loans

Under 20 U.S.C. Sec. 1082(a)(4), the Secretary of Education has general authority to "consent to modification, with respect to rate of interest, time of payment of any installment of principal and interest or any portion thereof, or any other provision of any note or other instrument evidencing a loan which has been insured by the Secretary . . . ." In addition, the Secretary has authority under 20 U.S.C. Sec. 1082(a)(6) to "compromise, waive, or release any right, title, claim, lien or demand, however acquired . . . ." Obviously, these provisions give the Secretary of Education broad authority to take various actions to change the terms of a loan to benefit a borrower, whether or not the borrower is encountering difficulties in repaying a loan. Moreover, 20 U.S.C. Sec. 1080(c) specifies that there is nothing in the statutory provisions governing the student loan insurance program that precludes any "forbearance for the benefit of the student borrower which may be agreed upon by the parties to the insured loan and approved by the Secretary, or to preclude forbearance by the Secretary in the enforcement of the insured obligation after payment on that insurance." In addition, 20 U.S.C. Sec. 1087(a) provides that if any student borrower "dies or becomes permanently and totally disabled . . . then the Secretary shall discharge the borrower's liability on the loan by repaying the amount owed on the loan." This amounts to a statutory right, on behalf of a deceased or disabled student borrower, to forgiveness of the outstanding balance of a guaranteed loan and applies whether or not the loan is in a default status.

3. Department of Housing and Urban Development - Multifamily Housing Loan Program

The Secretary of Housing and Urban Development (HUD) has authority under various provisions to grant debt relief to borrowers participating in HUD's multifamily insured loan program. /3/ For example, under 12 U.S.C. Sec. 1713(c), which applies to rental housing insurance, the Secretary "may consent to the release of a part or parts of the mortgaged property from the lien of the mortgage upon such terms and conditions as he may prescribe . . . ." Similarly, under 12 U.S.C. Sec. 1715k(e), which governs housing insurance in areas eligible for urban redevelopment or urban renewal projects, the Secretary is authorized "under such terms and conditions as he may prescribe, consent to the release . . . Of parts of the mortgaged property from the lien of the mortgage." See also 12 U.S.C. Sec. 1715(c)(2).

Under 12 U.S.C. Sec. 1715u(a), the Secretary has specific authority to make temporary mortgage assistance payments directly to the mortgagee on behalf of a mortgagor who has defaulted on an insured mortgage covering a one, two, three or four family residence "if such default was caused by circumstances which are beyond the mortgagor's control and render the mortgagor temporarily unable to correct a mortgage delinquency and to resume full mortgage payments." The Secretary can only make such payments if he determines that they are necessary to avoid foreclosure and that there is a reasonable prospect of repayment of the amount of the original mortgage plus the additional payment made by the Secretary. Alternatively, under 12 U.S.C. Sec. 1715u(b), the Secretary can provide assistance to insured mortgagors, if necessary to avoid foreclosure, by acquiring the mortgage from the mortgagee after a default and agreeing to forbear in the collection of interest or principal, or both, from the mortgagor for a limited period of time.

4. Small Business Administration - Disaster Home Loans

As explained previously, SBA is authorized by 15 U.S.C. Sec. 636(b) to make disaster loans to refinance the mortgages of totally destroyed or substantially damaged homes or business concerns. Under that section, the Administrator of SBA has the authority to "consent to a suspension in the payment of principal and interest charges on, and to an extension in the maturity of, the Federal share of any loan under this subsection for a period not to exceed five years . . . " if the loan was made to enable a homeowner to repair or replace his home and "the Administrator determines such action is necessary to avoid severe financial hardship . . . ." In addition to this authority, 15 U.S.C. Sec. 636 (c)(l) provides that the Administration "may further extend the maturity of or renew any loan made pursuant to this section . . . for additional periods not to exceed ten years beyond the period stated therein, if such extension or renewal will aid in the orderly liquidation of such loan."

5. Veterans Administration - Loan Guarantee (Vendee Loans)

The only statutory authority of which we are aware under which the VA can provide any kind of debt relief or forbearance to borrowers who received vendee loans under 38 U.S.C. Sec. 1816(d)(1), is set forth in 38 U.S.C. Sec. 1820, which discusses the general powers of the Administrator. Under 38 U.S.C. Sec. 1820(a)(2), the Administrator is authorized to "consent to the modification, with respect to rate of interest, time of payment of principal or interest or any portion thereof, security or other provisions of any note, contract, mortgage or other instrument securing a loan which has been guaranteed, insured, made or acquired under this chapter." In addition, 38 U.S.C. Sec. 1820(f) provides that whenever "loss, destruction, or damage to any residential property securing loans guaranteed, insured, made, or acquired by the Administrator under this chapter occurs as the result of a major disaster as determined by the President . . . the Administrator shall . . . pursuant to subsection (a)(2) of this section, extend on an individual case basis such forbearance or indulgence to such owner as the Administrator determines to be warranted by the facts of the case and the circumstances of such owner."

Having identified numerous statutory provisions authorizing the different agencies involved to provide the borrowers participating in the various loan programs some form of debt relief or forbearance, we must consider first whether these forbearance provisions are "enforceable" after the agency sells the loan, and second, whether the rights of borrowers are violated by such sales.

It is difficult to answer such questions hypothetically. We have not had the opportunity to examine the relevant loan forms and documents that are used in each of the different loan programs. Since a government loan to a borrower, whether direct or guaranteed, generally involves a contractual obligation, the terms and provisions of the loan documents are critically important with respect to these questions. Moreover, since there are significant differences between the different loan programs and the terms of the proposed loan sales may vary from program to program, a definitive answer to the questions you pose is not possible at this time. In all likelihood, if the Administration's proposal to sell these loans is implemented, these and other related questions will not be resolved without litigation. Nevertheless, we have attempted to set forth our general views on the questions you raise.

Most of the statutory provisions we have identified provide the head of the agency with discretionary authority to provide borrowers with some form of debt relief or forbearance, often in the form of extending loan maturity. It is left to the head of the agency to determine whether or not to provide any debt relief or forbearance to the borrower. The borrower is ordinarily not entitled to such forbearance. Accordingly, these forbearance provisions are not "enforceable" as such by a borrower whether or not a loan is sold to private purchasers or is retained by the government. /4/

Nevertheless, it is apparent that once a loan is sold by a federal agency to a private purchaser, the likelihood of debt relief or forbearance being granted by the agency is substantially reduced, if not eliminated entirely. As we understand the Administration's proposal, the loans would all be sold on a non-recourse basis. Thus, after a loan is sold, the agency would have no legal obligation to the purchaser in the event of default by the borrower, failure of collateral, or any other difficulty the purchaser might encounter with respect to the loan. In these circumstances, we fail to see how the agency could retain, in any meaningful sense, its statutory right and opportunity to grant debt relief or forbearance to the borrower, since this would obviously reduce the value of the loan to the purchaser. Presumably, the purchaser of the loan would not agree with the determination to grant debt relief to the borrower without some type of compensation from the government. While the purchaser would, of course, have the same right as any private lender to provide some form of debt relief to the borrower, the purchaser's interest in doing so would obviously not be the same as the agency involved. In all likelihood, the purchaser's interest would primarily, if not entirely, be a commercial one, whereas the agency's interest would include achieving those social and policy goals that led the Congress to establish the loan program in the first place.

This analysis leads us to the second question you posed. As explained above, borrowers generally have no "right" to forbearance since the decision whether or not to grant such forbearance is ordinarily left to the discretion of the Administrator of the agency or his delegee. However, borrowers may be entitled to a determination by the Administrator or other responsible official on a case-by-case basis as to whether or not to exercise such discretion. For example, in SBA's disaster loan program, the Administrator is authorized to consent to a suspension in the payment of principal and interest charges by the borrower and a limited extension of loan maturity if he "determines such action is necessary to avoid financial hardship." 15 U.S.C. Sec. 636(b). While a borrower certainly is not entitled to a suspension in mortgage payments or an extension of the loan under this provision, a strong argument could be made that a borrower would be entitled to have the Administrator, or his delegee, consider whether or not such debt relief is necessary "to avoid financial hardship" and should be granted.

There is clear legal precedent to support this view. In Simpkins v. Davidson, 302 F. Supp. 456, 458 (S.D.N.Y.1969), the plaintiff brought a mandamus action seeking to enjoin SBA from refusing to grant him a loan. While the District Court refused to issue an order that would compel SBA to make the loan, recognizing that the authority to determine whether applicants should get a loan was left to the Administrator's discretion, the court held that SBA had a statutory duty "to consider the application and come to a decision as to whether the loan will be granted." In another case, Dubrow v. Small Business Administration, 345 F. Supp. 4, 9 (C.D. Calif. 1972), the District Court commented on the holding in Simpkins, and said the following:

"What Simpkins makes clear is that a discretionary act of the SBA may not be reviewed, but, acts which are tantamount to a refusal to exercise discretion are subject to judicial review. Whatever the limit on this Court's authority to review denial of an application, they do not preclude judicial review when the SBA has refused to follow its statutory duty to determine whether the loan to a given applicant is 'necessary or appropriate."'

The principle articulated in these decisions is applicable, in our view, to any situation in which an agency official has an obligation or duty to consider whether or not to exercise discretion granted to him by statute and either refuses to exercise such discretion or acts in a manner that is incompatible with the exercise of such discretion. Thus, since the proposed sale of federal loans by these agencies would, in all likelihood, effectively terminate their opportunity to exercise their statutory discretion to provide debt relief to the borrowers involved, we think that the borrowers would have a sound legal basis for challenging the validity of the sales. As we suggested before, however, in light of the differences between the various loan programs and the myriad possible factual variations that might precipitate such litigation, it is impossible for us to predict the probable outcome of such litigation, should it occur.

1. The authority for the Secretary of Education to sell defaulted loans was enacted as part of the Higher Education Amendments of 1986, Pub. L. No. 99-498, Sec. 402(a), 100 Stat. 1401, October 17, 1986.

2. However, the statute specifies that notes securing loans made under 38 U.S.C. Sec. 1816 may be sold "with recourse" only to the extent that the Administrator determines that doing so is necessary to maintain the effectiveness of the loan guaranty program. 38 U.S.C. Sec. 1816(d)(3).

3. In light of the number of programs involved, we have not attempted to identify every forbearance provision that might be applicable to one of HUD's multifamily insured loan programs.

4. One exception in this respect is set forth in 20 U.S.C. Sec. 1087, which provides for mandatory debt relief in the form of complete forgiveness of the unpaid balance of a loan if the student borrower dies or becomes disabled. In order to insure that this provision remains enforceable by the borrower or his estate after a loan is sold by the Department of Education, the sales agreement should specify that the rights of the purchaser are subject to the forgiveness provision and should specify whether the purchaser or the Department will bear the "risk of loss."