Federal Law Preempts Connecticut’s Student Loan Servicer Licensing Law, According to Federal CourtSeveral states have recently ramped up their regulation of the student lending industry by passing laws requiring student loan servicers to be licensed in the state in order to operate there. Many of these state licensing laws are creating conflicts for servicers in an industry already dominated by federal law. Now a U.S. District Court in Connecticut has decided in Pennsylvania Higher Education Assistance Agency v. Perez that federal law preempts portions of Connecticut’s student loan servicer licensing statute, a decision that may limit the scope of other states’ licensing laws.

In 2017, Connecticut’s licensing statute placed student loan servicer Pennsylvania Higher Education Assistance Agency (PHEAA) in an impossible situation. The Connecticut Department of Banking, pursuant to Connecticut’s student loan servicer licensing statute, demanded PHEAA’s records and information related to the federal Public Service Loan Forgiveness Program. However, the Department of Education, which contracted with PHEAA for the servicing of certain federal Direct Loans in the Public Service Loan Forgiveness Program, instructed PHEAA to not disclose any data or documentation related to the Public Service Loan Forgiveness Program. The U.S. Department of Education took the position that PHEAA was prohibited from releasing the Public Service Loan Forgiveness Program’s records under the federal Privacy Act and declined to provide the records to the Connecticut Department of Banking.

Even though PHEAA informed the Connecticut Department of Banking that it could not respond to the request due to the U.S. Department of Education’s directive, the Connecticut Department of Banking threatened administrative action and suspension of PHEAA’s state license if it failed to comply with the records request. Ultimately, neither the Connecticut Department of Banking nor the U.S. Department of Education was willing to budge from their respective positions, leaving PHEAA’s state license hanging in the balance.

PHEAA sought a declaratory judgment from the federal district court as to whether federal law preempts the portions of Connecticut’s licensing statute relied on by the Connecticut Department of Banking in making its document requests. On summary judgment, the court examined the dispute under principles of conflict preemption, ultimately finding that federal law preempted the provisions of Connecticut’s licensing statute that required PHEAA to provide documents related to its servicing of federal student loans.

The court first noted that Connecticut’s “licensing requirements for student loan servicers overlap with [the U.S. Department of] Education’s own criteria for selecting its servicing contractors,” and accordingly interfere with the U.S. Department of Education’s selection process for its own contractors. This, the court held, violated the U.S. Supreme Court’s precedent set in Leslie Miller, Inc. v. State of Ark., in which the Supreme Court struck down a state licensing statute that virtually gave the state power of review over a federal contractor determination.

The court also held that “impossibility preemption bars the portions of [the Connecticut Department of Banking’s] demands that sought documents and information protected by the Privacy Act, since ‘compliance with both federal and state regulations [wa]s a physical impossibility’ for PHEAA.” The court noted that the U.S. Department of Education has “substantial discretion” in whether to release documents under the Privacy Act and has ownership of the documents themselves. PHEAA thus had no power on its own to provide the documents to the Connecticut Department of Banking, and impossibility preemption applied.

Notably, the court did not hold that Connecticut’s general licensing requirement was preempted, but rather limited preemption application to just those portions of Connecticut’s licensing statute that covered state investigations and record-keeping requirements for federal student loan servicers. Also, the opinion appears to restrict preemption to the servicing of federal student loans rather than privately held student loans. Lastly, while the court declined to reach the issue of whether field preemption applies, the court noted that there was some authority suggesting field preemption would not be appropriate as it relates to the relationship between state licensing laws and federal law.

This decision limits the reach of Connecticut’s licensing statute because it strips some potent tools from the Connecticut Department of Banking — investigatory powers and informational demands. While the decision likely will not slow the growing trend of state licensing laws aimed at the student lending industry, it may take the teeth out of some of the provisions.