Human capital contracts and bankruptcy: balancing the equities between exception to discharge and the opportunity to prove undue hardship.

• Author: Jutras, Saige Elizabeth

"[T]here's a new hot concept in the land of personal finance: personal corporatehood, the notion that people can act like corporations.... [I]t's easy to see something suspect about the idea of young people in a downtrodden economy pledging away part of their livelihood to the investor class.... [I]n the future ... we could wind up with a society where vast numbers of people are traded like stocks, where every life is assigned a monetary value, and where Wall Street bankers bundle the income streams of a bunch of 22-year-olds into exotic financial instruments." (1)

1. INTRODUCTION

   In times of economic downturn, educational prestige is directly correlated to financial resiliency. (2) Indoctrinated with the belief that virtually all highly-coveted jobs require postsecondary education, many ambitious yet financially disadvantaged young people in the twenty-first century face no alternative than to rely on student loans to fund educational pursuits. (3) While traditional federal and private loans may offer students the opportunity to enter the middle class, the debt incurred from these loans will likely follow them throughout the better part of their lives. (4)

   An innovative, less-restrictive financing option has gained popularity in recent years: HCCs allow investors to fund young investees' educational and entrepreneurial endeavors in exchange for a percentage of the investee's future income. (5) HCCs uniquely allow these investees to treat themselves as independent, corporate entities. (6) Touted as human "equity-like" investments, HCCs offer an effective alternative for many students skeptical of traditional public and private loans. (7) HCC proponents consider this financing option more financially sound than traditional loan models. (8) Specifically, repayments to investors are contingent upon the investee's actual income rather than traditional loans' fixed interest rates. (9) Furthermore, while mounting federal loan debt has sparked widespread criticism, increasingly progressive online accessibility to wealthy investors suggests HCC and similar lending practices are not likely to dwindle in the immediate future. (10)

   Unlike student loan debt, however, the bankruptcy treatment of HCCs remains unanswered. (11) Some scholars suggest resolving HCC bankruptcy treatment similarly to discharging student loans. (12) Student loan debt is considered an "exception" to conventional bankruptcy discharge, and students seeking to discharge traditional student loan obligations are permitted to do so only under limited circumstances. (13)

   Although a lofty threshold, if outstanding student-loan debt would present the debtor with undue hardship after filing for bankruptcy, a bankruptcy court may discharge the debt. (14) Despite failed legislative attempts, HCC investees do not yet enjoy the same limited recourse in bankruptcy. (15) The result is that even under circumstances of the most "undue hardship," students choosing to finance their educations by treating themselves as corporate entities must repay these debts to their investors, notwithstanding filing for bankruptcy. (16)

   This Note argues that HCC investees' financial obligations to their investors should be dischargeable in bankruptcy similar to student loan debt dischargeability; however, HCC bankruptcy treatment should also protect investors by subjecting dischargeability to an undue hardship threshold. (17) This Note begins by discussing HCCs' history and current trends in the United States. (18) Next, this Note reviews bankruptcy law's goal to provide debtors with a "fresh start" by discharging prebankruptcy student-loan debts if the debtor can prove undue hardship. (19) The analysis argues that similar to student loan debts, HCC payments should be categorized as claims in bankruptcy to protect investors and encourage widespread HCC implementation. (20) Likewise, although there should be a per se exception to discharge, HCCs should be afforded similar, limited bankruptcy discharge. (21) This Note's conclusion reiterates the commonalities between HCCs and student loans, emphasizing their proposed similar bankruptcy dischargeability under limited circumstances. (22)

2. HISTORY

   1. Human Capital Contracts

      1. History and Modern Structure

         HCCs permit individuals to acquire immediate financial backing in exchange for a fixed percentage of their income over a set period of time. (23) HCCs operate similarly to income share agreements (ISAs). (24) While HCCs have gained widespread attention in recent years, Nobel Prize winner Milton Friedman proposed an HCC-like financing option as a solution for funding higher education in 1955. (25) Friedman argued that although attaining higher education yields positive "neighborhood effects" for general society, financing higher education is ultimately a private venture because higher compensation more directly benefits the individual student than it does society. (26) Thus, Friedman suggested that the private market rather than the federal government should assist in financing higher education. (27) Identical to many modern HCC structures, Friedman's original proposal contemplated private investors funding professional education through buying shares in students' future incomes. (28) This funding concept became the basis for income-contingent loans (ICLs). (29)

         Over thirty-five years after HCCs' original contemplation, Human Capital Resources (HCR) became the first company to actively consider utilizing HCCs. (30) Ultimately, HCR chose not to implement HCCs because of the many legal uncertainties investors would face. (31) In 2001, however, the company MyRichUncle officially utilized HCCs for the first time in history, solidifying Friedman's vision. (32) MyRichUncle's initial success with HCCs was short-lived, however: the company filed for bankruptcy following the 2009 financial crisis. (33)

         In 2012, two new companies--Pave and Upstart--began offering HCC financing for educational and professional pursuits. (34) Using Upstart's platform, Security and Exchange Commission (SEC) "accredited investors" could loan money to recent college graduates for any educational or entrepreneurial venture in exchange for up to two to six percent of the borrower's income for as long as five years. (35) Pave also began offering HCCs in 2012; "Backers" offered "Talents," or borrowers, funding in exchange for up to ten percent of the borrower's income for a maximum of ten years. (36)

         Both Upstart and Pave made profits funding exchanges between borrowers and investors. (37) The companies treated borrower default differently, however; Upstart's deferral policy provided that deferred payments would increase the borrower's contract term by one year if his or her income dropped below a certain amount. (38) Pave did not have an extending period if a Talent's income fell below 150% of the poverty line, but if the Talent was enrolled in school, the repayment period would be extended. (39) Currently, both Upstart and Pave offer more traditional loan programs in lieu of HCCs. (40)

      2. Human Capital Contracts Versus Traditional Loans

         HCCs and ICLs offer borrowers a number of financial advantages over traditional loans. (41) For instance, HCCs provide students of many diverse backgrounds access to financing "without requiring a government guarantee or subsidy," and incentivize investors to support their investee students through mentoring. (42) Additionally, a student whose income drops below a certain threshold is not required to make immediate repayments, although the repayment term may be extended for up to fifteen years. (43) Nevertheless, borrowers who are financially able to repay their loans but fail to do so may face delinquency consequences that are similar to traditional loans, including credit report filings, collection agency involvement, and interest rates of up to fifteen percent. (44) In short, borrowers who are financially capable of repaying investors will be held to their HCCs. (45) Conversely, students who anticipate earning a significant income may limit the amount they repay by electing a "human capital option" (HCO) that contractually prevents a borrower from overpaying if they earn above a certain amount. (46)

      3. Implementation Challenges

         Despite HCCs' allure for many students, their implementation is fraught with regulatory, constitutional, and ethical challenges. (47) The greatest challenge to widespread HCC use is the lack of federal regulation. (48) In particular, the lack of bankruptcy regulation surrounding HCCs severely impedes implementation because HCC investors are currently entirely unprotected if an investee files for bankruptcy. (49) Investors' vulnerability is especially concerning when investees intentionally file for bankruptcy to avoid these very financial obligations. (50) Indeed, HCC implementation critically depends on protecting investors principally through amending bankruptcy laws. (51)

         HCC utilization faces additional regulatory and constitutional challenges: Although both Democrats and Republicans have introduced legislation for HCCs, these bills have failed to gain substantial traction. (52) HCCs have also faced Thirteenth Amendment challenges because contractual investments in future income is somewhat reminiscent of human ownership: HCC proponents consider this argument weak, however, given that investees retain full freedom of choice in HCCs. (53)

         In addition to regulatory and constitutional challenges, accessibility to HCCs is not always evenly distributed across genders and socio-economic classes. (54) When deciding whether and to what extent to invest in a particular student, investors consider numerous personal factors, including a student's academic institution, socio-economic status, and academic focus. (55) Students whose future careers promise the greatest financial return often raise the most funds and owe the lowest income percentages to investors; financially desperate students, on the other...