A fierce legal battle is under way between a student loan CUSO'sseven big credit union members and what was once one of the largestfor-profit education companies in the nation that went bankruptlast year.

What's at stake in this controversial case is hundreds ofmillions of dollars that the CUSO claims it is owed.

Indianapolis-based trustee lawyer Deborah J. Caruso, who isrepresenting ITT Technical Institute, claims the CUSO, Student CUConnect LLC, contributed to ITT's closure and bankruptcy and arguesthe $224 million in dispute should be withheld and/or recoveredfrom the CUSO.

“The CUSO loan program scheme was, at a minimum, a colossalbreach of ITT's former management's fiduciary duties, may haveconstituted outright fraud by such management and unquestionablyresulted in a massive fraudulent transfer of ITT's assets to and/orfor the benefit of the defendants (the CUSO and its credit unionmembers),” Caruso wrote in court documents.

New York City-based attorney Richard J. Bernard, who isrepresenting the CUSO, said Caruso's complaint has no merit.

“The defendants (the CUSO and its credit union members) at alltimes have acted properly and in good faith, and to the extent thatITT or its management has engaged in any wrongful conduct, thedefendants are victims of, not accessories to, that misconduct,”Bernard said. “We will respond appropriately to – and defendvigorously against – the trustee's filing.”

On March 30, Caruso filed a 76-page adversary complaint againstthe CUSO. Bernard has not yet filed his answers to Caruso'sadversary complaint. But in previous court documents, in whichCaruso has made similar fraud accusations against ITT, the CUSO andits credit union members, Bernard has said those allegations aredemonstrably false and contradictory.

What's more, he also wrote in court documents that Caruso“grossly mischaracterizes the facts” in one of her main argumentsover a key provision in an agreement between ITT and the CUSO thatrequired ITT to guarantee payments on defaulted loans that shecontends led to the bankruptcy of the Carmel, Ind.-based educationcompany.

The seven credit union members of Student CU Connect are the$1.3 billion Elements Financial Federal Credit Union (formerly EliLilly Federal Credit Union) in Indianapolis, the $3.7 billionBellco Credit Union in Greenwood Village, Colo., the $2.3 billionCommunityAmerica Credit Union in Lenexa, Kan., the $730 millionCredit Union of America in Wichita, Kan., the $670 millionDirections Credit Union in Sylvania, Ohio, the $3.1 billionVeridian Credit Union in Waterloo, Iowa and the $1.5 billionWorkers Credit Union in Fitchburg, Mass.

In February 2009, the CUSO inked a loan program agreement withITT that Caruso claims was allegedly used to protect and enhancethe compensation of ITT's former senior management, namely CEOKevin M. Modany and CFO Daniel M. Fitzpatrick.

ITT generated the overwhelming bulk of its revenues, hundreds ofmillions of dollars annually, from Title IV loans, a U.S.taxpayer-funded student financial aid program. However, the 90/10federal rule requires students to pay 90% of their tuition fromTitle IV loans, and the remaining 10% has to come from privatesources. Following the financial crisis in 2008 and 2009, mostprivate lending sources dried up. That meant ITT's ability tocomply with the 90/10 rule over time would be jeopardized andthreaten its main source of the company's revenue.

To address this looming crisis, senior management created atemporary credit program, which offered new students azero-interest, short-term loan they were required to pay back bythe end of the school year.

However, according to Caruso, a number of these students whoreceived the short-term loans had poor credit and were unlikely torepay the loans. These accounts dragged down ITT's income andearnings per share. ITT was a publicly-traded company and its stockperformance was tied to the compensation of senior executives.

In 2008, ITT and a consultant conceived the CUSO loan programthat enabled ITT to offload the underperforming student loans intothe loan program, which artificially boosted ITT's profits,earnings per share and ITT executives' compensation.

According to Caruso, ITT students who got short-term loansbecame members of the originating credit union, Elements Financial.For a fee, Elements Financial originated the CUSO loans that wereused to pay off the short-term loans. The 10-year loans thesestudents received from the CUSO included a 10% origination fee witha 13.75% interest rate. For students taking out loans in 2011, theinterest rate increased to 16.25%. By way of comparison, accordingto Caruso, the federal Stafford loans available under Tittle IVoffered interest rates for all borrowers that were 3.4% forsubsidized loans and 6.8% for unsubsidized loans and did not chargeany origination fees.

Bernard, however, pointed out in court documents that Carusoignored the fact that the origination fee was charged to studentswho had a credit score below 600, which is common for a high-riskloan, and that the interest rate loans were competitive forunsecured private loans. In addition, comparing the Stafford loanrate, guaranteed by the federal government, to the CUSO's loan ratewas an apples to oranges comparison.

However, Caruso also claims that the underwriting criteria wasallegedly undermined by a “temporary credit exception.” Thisexception allowed students who would not qualify for a CUSO loan tootherwise qualify so long as the student received an ITT-approvedshort-term loan, had graduated from ITT or was currently enrolledin an ITT program, and had not filed for bankruptcy over the lasttwo years.

Bernard said ITT requested this exception and that the CUSOrelied on ITT's representations that the exception would extend toonly a small percentage of borrowers. In fact, he said, the CUSOwas surprised and dismayed to learn of this unanticipatedadditional risk factor.

Nevertheless, Caruso alleges ITT and the credit unions knew thatthe temporary credit exception would likely result in higherdefault rates and trigger ITT's stop-loss guarantee obligationunder a risk sharing agreement.

To induce Elements Financial to originate loans and the othersix credit unions to purchase CUSO membership interest andparticipate in the CUSO's loan pools, the agreement required ITT toprovide a stop-loss guarantee to the CUSO that was triggered whenthe number of defaulting loans reached 35% of the loan pool. Thatmade ITT liable for payments on all defaulting loans that exceedthe 35% threshold. The default rate for the 2009 CUSO loan pool wasmore than 70%. Moreover, up through 2011, the default rates weremore than 60%.

However, in the agreement between ITT and the CUSO, theeducation company had the right to make a monthly minimal paymenton the loan amounts in default or make a discharge payment thatwould pay off the balance of loans in default with discountedinterest payments and other fees. Even though Caruso indicates incourt documents that ITT and the CUSO “secretly agreed” that ITTwould not make any discharge payments, Bernard said Caruso ignoresthe undisputable fact that ITT did make discharge payments of morethan $12.7 million.

Nonetheless, Caruso claims ITT's former management almost alwaysmade the monthly minimum payments and that ITT, the CUSO and itscredit union members knew or should have known that ITT's guaranteeobligation on the CUSO loans would increase exponentially, create aliability bubble that would burst and lead to ITT's bankruptcydemise.

However, Bernard argued in court documents that Caruso “grosslymischaracterizes the facts” about ITT's liability for guaranteepayments on all defaulting loans that exceeded 35%. That was herkey argument.

Because credit unions are generally conservative, the risksharing agreement provided the CUSO with a potential additionalrecovery source in the event of loan defaults, he said. Theadditional credit supported charging lower interest rates tostudent borrowers than they otherwise could have obtained based ontheir own credit scores and provided a potential backstop to limitthe CUSO's losses.

Relying on information provided by ITT, the CUSO's credit unionsbelieved that the loan default rates would generally be lower than35% and there was no expectation that ITT would be required to makesubstantial and regular payments.

“On the other hand, ITT and the managers who were privy to thereal make-up of the student borrower population, knowingly decidedto commit and voluntarily agreed to guarantee the loans,” Bernardwrote.

In May 2015, the U.S. Securities and Exchange Commission filed acivil lawsuit alleging fraud against ITT executives Modany andFitzpatrick. They have denied the SEC's fraud allegations. Thatlawsuit is still in litigation.

In February 2014, the CFPB filed a Truth in Lending civillawsuit against ITT. That lawsuit has been delayed until May31.

In both of these lawsuits, the CUSO and its credit union membershave not been accused of any wrongdoing and have not been named asdefendants.