On June 16, 2016, the U.S. Department of Education (the “Department”) published its proposed regulations (the “Proposed Rule”) regarding Borrower Defenses to Repayment (DTR) and related matters. The Proposed Rule is available here. The Proposed Rule establishes a 45-day notice and comment period, with comments due on or before August 1, 2016. Following the comment period, the Department must publish its final regulations by November 1, 2016, in order to take effect on July 1, 2017. This alert provides a high-level summary of the various components of the Proposed Rule, which remains subject to our continued review.
Standards for DTR Claims, Time Period of Availability, and Procedural Framework
The Proposed Rule permits both individual and group discharges of Federal Direct Loans received by students under Title IV of the Higher Education Act (HEA), with proposed discharge grounds and their respective periods of availability as follows:
- The student obtained a non-default, favorable contested state or federal court judgment against a school related to the loan itself or to the educational services for which the loan was made. There would be no time limit in which such DTR claims must be filed.
- The institution failed to perform its obligations under the terms of a contract with the student. There is no statute of limitations proposed for such DTR claims for amounts still owed to the Department on a Federal Direct Loan. For amounts previously paid, the borrower must assert the DTR claim no later than six years after the breach of contract.
- The school or any of its representatives, or any institution, organization, or person with whom the school has an agreement to provide educational programs, or to provide marketing, advertising, recruiting, or admissions services, made a “substantial misrepresentation” (as defined at 34 CFR 668.71 et seq. and amended by these proposed regulations) that the borrower reasonably relied on when the borrower decided to attend, or to continue attending, the school. Importantly, the definition of misrepresentation would be amended to explicitly include omissions of information and statements with a likelihood or tendency to mislead under the circumstances. There is no proposed limit on the time period for making such claims for amounts still owed to the Department on a Federal Direct Loan. For amounts previously paid, the borrower must assert the DTR claim no later than six years after he discovers, or reasonably could have discovered, the information constituting the substantial misrepresentation.
The proposed procedures for resolving individual or group DTR claims, and potentially seeking recoupment of the Department’s DTR losses from affected institutions, are summarized below.
For individual borrowers: An individual borrower would submit an application on a form approved by the Department. In the application, the borrower certifies that he or she received the proceeds of a loan to attend a school; can provide evidence that supports the borrower defense; and whether or not he has made a claim with respect to the information underlying the borrower defense with any third party, and, if so, the amount of any payment received by the borrower or credited to the borrower's loan obligation. The Department provides notice of the borrower’s application for a borrower defense to the school at issue.
To process the claim, a Department official would review the borrower’s application to determine whether it states a basis for a borrower defense and would resolve the claim through a fact-finding process conducted by a designated Department official. The official would consider any evidence or argument presented by the borrower and would also consider any additional information, including Department records, any response or submissions from the school, and any additional information or argument that may be obtained by the Department official.
The Proposed Rule specifically grants Department hearing officials the discretion to consider, with respect to whether a misrepresentation by a school was substantial and that borrower’s reliance was reasonable, the use by the school of “high-pressure sales tactics,” including demanding enrollment decisions immediately, unreasonably emphasizing the consequences of delay, discouraging the prospective borrower from consultation with others, and failing to respond to requests for additional information, among other things. At the conclusion of the fact-finding process, the Department official would issue a written decision, which would be final as to the merits of the claim and any relief that may be warranted on the claim. The Department may initiate, on a discretionary basis, a separate action to collect from the school the amount of losses it incurred based on the borrower defense.
For group claims against closed schools: When a group of borrowers with common facts and claims has been identified, a Department official would be designated to present the group’s common borrower defense claim to a hearing official. The hearing official first reviews the Department official’s basis for identifying the group. The hearing official then resolves the claim through a fact-finding process akin to that described above. For a group of borrowers with common facts and claims for which the Secretary determines there may be a borrower defense on the basis of a substantial misrepresentation that was widely disseminated, there would be a rebuttable presumption that all of the members of the group reasonably relied on the misrepresentation. This rebuttable presumption would shift the burden to the school, requiring the school to demonstrate that individuals in the identified group did not in fact rely on the misrepresentation at issue. The hearing official would issue a written decision determining the merits of the group borrower defense claim. If group relief is denied in full or in part, an individual borrower may request that the Department reconsider the borrower defense upon the identification of new evidence in support of the borrower’s individual borrower defense claim. Additionally, the proposed regulation provides that the Department may also reopen a borrower defense application at any time to consider evidence that was not considered in making the previous decision.
For group claims against open schools: A hearing official would resolve the borrower defense and determine any liability of the school through a fact-finding process like those described above. As part of the process, the hearing official considers any evidence and argument presented by the school and the Department official on behalf of the group and, as necessary, evidence presented on behalf of individual group members. The hearing official issues a written decision, regardless of the outcome of the group borrower defense. If the hearing official approved the borrower defense, that decision would describe the basis for the determination, notify the members of the group of the relief provided on the basis of the borrower defense, and notify the school of any liability to the Department for the amounts discharged and reimbursed.
If the hearing official denied the borrower defense in full or in part, the written decision must state the reasons for the denial, the evidence that was relied upon, the portion of the loans that are due and payable to the Department, whether reimbursement of amounts previously collected is granted, and would inform the borrowers that their loans – in the amounts constituting enforceable obligations – would return to their prior status. It also would notify the school of any liability to the Secretary for amounts discharged. After a final decision has been issued, if relief for the group has been denied in full or in part, a member borrower may file an individual claim for relief for amounts not discharged in the group process. The Department may collect from the school any amount of relief granted for the borrowers’ approved borrower defense. Relief may include discharge of some or all accrued interest, and the loss to the government in those instances would include such discharged interest.
Updated and Expanded Categories of False Certification Discharges
The rule proposes that borrowers be eligible for a false certification discharges not only if a school falsifies the student’s high school diploma or other high school graduation status, but also if the school refers the student to a third party to obtain a falsified high school diploma. A student’s Title IV loan debt is also eligible for false certification discharge if the borrower failed to meet applicable state requirements for employment due to a physical or mental condition, age, criminal record, or other reason accepted by the Department that would prevent the borrower from obtaining employment in the occupation for which the training program supported by the loan was intended.
Expanded Financial Responsibility and Administrative Capacity Requirements
The Proposed Rule includes multiple “triggering events” that would deem an institution “not able to meet its financial or administrative obligations.” Such events would require, in each instance, an irrevocable letter of credit. As described below, certain of these events automatically trigger a letter of credit requirement, and other events necessitate a letter of credit at the discretion of the Department. Any institution required to post a letter of credit would also be required to disclose that fact to students and prospective students. Additionally, as described further below, if an institution is deemed not financially responsible and is placed on provisional certification, in order for the institution to remain eligible beyond its first three-year period of provisional certification, the Proposed Rule permits the Department to require the institution or a party with substantial control over the institution to provide financial protection or guarantees.
Automatic Triggers: With respect to each of the following automatic triggers, the rule would require institutions to report the pertinent event to the Department within 10 days of its occurrence. Importantly, each trigger would necessitate its own percentage-based letter of credit in an additive manner (i.e., three triggers would require a letter of credit equal to at least 30 percent of the institution’s prior-year Title IV funds).
- Lawsuits and other actions: (a) If currently or at any time during the three most recently completed award years, the school is or was required to pay a debt or incurred a liability arising from an audit, investigation, or similar action initiated by a state, federal or other oversight entity, or settles or resolves a suit brought against it by that entity, that is based on claims related to the making of federal loans or the provision of educational services for an amount that exceeds the lesser of the threshold set for at 2 CFR part 200 (currently $750,000) or 10 percent of its current assets; (b) the school is being sued based on claims of any kind, and the potential monetary sanctions or damages from that suit or suits are in an amount that exceeds 10 percent of its current assets; (c) the school is currently being sued under the False Claims Act or by one or more private parties for claims that relate to the making of loans to students for the purpose of enrollment or the institution’s provision of educational services, if that suit has survived a motion for summary judgment and has not been dismissed; and seeks relief in an amount that exceeds 10 percent of the school’s current assets; or (d) if during a fiscal year for which the school has not submitted its audited financial statements to the DOE, the school entered into a settlement, had judgment entered against it, incurred a liability, or otherwise resolved that suit for an amount that exceeds 10 percent of its current assets.
- Repayments to the DOE: During the current award year or any of the three most recently completed award years, the school is or was required to repay the DOE for DTR losses in an amount that, for one or more of those years, exceeds the lesser of the threshold amount for which an audit is required under 2 CFR part 200 (currently $750,000) or 10 percent of its current assets.
- Accrediting agency actions: Currently or any time during the three most recently completed award years, the school is or was required by its accrediting agency to submit a teach-out plan; or was placed on probation or issued a show-cause order, or placed on a status that poses an equivalent or greater risk to its accreditation, for failing to meet one or more of the accrediting agency’s standards, and the accrediting agency does not notify the DOE within six months of taking that action that the school has come into compliance.
- Loan agreements and obligations: The school violates a loan agreement provision or requirement with its largest secured creditor; failed to make a payment for more than 120 days in accordance with its debt obligations owed to its largest secured creditor; or under the terms of a security or loan agreement with its largest secured creditor, a monetary or nonmonetary default or delinquency event occurs, or other events occur that trigger or enable the creditor to require or impose on the school, an increase in collateral, a change in contractual obligations, an increase in interest rates or payments, or other sanctions, penalties, or fees. (The institution may submit information to the DOE demonstrating that that the creditor waived the violation or otherwise cured the issue.)
- 90/10: A proprietary institution did not derive at least 10 percent of its revenue from sources other than Title IV program funds in any single fiscal year.
- Publicly traded institutions: As reported by the school or identified by the DOE: (a) the Securities and Exchange Commission (SEC) warns the school that it may suspend trading on the school’s stock, or the stock is delisted involuntarily; (b) the school disclosed or was required to disclose in a report filed with the SEC a judicial or administrative proceeding stemming from a complaint filed by a person or entity that is not part of a state or federal action (unless the school satisfactory demonstrates to the DOE why the disclosed matter does not constitute a material event); (c) the school failed to file timely a required annual or quarterly report with the SEC; or (d) the exchange on which the stock is traded notifies the school that it is not in compliance with exchange requirements.
- Gainful Employment Compliance: If more than 50 percent of the school’s total number of students who received Title IV program funds are enrolled in failing or “zone” programs under the DOE’s “gainful employment” regulations (unless under 50 percent of all students receiving Title IV program funds are enrolled in gainful employment programs).
- Withdrawal of owner’s equity: For a school whose composite score of financial responsibility is less than 1.5, any withdrawal of owner’s equity by any means, including by declaring a dividend. (The school may demonstrate that a withdrawal of owner’s equity was used solely to meet tax liabilities of the school or its owners. Or, where the composite score is calculated based on consolidated financial statements of multiple entities, the amount withdrawn was transferred to another entity within that group.)
- Cohort Default Rates (CDR): The two most recent official CDRs are 30 percent or higher, unless (a) the school files a challenge, request for adjustment, or appeal with respect to its rates for one or both of those fiscal years; and (b) that challenge, request, or appeal remains pending, results in reducing the CDR below 30 percent or precludes the rates from either or both years from resulting in a loss of Title IV eligibility.
Discretionary Triggers: The Proposed Rule further sets forth events and conditions that, in the Department’s view, are reasonably likely to have a material adverse effect on the financial condition, business, or results of operations of the institution, thus requiring a letter of credit. These events and conditions include but are not limited to the following:
- Significant fluctuations in Direct Loan or Pell Grant amounts received by the school.
- Citations from a state licensing or authorizing agency for failing state or agency requirements.
- Failure to meet a financial stress test to be developed or adopted by the DOE.
- The school or its corporate parent has a non-investment grade bond or credit rating.
- As calculated by the DOE, the institution has high annual dropout rates.
- Any adverse event reported by the institution on a Form 8-K filed with the SEC.
Guarantees from Parties Exercising Substantial Control: If an institution is deemed not financially responsible, whether due to any of the letter of credit triggers under the general financial responsibility standards or due to its financial responsibility composite score, and is placed on provisional certification, in order for the institution to remain eligible after a three-year provisional certification period, the Proposed Rule permits the Department to require the institution or any party with “substantial control” over the institution to provide “financial protection for an amount determined by the Secretary to be sufficient to satisfy any potential liabilities that may arise from the institution's participation in the Title IV, HEA programs.” Further, the Proposed Rule would also require a party or parties with "substantial control" to jointly and severally guarantee the Title IV liabilities of the institution at the end of the three-year provisional certification period. Among the reasons a party may have "substantial control" is the fact that the party holds an ownership interest of 25 percent or more.
Arbitration Clauses and Class-Action Waivers
The Proposed Rule significantly restricts the use of mandatory pre-dispute arbitration clauses and class-action waivers by postsecondary institutions. The rule would forbid schools from eliminating any student’s right to participate in a class action; similarly, the rule would permit students to pursue their claims in arbitration if they so choose and under specified conditions, but does not allow the school to mandate that resolution process. With respect to enrollment agreements that have already been executed and contain language that would be prohibited under the proposed regulations, the Department would not only effectively bar institutions from attempting to exercise those mandatory pre-dispute arbitration agreements or class action waivers if they relate to borrower defense-type claims, but also require institutions to either amend its enrollment agreements, or at least notify all students who executed those agreements that the institution will not attempt to enforce those agreements in a manner proscribed by the regulations. The Proposed Rule would also prohibit schools from compelling students to pursue complaints related to borrower defense claim through any internal institutional process before the student presents the complaint to an accrediting agency or government agency authorized to hear the complaint.
Loan Repayment Rate Calculation and Disclosures
For proprietary institutions only, the Proposed Rule adopts a new methodology to assess the loan repayment rate of student borrowers and requires related disclosures. The Department would measure the percentage change in the original outstanding balance (the amount owed when a borrower enters repayment, including any accrued interest) and the current outstanding balance for the cohort of borrowers whose Title IV loans entered repayment during the fifth fiscal year preceding the most recently completed fiscal year. For each borrower in the cohort, the Department would then calculate the five-year change in those outstanding balances, and then determine the median change for the cohort. Any proprietary institution with a repayment rate that is negative (i.e., reflecting negative amortization for the cohort), or which is 0 percent, would have to place a Department-issued plain language warning on its website and in all advertising and promotional materials, as well as provide the warning to prospective and enrolled students.
As part of this same regulatory action, the Department also proposes: (1) that Title IV loans and Teacher Education Assistance for College and Higher Education (TEACH) grant service obligations may be discharged based on electronically submitted death certificates rather than only original copies; (2) that Nurse Faculty Loans may be consolidated into a Direct Consolidation Loan; (3) that holders of outstanding loans under the former Federal Family Education Loan Program may not capitalize unpaid interest when a defaulted loan is rehabilitated; (4) that any school submitting a teach-out plan to the Department must also provide all students with a closed school discharge application and inform student of their right to opt out of the teach-out and instead receive the discharge; (5) technical changes to the Pay-As-You-Earn program regulations; and (6) increasing the Department’s debt compromise and resolution authority to $100,000 so as to be consistent with analogous Department of Justice standards.