Contingency Planning for School Closure: Key Issues

By Katherine Brodie, Special Counsel and Edward Cramp, Partner, Duane Morris LLP’s Higher Education Practice Group

Summary: School closures have been increasingly common in the private postsecondary education sector and are expected to continue due to the harsh economic and regulatory headwinds impacting schools of all sizes. Prior contingency planning for closure is critical to all stakeholders: students, taxpayers, the U.S. Department of Education, accreditors, states, owners, employees, and investors. This article argues that in the current environment, it just makes sense for all private postsecondary schools to have a well thought-out school closure contingency plan that can assist in mitigating the legal and regulatory risks that come with school closure and that are exacerbated by mismanaging closures.

Past and future: News reports of career school closures have been an all too common occurrence over the past few years, with increasing frequency over the past year. And the truth is, like it or not, many more proprietary schools and colleges will close this year. Some schools will close that have no anticipation, today, of doing so. The regulatory environment (including unprecedented coordination of federal, state and accreditor enforcement action against target schools) is highly unpredictable. The long-expected issuance of Gainful Employment Debt to Earnings rates, the impact of which is largely unknown, is also due soon. As a result, it is virtually certain that more schools will close this year.

Precipitous and unplanned school closure wreaks havoc on students, taxpayers, employees, owners, investors and the sector as a whole…

when it results in students unable to complete programs or transfer credits, institutional Title IV liabilities outstanding with the U.S. Department of Education (“the Department”), mishandling or neglect of student records, and other legal and public relations problems. As attorneys assisting both closing institutions and institutions seeking to assist closing institutions through teach out and transfer arrangements, we have seen some institutions completely unprepared for the demands of closing a school.

In an effort to provide guidance in this area, this article argues that, in this environment, even a reasonably healthy career school should have a well thought-out school closure contingency plan in the event of unforeseen regulatory or other action that threatens the ongoing viability of the school. Having a plan for closure, even if it is unlikely to occur, is a best practice in this environment. The consequences of not having one are dire for all stakeholders.

“Bad” school closures
Few schools plan for closure until it becomes clear that it is the only option. It is the obligation of a board of directors (and just human nature) to continue to try to salvage an institution through all possible means before admitting that school closure is the best course of action for all stakeholders.

When a school is under increasing financial distress, however, and closure is not evaluated early in the process of decision-making as a potential option, events like eviction, heightened cash monitoring, emergency action ending Title IV funds, or bankruptcy, among other events that can flow from financial distress, can quickly accelerate a closure scenario with no plan of action in place to smoothly transition students. Schools caught off guard by circumstances rarely have adequate cash on hand to pay employees or legal, accounting or other professional advisors for risk mitigation and regulatory compliance advice.

The result can be disastrous and include late, incomplete or unfiled Title IV close out audits, absence of an approved teach out plan and neglect of key regulatory requirements that expose owners to significant liabilities resulting in bars to future ownership roles in other Title IV, state-licensed or similarly accredited institutions. Further, “closed school” student loan discharge rights under current Title IV regulations permit the Department to seek recoupment from institutions, owners and their affiliates for discharged loans. And, the Department is currently undertaking a negotiated rulemaking addressing the potential to expand borrower defenses to loan repayment. Finally, some state laws expose owners to criminal liability for mishandling records or failing to provide an orderly teach out plan.

“Good” school closures
What is a “good” school closure? Although that phrase seems like an oxymoron, prior planning can result in a wind down of school operations that supports students to complete programs, gives fair warning to employees, and generates little or no closed school loan discharge claims, student complaints, or adverse media reports. This “good” school closure scenario is do-able, but takes prior, thoughtful planning.

In a good closed school scenario, the school identifies one or more teach out partners or develops a plan to teach students out at their closing campus so that students can complete programs. The school works early and often with its state agency, the accreditor and the Department to understand regulatory obligations and to satisfy them. The school has adequate funds to do a Title IV close out audit. It identifies and pays all outstanding Title IV liabilities. The school has the necessary accounting and legal support to advise on structuring a teach out. This allows it to meet regulatory requirements, including student refund obligations. It also allows for the orderly wind up of operations and disposal of assets.

No closing scenario is pleasant, but a planned closure allows all stakeholders to work in an informed, coordinated manner (to the fullest extent possible).

And, significantly, it is the type of closure scenario intended by accreditor, state and federal laws.

What makes the difference between good and bad closures? Prior planning.

Prior planning for closure makes a critical difference. Even if a school has not discussed closure as a scenario it should develop a contingency closure plan.

Key planning considerations

What should a school evaluate when developing a contingency plan for school closure?

1. Your current lease obligations
We mention a school’s lease obligations first because generally this takes the longest of any element required for a smooth closure. The starting point is to examine the current lease terms. Ask questions, such as: What are the terms of my lease? How much advance notice of termination is required under my current lease terms? Does my school have any leverage with the landlord to renegotiate more favorable lease terms now, such as smaller footprint, lower cost, earlier termination rights? How will the school build its existing lease obligations into a closure plan so that lease obligations are more likely to be met? Has anyone personally guaranteed the lease obligations? Will any unpaid lease obligations result in personal bankruptcy? These are very unpleasant, but critical and complex issues, best evaluated early – whether or not the school is under distress – to help inform a closure contingency plan and timeline. Stay tuned for an upcoming article in Career Education Review focused solely on school lease issues, including closure issues.

2. State law
Many states provide specific procedures that institutions must follow to close a school. Every school should know up front what state laws apply, including applicable state grant and educational agency regulations. Some states have specific teach out requirements and/or student recordkeeping obligations. Other states have “past performance” statutes that prohibit an owner of a school that violated state closure regulations to become an owner of another state licensed school. These laws sometimes apply to senior management and/or members of the board of directors. Many states impose liability on schools that close without following required student refund or other state policies.

A few state statutes impose criminal liability on school owners who do not follow state teach out and/or student recordkeeping requirements. Florida is one example. In late January 2016, the Florida Commission for Independent Education voted to refer the owner of a closed school to state law enforcement for prosecution for closing the school without safeguarding student records or providing a required teach out plan. Under that state’s law, failure to adhere to these requirements is a second degree misdemeanor.

Schools should also know what the board of director’s duties are when the school is in a state of financial distress. Many state corporate laws do not discharge the board’s duty to act in the interest of the corporation in times of insolvency or to prohibit intentional acts not in the interest of the company. Schools should explore the benefits and costs of an Directors & Officers Liability (D&O) insurance policy.

In short, schools need to know how their state laws impact school closures. Schools should bring state educational agencies to the table early in any school closing scenario. They should do so before the closure occurs and in close coordination with accreditors and the U.S. Department of Education.

3. Accreditor obligations
Meeting a school accreditor’s teach out standards, procedures and requirements is central to an orderly closure. All U.S. Department of Education recognized accrediting agencies, whether national or regional, must require an accredited institution to submit a teach out plan upon the occurrence of specific events, including a Title IV emergency action or termination proceeding against the institution; action by the accreditor to withdraw, terminate, or suspend the accreditation of the institution; notification by the institution to the accreditor that it intends to cease operations entirely or close a location that provides one hundred percent of at least one program; notification by a state licensing or authorizing agency to the accreditor that an institution’s license or legal authorization to provide an educational program has been or will be revoked. See 34 C.F.R. § 602.24(c). The accreditor is required by federal law to evaluate the teach-out plan to ensure it provides for the equitable treatment of students under the accreditor’s criteria, specifies additional charges, if any, and provides for notification to the students of any additional charges. The accreditor must also require an institution that enters into a teach-out agreement with another institution to submit that teach-out agreement for approval. These are critical accreditor-level requirements that must be adhered to by all closing institutions.

Many accreditors also have specific standards with regard to safeguarding student records that are applicable in a closure situation, and each accreditor would expect that its standards with regard to student refund rights are honored in a teach out situation.

Schools should keep an accreditor closely advised of a potential closure as early as possible. Having a teach out agreement template prepared and evaluated by counsel in your files will help expedite finalizing such a document and submitting it to an accreditor for formal approval in a time pressured closure situation. Contacting an accreditor to discuss school closing scenarios and asking for informal review of a teach out agreement template may raise concerns for a school of being potentially flagged as in distress. But, these concerns can be alleviated by working with outside counsel to develop a teach out agreement template that addresses accreditor standards and that can be formalized, finalized and approved when a closure situation becomes ripe.

4. U.S. Department of Education
As the gatekeeper of Title IV aid, the Department’s role in a school closure situation is critical. Some schools can be so focused on working with the state and accreditor that they leave liaison with the Department’s regional office covering their school to the last minute, or involve them later than they should. It is never advantageous to a school to have the Department learn from the state or accreditor that a Title IV participating school is closing, when they have not heard from the school itself. Although the Department will likely defer significantly to the accreditor and state on the details of teach out plans and teach out agreements, contacting the Department early can help schools in a variety of ways.

For example, a closing school needs to know, before they have a teach out agreement approved by their accreditor, whether the teach out partner they have selected is viewed as a viable teach out partner by the Department. The teach out partner may have a variety of regulatory issues that would prevent it from acting as such, and it is better for all concerned to be in touch with the Department early to flush out any significant issues.

Also, the Department staff serves as a resource for verifying the school’s refund, close out and recordkeeping obligations. A closing school must be familiar with its obligation to file a Title IV close out audit and the time frames involved. In addition, schools must be well aware of the impact of a personal owner or corporate bankruptcy filing on Title IV participation, and if bankruptcy is required, the filing must be timed as well as possible to meet obligations to students, teach out partners and the Department.

With respect to Title IV liabilities arising out of school closures, institutions should be familiar with the following:

Closed School Discharge

Failure to execute a smooth teach out means that a student unable to complete their programs or transfer credits to other programs, and who received Title IV student loans (either Direct or FFEL Programs) may be eligible to have his or her student loans discharged if the institution where he or she is enrolled closes.¹

The discharge applies to all Title IV loans paid to the school for the entire period of study, including any other charges and costs incurred with respect to the loans.² The student may also be entitled to reimbursement for any amounts paid voluntarily or involuntarily through enforced collection.³ Significantly, a student may decline to complete a teach-out and remain eligible for a discharge. ⁴

In such a situation, the Department assumes, upon discharge of the student’s loans, all claims or rights of recovery against third parties that the student would have had with respect to the discharged student loans, and the student must cooperate in any enforcement action to recover the discharged amounts.⁵ The Department is specifically authorized to “pursue any claim available to such [student] against the institution and its affiliates and principals…”⁶

Defense to Repayment
Separate from the school closure discharges discussed above, students who borrower under the Direct Loan Program (“Direct Loans”) may be able to assert defenses against repayment of their loans.⁷ These regulations specifically authorize a student to assert as a defense “any act or omission of the school attended by the student that would give rise to a cause of action against the school under applicable State law.”⁸ If the student’s defense against repayment is successful, then the Department relieves the student of the obligation to repay all or any portion of the Direct Loan to which the defense applies, including any associated costs and fees.⁹ The Department may then initiate a proceeding for those amounts against the school whose act or omission resulted in the borrower’s successful defense.¹⁰ The Department’s timeframe for initiating a proceeding against the institution is limited to the retention period for the applicable documentation, which is typically three (3) years after the end of the award year for which the loans were disbursed or in which the student last attended the institution, unless the institution was aware of the claim prior to the end of the retention period.¹¹ The Department has a 2016 rulemaking session underway now to consider changes to the current borrower defense regulations to specify the particular acts or omissions that will establish a defense to repayment federal standard rather than relying on state law.¹²

Past Performance Limitations
Title IV regulations provide that any person, including such person’s family members, who owes a liability for a violation of a Title IV requirement as a previous school owner or who previously exercised substantial control over an institution or third party servicer that owes such a liability may not exercise substantial control over another institution that participates in Title IV unless that person or family member can demonstrate the liability is being repaid to the Department in accordance with an agreement with the Secretary.¹³ A “family member” includes “a parent, sibling, spouse, child, spouse’s parent or sibling, or sibling’s or child’s spouse.”¹⁴ If any such person exercises control over another institution participating in Title IV, then the other institution is deemed to be “not financially responsible.”¹⁵ The institution deemed to be not financially responsible would not be permitted to continue to participate in Title IV programs, which is a substantial penalty.¹⁶ Therefore, if a school incurs liabilities from discharged loans by closing schools or other Title IV related liabilities (such as unpaid refunds) that the institution fails to repay, the executive officers, directors and any 25 percent shareholders, and their family members, may effectively be prevented from assuming an executive or director position with, or acquiring ownership of 25 percent or more of, another institution that relies on Title IV funds unless he or she can demonstrate that the liability is being repaid to the Department through a payment plan or otherwise.

Title IV Record Keeping
Title IV institutions must maintain all Title IV related student records following the closure of a school for a period of three (3) years after closure.¹⁷ The regulations further indicate that the institution must notify the Department “of the arrangements that the institution has made for the proper retention and storage” of the records.¹⁸ The regulations do not specify what constitutes “proper retention or storage,” but presumably it is a method that reasonably safeguards the students’ records and permits the Department to access the records if necessary. Also, as discussed above, “proper retention and storage” methods may differ depending on applicable state law.

A checklist for closure contingency planning

1. Lease: Examine lease for options to add termination flexibility or otherwise reduce burden on the school or owners personally in a closure situation. At the very least understand what the “landing strip” is for getting out of the lease on its terms based on the existing termination provision.
2. Teach Out Partner: Consider identifying one or more schools that could act as a Teach Out partner under a teach out agreement in the event of a closure to allow students to complete similar programs to transfer credits to similar programs.
3. Teach Out Templates: Consider preparing a Teach Out Plan template in accordance with your accreditor’s requirements and a Teach Out Agreement template and having those templates reviewed on an informal basis by your accreditor. Having at least a template of these documents prepared and in your files can save valuable time in a closure situation. If a school has concerns about approaching an accreditor for an informal consultation on these templates, consider having outside counsel approach the accreditor to seek input on the templates on a basis not attributable to your school. Remember, however, that no teach out plan or teach out agreement is official until your accreditor has approved it for the specific closure situation.
4. Records Retention: Develop a records retention plan that details how student hard copy and electronic records will be safeguarded and stored in a closure situation, how school operational data will be stored and backed up, and who will act as a point of contact for students and regulators.
5. Applicable Law: Know state, accreditor and Title IV regulations and standards applicable to school closure and keep up with changes in these rules.
6. Insurance: Explore corporate insurance options working with insurance brokers with knowledge of this sector. Some insurance brokers, such as Cobbs Allen, have insurance products specifically tailored to the sector. Your trade associations and your colleagues are other sources of information for reputable and experience insurance agencies.
7. Employees: Understand your obligations under federal and applicable state law to at-will and contract employees in a closure situation.
8. Cash: Safeguard adequate cash or access to cash to pay professional advisors to assist in a wind down scenario. To close smoothly, a school will need a CPA to prepare a Close Out Audit required under Title IV rules for schools terminating participation in the Title IV program. Failure to file required audits is a Title IV regulatory violation and may result in unpaid Title IV liabilities to the Department. The school will also need legal counsel to advise on steps to take to mitigate regulatory risk. The school and its owners may also need bankruptcy attorney.
9. Communications: Be prepared to have a clear and consistent communication strategy in place in the event of closure to get key information to the public, regulators and students, including where students can obtain copies of transcripts and related student records. Schools should consider working with state or national trade associations to assist in communications.

In closing: This is a difficult topic to write about, and moreover to experience first-hand. However, as a sector of higher education under extreme stress, we all owe it to students and staff to do our best to plan ahead for closure. The downside of not doing so will reverberate through media and regulators for many years if we fail to meet this challenge. While weighing all legitimate stakeholder interests, closing a school or campus should pursue an approach to closure that puts student interests at the forefront. A well-designed and executed teach-out plan will significantly reduce the likelihood of discharged student loans. Such efforts also have the benefit of reducing the likelihood of student-driven adverse media and complaints and thereby protect the institution’s reputation with the public, legislators, the Department, accreditors and the states.

Katherine D. Brodie , practices in the area of education law. Ms. Brodie has over two decades of federal regulatory, legal and policy experience. She began her career with over a decade in the public policy group of a Washington international law firm assisting clients with advancing their federal legislative priorities. She also served as Vice President of Government and Legal Affairs at the Association of Private Sector Colleges and Universities, where she had responsibility for helping define and implement the higher education institution members’ legal and legislative objectives.

Since 2009, Ms. Brodie has been focused on the needs of higher education institutions and their partners. Her experience and advice includes issues surrounding compliance with federal, state and accrediting body regulations and standards applicable to postsecondary institutions, including the complex rules governing the Title IV student financial aid programs administered by the U.S. Department of Education.

Ms. Brodie counsels institutions regarding institutional, student and program Title IV program eligibility requirements, program review and audit resolutions, risk management systems and policies, consumer protection regulations, Title IX and Clery Act compliance, and Department of Education change of ownership requirements in the context of school purchases and sale. She also counsels clients regarding federal guidelines governing marketing and recruiting practices, third party vendor relationships, student privacy regulations, student visa, and a variety of other legal and regulatory issues impacting educational institutions of all sizes. As a registered lobbyist for most of her career, Ms. Brodie is active in monitoring and engaging in the federal legislative process on Capitol Hill on behalf of firm clients. She is a frequent speaker at higher education stakeholder gatherings.

Contact Information: Katherine D. Brodie // Special Counsel // Duane Morris LLP // 202-776-5241 // kdbrodie@duanemorris.com

Edward M. Cramp is the managing partner of the firm’s San Diego office. Mr. Cramp is a higher education attorney who focuses on representing private postsecondary education institutions. He advises his clients in all areas of operations, including the application of state and federal laws, regulations and accreditation standards. He also represents and advises clients in civil rights matters, including defending against claims by students and employees in areas such as the ADA, Section 504 of the Rehabilitation Act, Title IX of the Higher Education Act, Title VII of the Civil Rights Act and analogous state laws. He advises clients on a range of business issues, such as mergers and acquisitions, licensing, trademark and copyright.

Mr. Cramp is active in the private postsecondary education community. He serves as general counsel to the American Association of Cosmetology Schools, the California Association of Private Postsecondary Schools, and the Beauty Changes Lives Foundation. He regularly speaks on a wide range of issues pertaining to the sector.

Mr. Cramp served on active duty and in the reserves as a judge advocate in the United States Navy, where he was appointed to the rank of Lieutenant Commander. During his time in the services, he defended numerous matters before courts-martial convened in the United States Armed Forces. He also represented the interests of the United States in actions involving claims brought against and on behalf of the Navy.

Mr. Cramp has served as an advisor to and a member of the board of directors of the San Diego Association of Business Trial Lawyers. Admitted to practice in California and Illinois, Mr. Cramp is a graduate, with honors, of the Illinois Institute of Technology’s Chicago-Kent College of Law and a graduate of the University of California, Riverside.

Contact Information: Edward Cramp // Partner // Duane Morris LLP // 619-744-2223 // emcramp@duanemorris.com

References
¹34 C.F.R. §§ 682.402(d), 685.212(e) & 685.214.
²34 C.F.R. § 682.402(d)(2)(i) & 685.214(b)(1).
³34 C.F.R. § 682.402(d)(2)(ii) & 685.214(b)(2).
⁴See Federal Family Education Loan Program, 59 Fed. Reg. 22462-01 (Apr. 29, 1994) (stating “a student may decline to complete the program through a teach-out at another school for any reason.”).
⁵34 C.F.R. §§ 682.402(d)(4)-(5) & 685.214(d)-(e).
⁶20 U.S.C. § 1087(c)(1).
⁷20 U.S.C. § 1087e(h); 34 C.F.R. § 685.206(c).
⁸34 C.F.R. § 685.206(c)(1).
⁹34 C.F.R. § 685.206(c)(2).
¹⁰34 C.F.R. § 685.206(c)(3).
¹¹Id.; 34 C.F.R. § 685.309(c); 34 C.F.R. § 668.24(e).
¹²See Negotiated Rulemaking Committee; Negotiator Nominations and Schedule of Committee Meetings—Borrower Defenses, 80 Fed. Reg. 63478, 63479 (Oct. 20, 2015).
¹³34 C.F.R. § 668.15(c); 34 C.F.R. § 668.174(b).
¹⁴34 C.F.R. § 668.15(f)(3).
¹⁵34 C.F.R. § 668.15(c); 34 C.F.R. § 668.174(b).
¹⁶34 C.F.R. § 668.15(a).
¹⁷34 C.F.R. § 668.26(b)(3).
¹⁸Id.