Home Legal and Regulatory Issues ED Issued its Final Rule on Borrower Defense to Repayment, and Then…
ED Issued its Final Rule on Borrower Defense to Repayment, and Then…

ED Issued its Final Rule on Borrower Defense to Repayment, and Then…


By Katherine Lee Carey, Special Counsel, Cooley LLP

“What a difference a day makes…” Or in the case of the final rule on Borrower Defense to Repayment (BDTR), what a difference seven days makes. A rule that was published to some level of consternation (although mildly mitigated by the amended language) on Nov. 1 is suddenly up in the air with the shocking outcome of the 2016 election.

BDTR is likely to be one of the final major regulatory initiatives under the Obama administration, and one that will not yet be effective on Jan. 20 when Donald Trump becomes President. However, BDTR is a promulgated rule that interprets an existing statutory provision, and even if the new administration wants to change or even withdraw it, it cannot do so in a vacuum and without following some specific required steps.

The elephant in the room cannot be ignored – what will the new administration, and its new Department of Education leadership, do with a rule that is published but not yet effective?

Especially a rule that has been argued by many, is a governmental overreach? The short answer to both questions is that we just don’t know, so it is wise for schools to assume the rule will become effective as written, on July 1, 2017, and prepare for it. In the meantime, perhaps (as many schools are hoping) some administrative or legislative action will change the rule’s course.

Proposed versus final

I wrote an article for CER about the proposed rule on Borrower Defense to Repayment (BDTR) shortly after it was published for comment in the Federal Register back in June 2016. The proposed rule contained many troubling provisions, and lacked clarity on processes and procedures, issues that are left largely unaddressed in the final rule.

The final rule’s explanation for how a student can make a BDTR claim, and the way the Department will evaluate it, is almost identical to the proposed rule, and it is still frustratingly unclear. Also, much like the proposal, the final rule goes far beyond the limited purposes of the BDTR provision of the Higher Education Act, substantially revising ED’s financial responsibility rules and allowing ED to evaluate the potential financial impact of certain events and to demand that schools post letters of credit (“LOCs”) ostensibly to ensure that the school can pay potential liabilities to the Department should the school close.

Interestingly, rather than provide clarification on the BDTR claim process, ED expressly states in the final rule that much of the nuts-and-bolts of the claim process (and how ED will try to recoup money from the school) will require the issuance of another rule or set of procedures.

No explanation was given as to why that was not included in the rule, and they provided no hint of a time frame to issue this final (and very important) piece; however, there have been rumors around DC that the ED team is feverishly working to finalize those procedures before the new administration takes over.

Setting aside the lack of clarity about how student relief efforts will actually work and how schools will participate in that process – the most significant changes in the final rule relate to the financial responsibility provisions. The Department has moved away from a laundry list of “automatic triggers” with a corresponding minimum 10 percent LOC in favor of a new, much more subjective process that puts ED in the position to assess the potential impact of a triggering event and the need for an LOC based on the anticipated effect on a school’s existing financial position. Under the new scheme, for most of the triggers, ED will recalculate the school’s composite score based on assumptions about the impact of the event. This new structure is a major shift in how ED has previously assessed the “financial responsibility” of a school. Now, instead of relying on a rigid formula based on an institution’s most recent audited financial statements, ED will adjust that formula based on its assumptions regarding the effects of future events, such as the outcome of a lawsuit. While ED may have abandoned its plan to automatically “stack” LOCs of at least 10 percent of an institution’s prior year Title IV funding for each triggering event, ED now has the discretion to assess what it believes to be the potential loss to the Department created by the triggering event in determining the necessary LOC amount. While it may on the surface seem like the removal of the automatic triggers is a positive, ED’s broad discretion in this new scenario may be just as problematic for schools.

Bases for borrower defense claims

A student making a BDTR claim, regardless of whether it is for- or nonprofit, independent or public institution, must show that the claim relates either to the student’s Direct Loan or to the educational services that the loan paid for, and the claim must establish one of the following three grounds by a “preponderance of the evidence,” meaning that it is more likely than not that one or more of the following occurred:

a. A decision of a court or administrative tribunal in favor of the student (whether as a plaintiff, member of a class, or covered party in a proceeding brought by a government agency against the school). The decision must be contested, meaning that the institution had a chance to defend itself in an adversarial proceeding. Even though a default judgment or non-contested outcome (such as a settlement agreement) does not rise to the level required to support a BDTR claim under this provision, either can serve as evidence in a borrower defense claim under the other two grounds.
b. The school’s breach of contract, which is generally the enrollment agreement, either in its express or implied terms, but may also include other documents such as program brochures and catalogs that make up the entire contract with a student.
c. A “substantial misrepresentation” by the school or any of its representatives regarding the nature of the educational program, the nature of the financial charges, or the employability of graduates upon which the borrower reasonably relied to his or her detriment. The Department expanded its current definition of misrepresentation to encompass any statement that has the likelihood or tendency to “mislead under the circumstances,” and further expanded this concept to include any statement that omits information that makes the statement false, erroneous or misleading. ED also clarified that the borrower must demonstrate actual and reasonable reliance to the borrower’s detriment, two important elements.

The time limits for borrowers to file claims vary. Generally, claims based on a court judgment or claims to assert a defense against loan payments that are still due can be made any time (with no statute of limitations), while most other claims (such as to recover loan funds already repaid to ED) must be made within six years of the underlying act by the school.

Claim resolution process

The final rule suggests a “fact-finding” process for ED to resolve individual and group claims based on the review of the evidence by an “ED official” or “hearing official.” And by “suggests,” I mean that the rule only alludes to the idea that schools will have some form of notice and an opportunity to respond, but the actual procedures are conspicuously absent.

In addition to processing individual claims, ED has granted itself discretion to process claims on a group basis, including creating a group based on information ED has received from other sources, consisting of borrowers who have not actually filed an application for BDTR. For group claims, ED will assign someone on the ED staff to create the group and advocate on its behalf, while another ED employee will evaluate and make the decision on the group claim.

This is another example where ED has outlined a procedure but left enormous holes, presumably to be filled in through further rulemaking or procedural guidance.

It is interesting though that in its discussion about further guidance or rules on this process, ED has in several places alluded to Subparts G and H of the Title IV regulations, which prescribe rigid procedures for adjudicating audits, programs reviews and fine or termination proceedings. Whether the planned procedures for adjudicating these claims ends up looking like the Subpart G and H processes remains to be seen.

Borrowers who file successful claims could have all, or part, of their loans discharged, with ED making the determination in various ways, several of which are entirely subjective. While the proposed rule included specific factors that ED would use, the final rule replaced those with some “conceptual examples” describing scenarios where a borrower might be entitled to no relief, partial relief, or full relief. In one example, ED describes a borrower who wanted to become a nurse and was told by an admissions advisor that nursing program applicants had to complete a medical assisting program first – an obvious false statement. In that example, ED states that the student would be entitled to a full loan discharge for loans made for the medical assisting program. ED also points out that the school could be held responsible to pay the loan back to the government. In another example, a borrower would not be entitled to any relief after graduating from a selective, regionally accredited liberal arts school even if she relied to her detriment on the school’s ranking that was based on falsified admissions data. ED’s explanation is that THAT student actually received the benefit of her education. (The implication being, of course, that the student in the previous example would not benefit from the MA training.)

Recovering discharge loans from the school

As noted earlier, ED did not address any of the questions raised during the comment period about the proposed rule’s lack of due process for schools in the BDTR claim process. Clearly, ED is having a particularly difficult time figuring out how and when it will require institutions to repay BDTR claims and how it will pursue collections in those situations. (Which you would think would be a priority since ED’s own estimates is that BDTR claims could cost the U.S. Treasury $42 billion in the next 10 years.) ED promises that there will be a “proceeding” in which it tries to collect from the school for individual claims but surprisingly, for group claims, (given the assumption that those will be claims for larger sums as many more borrowers are involved) the regulation does not include a separate collection proceeding. Rather, it appears the Department’s idea of due process for group claims is limited to the institution’s involvement in the still undefined “fact-finding process” that ED had presented in the proposed rule. If ED determines a group discharge is warranted, the final rule suggests that it will go straight to collections from the institution. Compared to the proposed rule, the only change in this process is the addition of some time limits for the individual borrower claims.

ED’s new financial responsibility rules

When the Department issued its Notice of Proposed Rulemaking on borrower defense, it is doubtful anyone would have expected that process to evolve into a rulemaking on a process that is entirely separate from the administration of the BDTR claim system. But what we got was a final rule that fundamentally overhauls the Title IV financial responsibility regulations that determine whether and under what conditions a school can participate. Bootstrapping these financial responsibility elements, which have nothing to do with the BDTR statute, is a major concern.

In the final rule the originally proposed system of “early warning” triggers evolved into a new process using ED’s existing composite score formula. Some of the triggers become discretionary and most of the automatic triggers will now have ED evaluating the potential economic impact of the triggering event on the institution’s composite score, and if the score drops below 1.0, ED will determine the amount of any LOC needed to protect the Title IV program from losses related to the trigger. These changes appear to respond to the (many) comments to ED about how the automatic trigger system failed to consider an institution’s full financial condition and ability to absorb a negative event; this new system also introduces much more subjectivity into these financial score calculations that were designed to be based on objective, audited financials.

Under the new system, after July 1, 2017, institutions will be required to notify the Department when certain triggering events occur. Depending on the trigger, ED will then recalculate the institution’s composite score (that was based on the school’s last-submitted audited financial statements) by adjusting entries using its assumption of the potential loss or liability caused by the triggering event. This will not be easy, or likely, accurate. A lawsuit or agency action, for example, will have ED assuming the amount that the plaintiff claims in their demand is the actual amount of loss to the school. (And we all know how realistic lawsuit damage demands can be.)

If the recalculation results in a composite score below 1.0, then the school will be required to post an LOC in an amount the Department thinks will be sufficient. Generally, that means a minimum coverage of 10 percent of the federal student aid the school received in the prior year, but since ED provides so much discretion in the final rule, the 10 percent level seems to really be more of a benchmark.

There are still four automatic triggers for an LOC: failing the “90/10” score in one year, a cohort default rate of 30 percent or higher for two consecutive years, the SEC suspending or delisting the stock of an institution that is publicly traded, or the failure of a publicly traded school company to timely file a required SEC filing.

It probably comes as no surprise that three of the four automatic LOC triggers apply only to for-profit institutions.

While the final rule gets rid of the “stacking” of LOCs for multiple triggering events, the final rule gives the Department authority to determine the amount of any new or additional LOC that they believe is required based on the school’s particular circumstances such as compliance history, the type of loss anticipated, other existing liabilities to ED, and the potential risk of borrower defense claims. But their discretion doesn’t stop there. The final rule also preserves ED’s option to find that “any event” has a material adverse effect on the financial health of a school, leading ED to recalculate the institution’s composite score and, potentially, trigger a demand for any LOC that ED deems appropriate.

One new addition to the final rule is the option for the school to dispute the amount of (or need for) an LOC by showing that, for example, the condition was resolved, the institution has insurance to cover the debts and liabilities arising from the event, a given lawsuit or proceeding could not result in the amount claimed by the plaintiff, or that the amount is unnecessary to protect the federal interest.

Finally, ED promises yet another disclosure requirement mandating that schools publicly disclose the triggering events to their enrolled and prospective students.

Required warnings to students of new repayment rate

While the bulk of the new rule applies to nonprofit and proprietary institutions alike, ED has reserved one particular provision for the proprietary sector: the requirement to post and deliver a warning to current and potential students if their loan repayment rate falls below a certain threshold.

ED has also used the final rule to change the formula for calculating the repayment rate.

Since all proprietary institutions are subject to the Gainful Employment (GE) Rule, which already calls for ED to calculate the repayment rates for GE programs, ED has adopted that same method to calculate programmatic loan repayment rate. Under this formula, if ED determines that the “median borrower” in the two-year period used to calculate GE rates has not reduced the principal balance of his or her federal student loan by at least one dollar since entering repayment, the institution will be required to issue specific warnings in all institutional advertising and promotional materials, such as its web landing page, program webpages, financial aid webpages, emails and media, in print, on TV or radio. This even includes having to both speak and write the warning simultaneously in television or video promotions.

Forbidding mandatory arbitration clauses or class action waivers

As in the proposed rule, the final rule prohibits schools from incorporating in its student agreements a class action waiver or provision restricting class actions, or a requirement that a student resolve a claim against the school through arbitration.

If a school’s enrollment agreement currently contains a “pre-dispute” mandatory arbitration provision or a class-action waiver, the institution will be required to amend the agreement or provide a specific notice to students, using language provided by ED that explains that those provisions have been changed. In practical terms, after July 1, the school will have to tell every student during their financial aid exit counseling that the school cannot require the student to use arbitration to resolve a dispute, or if the student completed (or withdrew from) the program before July 1, then the school will be required to advise any student who makes a legal claim after that date.

Effective date

And back to the elephant in the room. Unless a court or Congress decides otherwise, or the new administration takes action to modify or withdraw the rule, the new regulations will become effective on July 1, 2017. These rules will have a wide-ranging impact on every institution whose students receive Title IV assistance. Now is the time for all schools to conduct operational reviews and make changes to policy, process and procedure to mitigate the risk of claims and financial damage. Most importantly, schools should be looking at their student-facing policies, procedures and – most of all – publications, to ensure their accuracy and clarity.

While Mr. Trump is clearly not a fan of government regulation, he has not given any indication how he would approach the issue of debt relief for defrauded borrowers.

But he has sympathized with the plight of struggling student loan borrowers at various times on the campaign trail which means his new administration may support some aspects of the new rule. Much remains to be seen, but I recommend that every school take the next few months to review the rule closely, figure out how it impacts your school, and be prepared. To quote another cliché… better safe than sorry.

Katherine Lee Carey

Katherine Lee Carey (Kate) is Special Counsel in the Education practice group of Cooley LLP.  Prior to joining Cooley, Kate spent close to 15 years serving in numerous roles in higher education institutions, including the most recent seven years as General Counsel and Vice President for Government Affairs. Previously, Kate served as the Vice President of Compliance and Assistant Director of Regulatory Affairs for two other higher education institutions.

Kate’s practice focuses on the legal, accreditation, administrative and regulatory aspects of higher education institutions and companies that provide services to the education industry. She provides clients with practical interpretation and implementation guidance on legal and regulatory requirements, assistance in preparing for regulatory and statutory changes, and impact analysis and strategic plans to implement complex regulatory requirements and compliance structures.

Kate also serves on the Advisory Board for the California BPPE, is Vice Chair of APSCU’s Federal Regulatory Affairs Committee, serves on APSCU’s Litigation and HEA Reauthorization committees, as well as the Diverse Women’s Committee of the San Diego Lawyer’s Club. She previously served on the Board of the California Association of Private Postsecondary Schools (CAPPS).

Contact Information: Katherine (Kate) Lee Carey // Special Counsel // Cooley LLP // 858-550-6089 // kleecarey@cooley.com // www.cooley.com


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