Understanding Common Legal Pitfalls in Online Service Agreements

In recent years, collaboration between traditional colleges and universities and private third-party service providers to create academically rigorous online programs has been a driving force in online education. And the advances in technology that made quality online education possible have been accompanied by a broader trend of disaggregation in postsecondary education. Colleges and universities recognize that it is often more efficient to “contract out” many of their business functions while retaining control over their core academic purposes, such as teaching, curriculum development and student assessment. While a variety of vendor relationships exist, the most notable are the so-called “online program management” agreements. Such partnerships provide postsecondary institutions with access to the capital, technology, and expertise to convert their academic programs into high-quality, widely-accessible online offerings.

While there are many benefits to third-party collaborations and outsourcing in online education, the arrangements do not come free of legal and regulatory risks. As a general rule, institutions of higher education are held responsible by regulatory authorities for the actions of their contractors. And it is fair to say that the Department of Education (“ED” or the “Department”) remains wary of online education, in part due to fraudulent activity, and in part simply because the growth in online programs is difficult for ED to monitor and control. Many of the important legal and regulatory issues in distance learning contracts stem from new rules or revisions to existing regulations promulgated as part of the Department’s 2010 “Program Integrity” rules. As the name suggests, the Program Integrity Rules were issued to address many of the Department’s concerns about recruiting practices and to ensure that approved, eligible institutions (whether non-profit or for-profit) remain fully accountable for their course content and administration of Title IV student aid. The principal provisions that came out of the 2010 rulemaking include revisions to the incentive compensation rule, the misrepresentation rule, the written arrangements rule, rules regarding third-party servicers of financial aid, and state authorization requirements.

The following article outlines key legal and regulatory issues and risks that institutions and third parties should consider when collaborating to offer programs or student services online. We first identify the legal requirement and then provide some practical tips on how to address those risks in your contractual arrangements. This article is meant to highlight the most common and significant federal education law issues when contracting with third-party service providers. Third-party arrangements may implicate a number of other legal issues, including student privacy (including the Family Educational Rights and Privacy Act, or “FERPA,” and state privacy laws), intellectual property issues, and other consumer protection laws (such as the federal “Do Not Call” laws and regulations and related state laws), all which warrant careful review by experienced counsel.

As third-party partnerships continue to offer opportunities for institutions and servicers alike, it is important to remember that these agreements put institutions at risk as well. Institutions and vendors must carefully protect against such risks in both the negotiation and implementation of their business arrangements.

 

Issue #1: Compensating Third-Party Recruiters and Lead Generation Firms

The Higher Education Act of 1965 (“HEA”) provides that an institution that participates in the Title IV programs must agree in its Program Participation Agreement that it will not provide any incentive payments for recruiting, enrolling or awarding financial aid to students. Under the federal rules, institutions may not “provide any (1) commission, bonus, or other incentive payment; (2) based in any part, directly or indirectly, upon success in securing enrollments or the award of financial aid; (3) to any person or entity who is engaged in any student recruitment or admission activity, or in making decisions regarding the award of Title IV HEA program funds.” 34 C.F.R. § 668.14(b)(22) (emphasis added).

The federal rule (known as the Incentive Compensation Rule) applies equally to payments to an outside entity and payments to an institution’s own employees. The ban also extends to any higher level employees with “responsibility for recruitment or admission of students, or making decisions about awarding Title IV, HEA program funds.”  This clause can cause complications for service providers, who often provide bonus payments to their executives.

Although the rule banning incentive compensation is very broadly worded, the Department has provided some guidance on recruiting activities and corresponding payment structures that are permissible (U.S. Department of Education, 2011). Payment in exchange for collecting student contact information is permissible under the rule, provided payment is not based on the number of students who apply, are awarded aid, or are enrolled for any period of time. Payment based on number of “clicks” on a website is also generally permissible, provided payment is not based “in any part, directly or indirectly” on number of individuals who enroll or are awarded financial aid.

“Revenue sharing” of tuition in exchange for recruiting and admissions services is considered incentive compensation and is generally prohibited under the rule. However, there is one important exception, known as the “bundled services rule.” Department guidance states that tuition-sharing arrangements for services covered by the rule may be permitted if each of the following conditions is met:

• The institution procures recruiting and other services from another party that is unaffiliated with any other institution that provides educational services.
• The third party provides a range of “bundled services.”
• The institution pays the third party an amount for all bundled services that are offered and provided collectively rather than paying the third party separately for recruiting services.
• The third party does not make incentive payments to its employees.
• The institution determines the number of enrollments, rather than the third party.

Although the term “bundled services” is not defined, the Department has issued guidance on this important issue (U.S. Department of Education, 2011). The guidance identifies marketing, enrollment application assistance, course support for online delivery of courses, the provision of technology, placement services for internships, and student career counseling as examples of “bundled services” that can permissibly be combined with recruiting activities under tuition-sharing arrangements. The “bundled services rule” effectively creates a safe harbor for revenue sharing in contracts that includes recruiting or marketing activities, but institutions must review the Department’s guidance carefully to assure all conditions are met.

 

Contractual Protections

Violations of the Incentive Compensation Rule can carry substantial monetary fines and penalties, including the possible loss of Title IV eligibility. The Department of Education may identify violations through program reviews and audits. In addition, schools risk qui tam or “whistleblower” actions filed by students or school employees under the False Claims Act, which may lead to substantial judgments or settlements and can be expensive to defend, even when frivolous. Given these risks, it is essential that institutions take steps to limit their liability when contracting with third-party servicers for any activities related directly or indirectly to securing enrollments or financial aid. While it is impossible to eliminate all risk of liability, the following practices should be considered:

1. If you plan to contract solely for lead generation services, explicitly state that you are providing compensation for leads, contact information, or website hits and not enrollments or applications.
2. Ensure that arrangements that include revenue sharing for services related to securing enrollments or financial aid also include several additional services so that a “bundle” of services is provided throughout the life cycle of the agreement. Carefully document that the additional services are in fact provided throughout the course of the arrangement.
3. Clarify in the agreement that the institution is responsible for making final decisions about enrollments and enrollment targets for its programs.
4. Incorporate standard contract clauses to protect the institution:

• Representations and warranties as to compliance with the Incentive Compensation Rule;
• Indemnification provisions in the event third-party conduct results in a law suit or agency investigation;
• Require that third parties carry adequate insurance to cover the cost of such lawsuits or investigations.

 

Issue #2: Understanding Arrangements with Third-Party Financial Aid Servicers

ED’s regulations impose specific responsibilities on both institutions and outside vendors when an institution contracts with a third party to administer the institution’s participation in the Title IV programs. This is currently an area of particular concern for the Department, and one where institutions can expect to see more enforcement activity.

The question of what types of financial aid services are covered is a source of confusion. Under the regulations, an entity is considered a third-party servicer of financial aid by ED if it has been contracted by an institution to “administer . . . any aspect of the institution’s participation in any Title IV, HEA program.” The regulation elaborates that such activities include, but are not limited to, processing student aid applications; performing need analysis; determining student eligibility; and certifying, servicing, or collecting loans. More recently, however, the Department issued a Dear Colleague Letter suggesting the “servicer” definition is much broader than typical Title IV processing and includes activities such as student financial aid counseling, default prevention services, preparing consumer disclosures, and even hosting portals for the transmission or electronic storage of and access to Title IV records. Careful consideration of contracted activities is necessary to prevent inadvertent classification as a third-party servicer of financial aid. Third-party contractors that provide Title IV financial aid services must comply with the Department’s regulations, must include special provisions in their contracts and must report to and are subject to audit by the Department. Understanding this issue is especially important because the third-party servicer and the institution are jointly and severally liable for any violation by the servicer of any Title IV statutory or regulatory provision under the Department’s authority. 34 C.F.R. § 668.25. In other words, your institution remains legally “on the hook” to the Department for any errors in the administration of Title IV aid.

 

Contractual Protections

It is therefore critical for institutions to consider whether the terms of their service contracts qualify as a third-party servicer arrangement and ensure such contracts contain adequate protections.

1. Consider whether the rule is applicable to the services being contracted; consider revising the arrangement if that is not the relationship that is intended.
2. Include a specific disclaimer that the agreement is not intended to be a third-party servicer arrangement, if that is the case.
3. Include the Department’s mandatory contract language as set forth in the applicable regulations, if using a third-party servicer.
4. Make sure third-party servicers have the necessary assets or insurance to sustain a Department finding and require insurance.

 

Issue #3: Avoiding Third-Party Misrepresentation

The HEA prohibits an institution that participates in the Title IV programs from engaging in “substantial misrepresentation” regarding three broad subject areas: (1) the nature of the school’s education programs, (2) the school’s financial charges, and (3) the employability of the school’s graduates. “Substantial misrepresentation” is a misrepresentation on which the person to whom it was made could reasonably be expected to rely (or has reasonably relied) to that person’s detriment.

In 2010, ED significantly expanded the scope of its misrepresentation rules. The revised misrepresentation regulations now cover statements made by any school representative (including employees, agents, and third-party service providers) to essentially any other individual or regulatory body. The regulations also define “misrepresentation” as any false, erroneous, or misleading statement made by an institution, as well as any false statement that “has the likelihood or tendency to deceive.” Thus, under the current regulations, a false statement need not be intentionally deceitful to qualify as a misrepresentation; it is essentially a strict liability standard.

As a corollary to the Department of Education’s misrepresentation rules, the Federal Trade Commission (“FTC”) also has similar regulations that prohibit schools from making misrepresentations. Although the FTC regulations only apply to for-profit institutions, most states have adopted their own versions of the FTC regulations, which often apply to both for-profit and non-profit institutions. Just as the federal Misrepresentation Rule essentially imposes strict liability on institutions, so too do the FTC regulations and their companion laws at the state level.

While the Misrepresentation Rule is enforced by the Department of Education, in recent years, state attorneys general have been far more active in policing institutional misrepresentations. These state audits and lawsuits can be extremely burdensome and expensive to resolve. Substantial misrepresentations are subject to fines and the possible loss of Title IV funding by the Department, and are equally ripe targets for whistleblower complaints. Complaints may originate from state or accrediting bodies, students, or even from an institution’s competitors.

 

Contractual Protections

Given these concerns, at a minimum, institutions should consider the following when contracting with service providers:

1. Limit the length of a third party’s “leash” when providing recruiting services. Interactions with prospective students should be based on approved scripts, and recorded and reviewed regularly to make sure recruiters are staying on message.
2. Ensure that the institution always has final approval rights over marketing materials and actually exercises those rights before any fliers, ads, or call scripts are utilized.
3. Incorporate standard contract clauses to protect the institution:

• Representations and warranties as to compliance with the Misrepresentation Rule (and similar laws);
• Indemnification provisions in the event the institution is the subject of a suit or agency investigation;
• Require that third parties carry adequate insurance.

 

Issue #4: “Written Arrangements” with Other Institutions or Organizations for Academic Programs

Another important restriction that institutions must keep in mind if they contract with third parties to offer joint degree programs or develop course content is the Department’s regulations (and related accreditation standards) regarding “contracting out” of educational programs. The Department’s regulations address circumstances under which an institution that is Title IV-eligible contracts with another institution or entity to provide part of the eligible institution’s educational program. 34 C.F.R. § 668.5. The “written arrangements rule” addresses several different types of arrangements, including: 1) arrangements between two (or more) eligible institutions and 2) arrangements between an eligible institution and an ineligible institution or organization.

1) Arrangements between Eligible Institutions

Written arrangements between two (or more) Title-IV eligible institutions are generally permissible as long as they are in writing and provide adequate disclosure to students.

2) Arrangements between an Eligible Institution and an Ineligible Institution

Written arrangements between a Title IV-eligible institution and a non-Title IV-eligible institution or organization are more complex and should be approached with additional care. The ineligible institution or organization may provide 25% or less of program without triggering any additional requirements. But the ineligible institution may not provide more than 50% of the educational program. If the ineligible institution provides more than 25% (but less than 50%) of the educational program, the eligible institution’s accreditor must approve the arrangement and verify that it meets the accreditor’s standards.

ED’s regulations also outline certain impermissible characteristics that would disqualify the ineligible institutions from providing any portion of the eligible institution’s program under a written arrangement. For example, if the ineligible institution has had its eligibility to participate in the Title IV programs terminated by the Secretary, or had its application for re-certification to participate in the Title IV programs denied by the Secretary, the ineligible institution or organization is prohibited from offering any portion of the eligible program.

In addition to the Department’s regulations, schools must consider the standards of their accreditors as well, which often have very specific restrictions on the types and amount of activities that an institution can contract out without prior approval. One important example is the Western Association of Schools and Colleges (“WASC”) recent standards (WASC Senior College and University Commission, 2015). WASC’s starting premise is that an accredited institution bears final responsibility for ensuring the quality and integrity of all activities conducted in its name, including those activities which are outsourced. Further, the standards outline institutional responsibilities which can never be outsourced at all, such as setting admissions criteria and making admissions decisions, selecting and approving faculty, awarding credit for prior or experiential learning, approving course content and curriculum, and assessing student learning. Even schools that are not accredited by WASC should review the standards closely, as they are likely to become the model for permissible outsourcing by other accrediting bodies as well as the Department.

On October 15, 2015, the Department issued a long-awaited notice announcing an “Experimental Sites Initiative” to permit limited access to federal loan and grant programs for students enrolled in short, non-institutional programs (U.S. Department of Education, 2015). The program allows Title IV-eligible institutions to contract with a non-institutional provider to enable the provider to offer more than 50% of an eligible program to students of the institution, in effect providing a limited waiver from the written arrangements rule.  The pilot program is very narrowly drawn, however, and is not expected to result in significant new activity, at least in the near term.

 

Contractual Protections

The risks associated with arrangements with other institutions to provide an educational program are significant because they represent an “all or nothing” proposition. If an arrangement violates the Department’s regulations, or an accreditor’s standards, the institution could be liable to the Department for all Title IV funds disbursed to students in the unapproved program. As a result, institutions must carefully choose their partner institutions, include contractual protections in any written arrangements, and take steps to monitor each party’s responsibilities.

1. When partnering with an ineligible institution, carefully evaluate the entity and require representations that the institution has not had its Title IV eligibility revoked or denied. Require notice of any change in the accreditation of the partner institution. Indemnification and adequate insurance are also a must.
2. Include contractual provisions that expressly identify the portions of the educational program each institution will be required to provide under the arrangement.
3. Include provisions that limit third parties from expanding “services” without prior authorization, which may avoid unauthorized teaching arrangements.
4. In addition to contractual protections, consider implementing the best practices outlined under WASC’s standards, which will help ensure that the institution retains control over its core “non-delegable” functions.

 

Issue #5: Don’t Forget State Authorization

Adequate state authorization remains a condition to your institution’s Title IV program eligibility. The Department’s state authorization rules, promulgated as part of the 2010 Program Integrity rule package, remain largely intact. Although the federal regulations currently require that institutions be authorized only in the state where they are physically located, the real challenge is at the state level; institutions are also subject to state laws that may require authorization for distance education programs independently of any federal mandate. State authorizing agencies are more active than ever, and state laws and requirements continue to shift frequently, often simply through informal changes in agency guidance. Although the State Authorization Reciprocity Agreement (“SARA”) compact holds great promise in simplifying these requirements, and is rapidly gaining momentum, reciprocity will not provide a complete solution to this problem. It is unlikely that all states will adopt SARA, reciprocity is currently limited to degree-granting institutions only and, most importantly, SARA does not cover professional licensure approvals. As a result, institutions planning to offer online educational programs nationally must still have a comprehensive plan to obtain and monitor the necessary authorizations or risk legal challenges at the state level as well as potential student litigation.

 

Contractual Protections

In most online program management contracts, responsibility for state authorization falls squarely on the institution offering the program. Bear in mind that:

1. Institutions offering online courses must have a plan for tracking student enrollments, tracking changes in law, and centralizing the institutional authorization process to be sure the institution does not violate state law requirements.
2. Agreements should address who is responsible for state approvals, and the need for such approvals should be reflected in the parties’ agreed upon marketing plan and enrollment goals.

As online program management and other agreements grow in popularity, institutions must remember that delegation is not abdication. Institutions remain largely responsible for what goes on under their brand name and should treat such arrangements with the care they deserve.

 

References

U.S. Department of Education. (2011, March 17). GEN-11-05: Implementation of Program Integrity Regulations. Information for Financial Aid Professionals (IFAP). Retrieved from http://ifap.ed.gov/dpcletters/GEN1105.html

U.S. Department of Education. (2015, October 15). Notice Inviting Postsecondary Educational Institutions To Participate in Experiments Under the Experimental Sites Initiative; Federal Student Financial Assistance Programs Under Title IV of the Higher Education Act of 1965, as Amended. Information for Financial Aid Professionals (IFAP). Retrieved from http://ifap.ed.gov/fregisters/attachments/FR101515InvitationtoParticipateintheExperSitesInitiatInv.pdf

WASC Senior College and University Commission. (2015, February). Agreements with Unaccredited Entities Policy and Guidelines. WASC Senior College and University Commission. Retrieved from http://www.wascsenior.org/content/agreements-unaccredited-entities-policy-and-guidelines

 

Gregory Ferenbach is special counsel in the Education practice group at Cooley, LLP. Mr. Ferenbach assists clients with transactions and in developing new ventures in the higher education field, with an emphasis on issues arising from online learning. He was senior vice president, general counsel and secretary of Strayer Education, Inc. (NASDAQ) and of Strayer University, Inc., where he worked from 2002 to 2010, and prior to joining Strayer, he was senior vice president and general counsel to the Public Broadcasting Service (PBS).

Paul Thompson is an associate in Cooley’s Education practice group. Prior to joining Cooley, Mr. Thompson worked in Duke University’s Office of Counsel and American University’s Office of General Counsel. In those roles, he counseled institutional clients on a broad range of issues, including employment law, copyright and trademark law, and compliance with FERPA and the Clery Act.