I usually like to start my articles with a little humor, but in the case of borrower defense to repayment, that’s a tough charge. The rediscovery of this regulation has come in the wake of devastating school closures and heartbroken students. The sudden collapse of the Corinthian College chain of schools in 2015, for example, disrupted the educational plans of thousands of students. The impact was felt most acutely in California, where the campuses were forced to close under the intense financial stress of multiple regulatory investigations and lawsuits. The publicity around the closure forced the US Department of Education (ED) to address what would happen to the federal loans of all of the impacted students. In the context of explaining the “closed school discharge” option, ED also provided potentially affected students, including those who were not attending schools that closed, with another option—the borrower defense to repayment (BDTR). This option could be pursued not only by current students, but also by borrowers who were no longer enrolled when the school closed and who believe that their school may have broken a state law related to their education. This opens the door very wide, essentially telling Corinthian alumni that they could be eligible for loan discharge. This option extends as well to any student who ever attended any school and who thinks that school acted improperly.

If you hadn’t heard of borrower defense to repayment before April of 2015, you are not alone. Despite having been effective since the mid-1990s, there had only been five applications under this provision in the 20 years that followed, according to ED. This little known, or used, provision allows Federal Direct Loan borrowers to petition ED to relieve their obligation to repay the loan based on an “act or omission” by the school that “could give rise to a state law claim.” Exactly what that means, and how to apply it to the now more than 30,000 applications, was a question not even the Department of Education could answer. ED first sought assistance from a “Special Master” whose focus was to identify a process to evaluate the 11,000 applications pending at that point, but it quickly became clear that the regulations’ complete lack of guidance on this provision was going to be a major obstacle. The result was a Department of Education Negotiated Rulemaking to “clarify” the requirements and process that concluded, without consensus, in March 2016.

I used quotation marks with the word clarify above because what may have started as an attempt to clarify the acts or omissions that lead to a borrower’s defense to repayment claim soon turned into a much broader discussion about institutional responsibilities, financial capability and “early warning signs” of potential problems that some negotiators believe could identify a school at risk of closure. The negotiators chosen to participate represented institutions, financial aid organizations, student and veteran advocacy groups, and state Attorneys General. The negotiations themselves became a bit of a spectacle, with appearances by members of Congress and television film crews, as well as heated debates about the broadness of the proposals and the lack of time provided for review. In the end, after nine days of debate over three months, multiple versions of each proposal, and new proposals being added seemingly every day, the rulemaking ended without agreement among the negotiators, meaning that the Department was left to draft its own version of the regulations.On June 16, 2016, the Department issued its proposed rule via a Notice of Proposed Rulemaking, opening a 45-day comment period. The proposed rule did not deviate much from the last version of the drafts circulated during negotiated rulemaking, but the preamble provided some interesting insights into ED’s thinking and rationale. In the corresponding comment period, over 10,000 comments were lodged with the Department, many of them expressing grave concern with the proposal, specifically with financial responsibility triggers.

On June 16, 2016, the Department issued its proposed rule via a Notice of Proposed Rulemaking, opening a 45-day comment period. The proposed rule did not deviate much from the last version of the drafts circulated during negotiated rulemaking, but the preamble provided some interesting insights into ED’s thinking and rationale. In the corresponding comment period, over 10,000 comments were lodged with the Department, many of them expressing grave concern with the proposal, specifically with financial responsibility triggers. On October 28th, the Department published the final rule, and it primarily sticks to the proposal, with the exception of the financial responsibility amendments, which were altered drastically in response to the comments.


Who Is Covered by the Current and New Rules?

The borrower defense to repayment option applies to all Direct Loan (DL) borrowers, and thus all institutions that participate in the federal student aid program and offer Direct Loans. The final rule applies to DLs made after July 1, 2017; the current rule will continue to apply to existing loans and those made up until that date, with a few caveats. The existing standard for review—an “act or omission” that could give rise to a state law claim—remains for loans made before July 2017, but the final rule would apply the new process for reviewing claims relating to those loans. A borrower with a pre-2017 loan could make a BDTR claim as long as the underlying “act or omission” is within the statute of limitations for the state law claim. ED’s ability to pursue the institution for the loss is limited to three years from the borrower’s attendance or the same time frame as the state law under which the student is making his or her claim.

School administrators should be aware that the Department’s final rule goes far beyond simply assigning financial liability to schools for their students’ successful defense to repayment claims (which it does). The proposal also includes significant new regulations about financial capability, including letters of credit, which apply to all Direct Loan (DL) participating private institutions, both nonprofit and proprietary.


A New Federal Standard for “Acts or Omissions”

Since the borrower defense option was created in 1993, it has provided a legal right for student borrowers to claim that ED cannot collect on their DLs due to the acts and omissions of the institution they attended based on state law violations, but without any specific explanation of the school’s acts that would trigger this relief. The new rule establishes a new, three-part federal standard that will apply to loans made after July 1, 2017. The standard will create three new claim bases, but also will retain students’ right to use a state court judgement as the basis to seek loan forgiveness.


Claim Base 1: Judgment against the School 

A borrower can make a claim if he or she obtains a favorable contested judgment against the school based on state or federal law in a court of competent jurisdiction. A contested judgement in this context means the institution presented a defense and lost (as opposed to a default judgement, where one party does not respond to a claim and the judge orders in favor of the other party). A borrower may assert this as a basis for a claim at any time without regard to any statute of limitations.

Although ED will not consider a settlement agreement or dismissal order to be a contested judgement under this provision, it welcomes borrowers to submit court documents such as these to support claims under the other two options described below.


Claim Base 2: Breach of Contract by the School 

A borrower can make a claim if the school he or she attended failed to perform its obligations under the terms of a contract with the student. There are two timeframes under this section. If students make a claim based on a debt they still owe to ED, there is no time limit; they can assert that claim at any time after the alleged breach. For claims to recover amounts previously collected by ED, the student must make the claim not later than six years after the breach.


Claim Base 3: Substantial Misrepresentation by the School 

A borrower can also make a claim if the school or any of its representatives or third-party agents that provide marketing, advertising, recruiting, or admissions services made a “substantial misrepresentation” that the borrower reasonably relied upon. Importantly, the Department proposes to broaden the definition of “substantial misrepresentation” to eliminate the need to prove any intent on the part of the institution to deceive, replacing intent with a “misleading under the circumstances” standard. The rule also adds that “substantial misrepresentation” includes any statement made by a representative of an institution that omits information in such a way as to make the statement false, erroneous or misleading. While the new rule does require the borrower to prove that he or she relied upon the misrepresentation to his or her detriment, the nature of what could be construed as the “false, erroneous, or misleading” statement—particularly where no intention to mislead is required to be shown—is extremely broad.

The focus on ensuring the claimant actually suffered damage under this type of claim resulted in a heated debate during the rulemaking, specifically relating to ED’s insistence that it have the discretion to determine the amount of the debt that it might discharge. In the final rule, ED preserves its discretion and outlines factors and “conceptual examples” it could consider in deciding the amount of relief due to the borrower.  ED will consider the cost of the attendance against the value of the education received and provides various illustrative scenarios to explain its review process.

Additionally, the proposal attempts to clarify the actions by an institution that might warrant “reasonable reliance” by the borrower on the institution’s “substantial misrepresentation.” The rule includes the following: 1) if the school makes insistent demands that the student’s enrollment or loan-related decisions be made immediately; putting too much emphasis on negative consequences of delaying enrollment; 2) if the institution makes statements discouraging the borrower from consulting an adviser or family member; 3) if the institution has failed to respond in a timely manner to borrower requests for information about costs and financial aid; and 4) if an institution has otherwise unreasonably pressured or taken advantage of the borrower’s “lack of knowledge or sophistication.”

A borrower can make a claim based on substantial misrepresentation for a debt still owed to ED at any time; there is no time limit. For claims to recover amounts that students already paid to ED, they must make the claim not more than six years after the “student discovers, or reasonably could have discovered,” the information constituting the substantial misrepresentation. (This is lawyer-speak for allowing time for a student to figure out whether there was a misrepresentation or whether the student suffered injury due to the misrepresentation.)


The Borrower Defense Claim Process for Borrowers

When the Department began the discussion of the borrower defense to repayment process in the summer of 2015, it repeatedly stated the importance of establishing a simplified application process for borrowers. However, the new rule does not do much to make the process for individual borrowers easier. The application process will still require the borrower to complete an application and provide evidence of the school’s wrongdoing, which will be subject to review by ED. As long as the school is still open, the institution has the chance to respond. The process is a bit less cumbersome for borrowers when ED determines that a group discharge is appropriate: this can be determined based on a number of similar borrower claims or “from any other source,” meaning ED can act on information provided by anyone that indicates a group claim may be appropriate. If ED determines a group exists based on common facts and claims, it will create a group claim, even if affected borrowers never filed a request. ED will be required to notify any borrower it plans to include, allowing impacted borrowers to opt out.

Personnel from within the Department will review applications, determine and/or establish group status for claims, serve as an advocate for those groups, and serve as adjudicator of the claim; ED will determine the level of damage suffered by individual borrowers. This process caused major concern for negotiators. As one negotiator pointed out, ED has an inherent conflict of interest as the evaluator of these claims because it has a vested interest in the outcome. In the final rule, this concern was not resolved; the role of both advocate and adjudicator remains within the Department.


Process and Impact on Institutions 

Institutions will be impacted on multiple fronts under the new rule. Not only does it provide little by way of explanation or assurances that an institution will have an opportunity to respond to students’ claims, it also included expansive new financial capability measures that could negatively affect institutions, whether a single student ever claims a defense to repayment or not.

The Process for Individual Borrower Claims

For individual claims, the rule includes a process in which a borrower submits an application supported with evidence for the claim. ED assigns a “Department official” to investigate, using its own records, the claim, any response from the institution (which supposes that the school is notified in a timely fashion and allowed the opportunity to respond, though no notice or timing procedure is included in the proposal), and any additional information that ED requests from the borrower. ED will then make a decision and notify the borrower.

For institutions, the final rule states that ED “may initiate [a] separate proceeding to collect from the school the amount of relief resulting from a borrower defense;” however, there is no real explanation of what the process or procedure will be for institutions either during the review process or in the “separate proceeding.” This is particularly troublesome because the ultimate responsibility for discharged loans will rest with the institution despite the lack of defined process in the rule. The final rule did add a time limit on ED’s ability to seek recoupment from the institution to within the same time limits as the borrower’s claim, i.e., within six years from the occurrence for breach and misrepresentation claims (no limit for judgement claims), or later, as long as the institution received notice of the potential claim during the six year time period.

The Process for Group Borrower Claims

In the final rule, ED also retains broad discretion when it comes to group borrower claims. ED makes the determination whether or not to initiate a group claim. If a group claim is created, ED will assign a Department official to present the group’s claim in the fact-finding process. This set-up is a bit odd because it essentially pits ED against itself by having an ED officer represent a group of students against ED. For those borrowers who have been identified as members of the group, notice will be sent to each borrower allowing him or her to opt out of the proceeding. Thus, students will automatically be included in the Department’s group unless they proactively request to be removed.

The Group Process for a Closed School

The assumption under this process is that the school has closed and has no remaining entity or assets, leaving ED without a school to go after to recoup its losses; however, if the institution is still accessible, the Department may consider information provided by the school practicable, as well as all the evidence submitted by the claimants or otherwise deemed relevant by the ED official reviewing the claim. If the borrowers’ claims are denied, individual borrowers have access to another bite at the apple: if a borrower feels that he or she has new evidence that specifically supports an individual claim, he or she may file as an individual.

The Group Process for an Open School

This section is the one that schools should be reviewing very closely. As part of the “fact finding” process, ED needs only “consider evidence and argument presented by the school.” The rule does not define the process for conducting evidence gathering, the presentation of arguments, the forum, or procedure. Based on this process alone, the ED official makes a decision and “the Secretary collects from the school any liability to the Secretary for any amounts discharged or reimbursed to borrowers.” This means that any discharge or other relief that ED decides to grant a borrower will result in ED going directly to the school to get that money. Thus, an institution’s only option for defending itself against a group claim will come as part of the fact-finding process; once ED makes its decision, the institution’s liability is established. The final rule did add a time limit to the Department’s ability to seek redress from the institution that mirrors the limitations in the individual borrower process outlined above.

The final regulations leave the role of the institution uncertain, and the ability to meaningfully participate in the process, when risk of enormous financial loss is on the line, remains frustratingly unclear.


New “Financial Responsibility” Measures

The Department’s final rule overhauls its proposal on the financial responsibility regulations, which were a source of major concern throughout the negotiated rulemaking process and comment period. The final rule takes the proposed rule’s system of “early warning” triggers—which had allowed ED to require institutions to post a letter of credit (“LOC”) with the Department, in many cases automatically and without consideration of the institution’s full financial health—and integrates it into the existing composite score test to determine financial responsibility. And though a majority of the originally proposed triggers remain in the final rule, many of the triggers that were “automatic” under the proposed rule are now discretionary or subject to review as part of a composite score calculation. These significant changes respond to many commenters’ concerns about the proposed automatic early warning system’s failure to take into account an institution’s full financial condition, while providing institutions an opportunity to show that a given triggering event will not negatively affect financial health. The final rule also appears to provide an opportunity to challenge the amount of the LOC. Note that these rules apply to both proprietary and nonprofit institutions, but public institutions are exempt.

Under the final rule, institutions are still required to self-report specified triggering events to the Department within a specified number of days. Once reported, for a number of triggers, the Department will recalculate the institution’s composite score using the institution’s last-submitted financial statements to make adjusting entries for the potential “loss” or liability of the triggering event. The formula for determining the loss or liability of a given event is outlined in the rule: for events such as a lawsuit or agency action, the amount of loss may be the amount claimed in the complaint or demand, or the amount set in a court ruling. For the loss of eligibility of gainful employment programs, the amount will be the amount of Title IV funds in the most recently completed fiscal year for that location or program. In the self-reporting notice to ED, institutions may demonstrate that a given lawsuit or action cannot produce the amount claimed in a complaint or demand, that the action no longer exists, or that the debts and liabilities will be covered by insurance.

If the recalculation results in a failing composite score—which means a score below 1.0—the institution will be required to post an LOC in an amount determined by the Department, generally 10% for a first violation. If the recalculation results in a passing composite score, the Department will regard the event as not posing a risk to financial health and will not require an LOC. The composite score will be recalculated “regularly”(though regularly is undefined),and once an institution can demonstrate either a passing composite score or that the triggering event no longer exists or is covered by insurance, ED will no longer require an LOC.

There are still other events, most notably a cohort default rate of 30% or higher for two consecutive years, that require an automatic LOC. In ED’s determination, these events are sufficiently severe as to impact an institution’s financial condition regardless of composite score. Thus, any of these events will automatically require an LOC of 10% of an institution’s Title IV funds in the prior award year, and the composite score will not be recalculated.

While the final rule eliminates the prescriptive and cumulative LOCs for multiple triggering events, the final rule gives the Department significant discretion to determine the amount of the LOC that is warranted. The minimum LOC will be 10% of an institution’s Title IV funds in the prior year. However, the Department may also conclude additional surety is required to sufficiently protect the taxpayers based on any number of facts and circumstances, such as the institution’s history, the nature of the risks posed, the presence of existing liabilities to ED, and the potential risk of borrower defense claims.

The final rule provides an avenue to dispute the amount of the LOC under Subpart G through a showing that, for example, the event or condition was resolved, the institution has insurance to cover the debts and liabilities arising from the event, the amount of educationally related expenses exceeds the amount of loss, 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. The type of showing required varies by the triggering event at issue.

The final rule also makes a number of changes to the individual triggering events, clarifying that the final rule only applies to events occurring on or after July 1, 2017. In particular, ED eliminated the three-year lookback in the lawsuit and other action-triggering events. ED also amended the triggers for certain accrediting actions (such as probation or a show cause), violations of loan agreements, and pending borrower defense claims to be discretionary.  ED retains the right to consider any material event at an institution, regardless of whether it appears in the regulation, to be a potential trigger requiring additional financial surety. Note also that, despite objections from many commenters, a teach-out plan required by an accrediting agency continues to be an automatic trigger, which will result in a recalculation of the composite score.

ED also declined to restrict its discretion in determining what may constitute a triggering event, and maintains its ability to determine that any event has a potential material adverse effect (which remains undefined in the final rule) on an institution’s financial health. Unlike the original proposal, however, such a determination from ED would result in a recalculation of the composite score, which allows the institution to show there is no actual impact on financial health.Finally, the final rule maintains the requirement to publicly disclose to enrolled and prospective students the occurrence of triggering events. However, ED plans to conduct consumer testing to determine which events will require a disclosure, as well as the format of the disclosure. ED expects to publish a Federal Register Notice with the template in the future.

Finally, the final rule maintains the requirement to publicly disclose to enrolled and prospective students the occurrence of triggering events. However, ED plans to conduct consumer testing to determine which events will require a disclosure, as well as the format of the disclosure. ED expects to publish a Federal Register Notice with the template in the future.


Loan Repayment Rate Disclosure

Interestingly, given the other serious concerns around the rule, one of the most contentious debates during the rulemaking was over the proposal that schools issue a loan repayment rate disclosure to students when the rate dips below a certain threshold. The rate would be calculated by ED using the same methodology that is currently used for the Gainful Employment repayment rate disclosures. It would evaluate whether the median student in the cohort had reduced the balance on his or her federal loans at least one dollar since entering repayment. Traditional institutions and community colleges alike disagreed with the purpose and the methodology and adamantly refused to support this proposal. ED countered that loan repayment rate data was important to students and that they have the right to know if an institution they are considering attending has a low rate of repayment. Despite ED’s own public policy argument about the importance of this disclosure, ED decided only students attending for-profit institutions were entitled to loan repayment information, and limited its application to that sector only.


What Schools Need to Do

The final rule impacts every institution of higher education that participates in the federal student loan program, whether nonprofit, private, community college, state school, or proprietary. Now that institutions know what the rule says, there are many operational questions that should be considered. Does your institution need to review its training on misrepresentation? Are you appropriately managing and controlling your external messaging to students through marketing, publications, and disclosures? Is there an accreditor action pending that could become a trigger for a financial responsibility review? The rule becomes effective on July 1, 2017, so you should use this time to evaluate your operations to be sure you are compliant and prepared.

Finally, it should be remembered that this rule was intended to make sure student borrowers have recompense if their school acted in a way that could violate the law. But there is genuine concern that broadening this rule too much could open a Pandora’s box. Even the Department of Education seems to recognize, and wants to guard against, frivolous claims made by disgruntled students, or those who simply think this is the loophole that gets them out of student debt. One Department official even stated that this was not intended to relieve the debt of a student because he “doesn’t think the quad looks like the picture in the catalog.” So, as you review these new rules, be sure to remember that the goal is to ensure students make informed decisions about their education, and get what they pay for. We should be doing everything we can to make sure both of those goals are met.


Katherine (Kate) Lee Carey is Special Counsel with the Higher Education Practice Group of Cooley LLP. She has been working in higher education for more than 15 years in operational, legal, regulatory, compliance, and governmental affairs capacities. Kate has developed expertise in accreditation, state licensing, federal Title IV, and other relevant state and federal higher education statutes and regulations, assessing and operationalizing new and changing laws and regulations, developing compliance structures including analysis of existing operations, development of policies and procedures, compliance auditing, and legislative and other governmental policy review and development.