ED Proposes Substantial Expansion of Financial Responsibility Indicators

The Department of Education recently proposed a new rule on borrower defense to repayment of federal student loans, spurred by former Corinthian College students refusing to pay their debts after the for-profit chain's demise. While ED has long allowed forgiveness of loans in some cases, the rules were skeletal and seldom used.

During the negotiated rulemaking sessions that preceded the notice of proposed rulemaking (NPRM),  ED introduced potentially onerous requirements in order  to hold higher education institutions accountable and protect the federal government's financial interests.

The NPRM would establish new standards for determining whether a borrower can establish a defense to repayment on a loan based on an act or omission of a school. The proposed rule is aimed at providing relief for students who have been mistreated.

While the proposed regulations are still under review, NACUBO is concerned that ED would penalize nonprofit colleges and universities for circumstances that are unrelated to student outcomes and not indicative of potential risk to the federal government. Proposed triggers that would require schools to obtain letters of credit or provide other surety are not comprehensive financial indicators and do not suggest that an institution is about to close precipitously. The triggers would also require extensive disclosures to enrolled and prospective students.

Comments are due to ED by August 1. NACUBO welcomes members' feedback, comments, and observations on any provisions in the proposed rules that seem problematic as the association prepares to respond.  Anecdotal information on the circumstances surrounding potential triggering events is welcome as no data are available about such occurrences.

NACUBO also encourages members to file comments with ED. No stakeholders with financial expertise were included on the negotiated rulemaking committee selected by ED, so insight from business officers is needed.

A summary of the two main sections of the proposal follows.

Borrower Defense to Repayment
Institutional Accountability and Financial Responsibility

Borrower Defense to Repayment

The proposed rules establish a new federal standard [§685.222] for a borrower defense to repayment for loans disbursed on or after July 1, 2017. ED proposes three circumstances to serve as a basis for a claim to be eligible for loan forgiveness (a discharge):

1. A favorable contested judgment against the school from a court or administrative tribunal for relief, provided the claim relates to the making of the borrower's Direct Loan.
2. A breach of contract between the borrower and an institution where the school failed to perform its obligations.
3. A substantial misrepresentation by the institution that the borrower reasonably relied on when he or she decided to attend, or to continue to attend, the school.

There would be no time limitation for borrowers to assert a defense to repayment for amounts still owed on a given loan for all three circumstances listed above. Additionally, there would be no time limit for claims for recovery of amounts previously collected when the defense is based on a judgment. If a claim to recover amounts previously collected is made based on a breach of contract, a borrower would have six years from the date of the breach to make the claim. Similarly, if a claim to recover amounts previously collected is based on a substantial misrepresentation, a borrower would have six years from the date of the discovery of the misrepresentation to make a claim.

The proposed rule would allow claims to be made by individuals or groups of borrowers. If the department determines that common facts and claims exist that apply to borrowers who have not filed an application, it could include those borrowers in a group, with individuals having the option to opt out.

Once ED receives an application for defense, it would either place the borrower(s) in forbearance, or if the loan was in default, suspend collection activity on the loan. Department officials would use the application and accompanying documentation to begin a fact-finding process to determine if a defense should be granted. ED would then notify the borrower(s) of its decision, and those denied could request reconsideration of the claim if new evidence is submitted.

Under the proposed rules, if a borrower defense claim is approved, ED would determine the appropriate method for calculating relief to the borrower. This may include a discharge of all amounts owed to ED and recovery of amounts previously collected, or some lesser amount. The department is excluding relief based on non-pecuniary damages such as inconvenience, aggravation, emotional distress, or punitive damages.

Institutional Accountability and Financial Responsibility

NACUBO is concerned that the proposals related to institutional accountability and financial responsibility would penalize nonprofit colleges and universities for circumstances that may be completely unrelated to students and not indicative of potential risk to ED or the federal government.  The proposed rules include significant changes to the current financial responsibility regulations but do not attempt to correct ED's flawed practices related to calculation of institutional composite scores. The proposed new criteria would be in addition to those requirements, establishing a number of new ways for schools to be considered not financially responsible. 

The department proposes to establish a number of new "triggers" that would require institutions to provide a letter of credit or other financial protection to "help protect students, the Federal government, and taxpayers against potential institutional liabilities." The provisions impact proprietary institutions and private nonprofit colleges and universities. As in the existing regulations, public institutions that are backed by the state are assumed to be financially responsible and would not be impacted by these changes.

Triggers

Under the proposal, an institution that is subject to one of the listed triggering events would be considered "not able to meet its financial or administrative obligations." It could continue to participate in the Title IV programs only under provisional certification and would be required to provide a form of financial protection to ED (generally a letter of credit). The amount of the surety would vary depending on circumstances, generally with a floor of 10 percent of the amount of Title IV program funds received by the institution during the most recently completed fiscal year. The penalties would be cumulative, in some cases requiring multiple letters of credit-for example, four triggering events could require letters of credit or other surety valued for at least 40 percent of an institution's prior-year Title IV funds. 

In addition to the new "automatic triggers," ED is also proposing additional discretionary triggers that the "Secretary could consider in determining whether an institution is financially responsible."  

Automatic Triggers

Automatic triggers are events tied to mandatory sanctions, and include:

• State or Federal Agency Actions: If currently or in the three most recently completed award years, an  institution  had  to  repay  a  debt  or  liability  arising  from  an  investigation  by  a  state,  federal,  or  other  oversight  entity;  or  settles  or  resolves  a  suit  brought  by  one  of  those  entities  related  to  the  making  of  a  federal  loan  or  the  provision  of  educational  services [§668.171(c)(1)(i)(A)];  or  is being  sued  by a government agency or other oversight entity for such claims [§668.171(c)(1)(i)(B)] . Repayments to ED to cover losses for successful borrower defense claims or an active suit brought by one of these entities based on any other type of claim constitute additional triggers if the repayment amount or potential damages are material [§668.171(c)(1)(ii)].
  
  Under some circumstances, suits brought under the False Claims Act or by private parties, if related to the making of federal loans or provision of educational services, could also be considered a triggering event [§668.171(c)(1)(iii)].
  
  These triggers, and others that are pegged to certain liabilities, would be subject to a materiality test that was added during negotiated rulemaking. Generally, the amount of the liability for one or more of the years must exceed the lessor of the threshold amount to be subject to Single Audit requirements (currently $750,000) or 10 percent of the institution's current assets [§668.171(c)(2)].  

• Accrediting Agency Actions [§668.171(c)(3)]: If  currently  or  at  any  time  in  the  three  most  recently  completed  award  years,  the  institution's  primary  accrediting  agency  required  the  institution  to  submit  a  teach-out  plan  for itself or any additional branches or locations or placed the  institution  on  probation,  issued  a  show-cause  order,  or  placed  the  institution  in  a  similar  accreditation  status  for failing to meet one or more of the agency's standards, and  the  accrediting  agency  does  not  notify  the  secretary  within  six  months  that  the  institution  has  come  into  compliance.

• Loan Agreements and Obligations [§668.171(c)(4)]:  If, as  disclosed  in  a  note  in  its financial  statements or reported to ED, an institution in relation to its largest secured creditor:

1. Violated  a  provision  or  requirement  in  a  loan  agreement;     
2. Failed  to  make  a  payment  for  more  than  120  days; or
3. A  monetary  or  nonmonetary  default  or  delinquency  or other event,  as  defined  under  the  terms  of  the loan  agreement,  triggers  or  provides  a  recourse  by  the  creditor  for  an  increase  in  collateral,  changes  in  contractual  obligations,  an  increase  in  interest  rates  or  payments,  or  imposes  some  sanction,  penalty,  or  fee  upon the institution.

This trigger does not have a materiality provision, but only applies to the institution's largest creditor.

• Gainful Employment (GE) [§668.171(c)(7)]:  For  institutions  where  more than  50  percent  of  students  who  receive  Title  IV  aid  are  enrolled  in  GE  programs,  if  more  than  50  percent  of  those  enrolled  in  GE  programs  are  in  programs  that  failed  or  are  in  the  zone  under  the  debt-to-earnings rates measure.

• Cohort Default Rates (CDR) [§668.171(c)(9)]:  Institution's two most recent cohort default rates are 30 percent or greater.  Does  not  apply  if  the institution  files  a  challenge,  request  for  adjustment,  or  appeal  with  respect  to  its  CDR,  and  that  action  results  in  reducing  the  CDR  below  30  percent  or  the  institution  not  losing  eligibility  or  not being placed on provisional certification.

Discretionary Triggers

• Fluctuation in Direct Loan or Pell Grant Volumes [§668.171(c)(10)(i)]: Significant  fluctuations  in  Direct  Loan and/or  Pell  Grant  funds  received  by  the  institution  in  consecutive  award  years  that  cannot  be explained by changes in the institution's programs. No specific threshold is established.
• High Annual Dropout Rates [§668.171(c)(10)(v)]: High dropout rates as calculated by the secretary; no specific threshold is currently established.
• State Licensing Agency [§668.171(c)(10)(ii)]: The institution has been cited by a state licensing or authorizing agency for failing state or agency requirements.
• Credit Rating [§668.171(c)(10)(iv)]: The institution or corporate parent has a non-investment grade bond or credit rating.

Reporting and Disclosure

Institutions would be given 10 days to notify ED of any action or event that constitutes an automatic or discretionary trigger. Currently, only institutions that have run into trouble with the financial responsibility standards and are participating under the zone alternative or provisional certification are subject to this type of prompt reporting requirement [§668.171(d)].

The proposed regulations would also require widespread disclosure, in writing, to enrolled and prospective students that an institution was required to provide a letter of credit or other financial protection to the department. Schools are given the option of hand-delivering or emailing a "student warning." Additionally, institutions would be required to post a disclosure on the home page of the institution's website that identifies and explains the circumstances behind the required letter of credit [§668.41(i)].