Borrower Defense Regulations—Final Rule Issued

The Education Department’s new regulations for borrower defenses to federal student loan repayment are scheduled to be implemented July 1, 2017.  The final regulations, prompted by the recent collapse of Corinthian Colleges and the negative effect of their closure on thousands of borrowers, were published November 1.  

The regulations clarify and expedite the way in which certain borrowers who have been defrauded by the institution they attended can get relief from student loan repayment.  They also seek to prevent future harm to borrowers and cost to the Department of Education when loans are forgiven by tightening institutional financial responsibility provisions.  Under the new rules, institutions can be required to reimburse the Secretary for borrower defense claims paid and to secure letters of credit for new financial responsibility violations.          

While the final regulations have not changed much from the notice of proposed rule-making (NPRM) (Washington Update, June 13, 2016) issued in June, they remain controversial and complex.  

Some changes were made in the final regulation that are significant for private, nonprofit colleges.  While the borrower defenses section retains the NPRM changes to the definition of misrepresentation, it addresses an important concern raised in comments to the proposed rule. The final rule clarifies that a borrower must have relied upon a substantial misrepresentation to his or her detriment to assert a borrower defense claim.  This should help deter frivolous claims.

The final rule also makes important changes to the financial responsibility provisions. It eliminates most of the automatic financial responsibility triggers described in the NPRM, each of which required a separate letter of credit.  They are replaced by three types of triggers.  Of the first trigger type, private, nonprofit institutions would be affected only when they have a cohort default rate of 30 percent or more for two consecutive years. This would result in an institution automatically being considered not financially responsible. The second type of trigger, based on a range of financial vulnerabilities, would require a recalculation of an institution’s financial responsibility score. The third type of trigger is based on Secretarial discretion to determine if a financial condition, such as a significant fluctuation in Pell Grant or Direct Loan participation, has a materially adverse effect on an institution’s financial condition. 

In addition, institutions must report reaching any of the triggers to the Secretary, generally within 10 days.

Also noteworthy, the Department acknowledged in a comment in the final rule that the very governance structure of non-profit colleges provided a level of protection to students that was not present at for-profit institutions.  The language from the final regulation, provided below, closely tracks comments on the borrower defense NPRM by NAICU president David Warren. 

Another commenter appreciated the distinction made in the NPRM between nonprofit/public institutions and proprietary schools as the basis for restricting the loan repayment rate disclosure to proprietary schools. The commenter suggested that the fundamental differences in the governance structures and missions of the public and non-profit sectors versus the for-profit sector provide a substantive basis for differentiating this regulation among the sectors.

- Federal Register, Rules and Regulations, Vol. 81, No. 211, November 1, 2016, p. 76086.

Additional provisions in the final regulation include: 

1. Borrower defense claims for loans disbursed prior to July 1, 2017 will be considered under the current regulation that uses state consumer law based on “cause of action.”
2. The Department will be providing additional guidance about due process for institutions to be used in its review of borrower defense claims.
3. There is no time limit on borrower defense claims based on court judgments. There is a six-year time limit to recover loan payments on claims based on breach of contract and substantial misrepresentation.
4. Processes are in place for group-wide borrower defense claims, and the Secretary may identify eligible groups.
5. Institutions may have to disclose when they are required to provide financial guarantees due to failing financial responsibility standards. The Department is going to determine the effectiveness of such disclosures through focus groups and issue further guidance.
6. Students who attended a “closed school” may be eligible for automatic loan discharge.
7. A “closed school” must provide students with information about their options – loan discharge or teach-out.
8. The basis for loan discharge under false certification is expanded.
9. A borrower who files a borrower defense claim is put on mandatory forbearance.
10. Additional electronic and database modes of notification of a borrower’s death may be used. 
11. A clarification is provided regarding nursing school loans that can be included in Title IV consolidation loans. 

Future of the Regulation

The election of Donald Trump has made the future of this regulation uncertain.  President-elect Trump has promised to roll back many of the Obama Administration regulations, and given the newness of this regulation and its complexity, it could be a target.  But what sets this regulation apart from many of the other Obama higher education regulations is that it has a clear basis in a provision of law that allows defrauded borrowers to have their loans forgiven.  The collapse of Corinthian, and more recently ITT, and the subsequent massive applications by borrowers for forgiveness, made the need for a regulatory process evident.

Because of the increased level of financial risk, private, nonprofit colleges should have their legal counsel, compliance officers, and CFOs review the regulations to determine potential implications of the new rule for their campus.