NASFAA Policy Analysis: Final Rules for Borrower Defense and Financial Responsibility

By Joan Berkes, NASFAA Policy & Federal Relations Staff

The Department of Education (ED) last week released a summary and unofficial version of the final borrower defense and financial responsibility regulations. Official publication in the Federal Register is scheduled for today, November 1, making the Master Calendar deadline for an effective date of next July 1.

These rules:

  • Revise the financial responsibility regulations to identify events that may signal impending financial problems that could result in school closure, and required financial guarantees to the federal government against potential liabilities;
  • Expand and clarify the definition of misrepresentation;
  • Establish a new federal standard and a process for determining whether a borrower can be excused from repaying a loan (i.e., has a defense to repayment) due to a fault of the school;
  • Require all institutions to disclose to students certain events that could indicate potential financial failure or distress;
  • Add additional warnings by proprietary schools to students regarding poor loan repayment rates;
  • Prohibit certain contractual provisions imposed by schools on students regarding dispute resolution;
  • Make other changes to discharge rules across several Title IV programs.

The final rules incorporate a number of modifications to the proposed rules, many of which result from comments made by the higher education community in response to the Notice of Proposed Rulemaking.

Borrower Defenses to Repayment

Under the new rules, a “borrower defense” refers to any act or omission by a school related to the making of the loan, or the provision of educational services for which the loan was provided, that would give rise to a cause of action against the school under applicable state law. A borrower who successfully invokes a defense to repayment may be excused from repaying the outstanding amount of the loan and, within certain time limitations, may recover amounts already paid on the discharged loan. A borrower may be granted full, partial, or no relief depending on the circumstances.

Defense to repayment discharges may encompass defaulted loans. In the case of Direct Consolidation Loans, the discharge may apply to any underlying Direct Loan, FFEL Program Loan, Federal Perkins Loan, Health Professions Student Loan, Loan for Disadvantaged Students, Health Education Assistance Loan, or Nursing Loan that was repaid by the Direct Consolidation Loan.

For loans first disbursed on or after July 1, 2017, borrower defenses are established if a preponderance of evidence satisfies the new rules. Borrower defenses may be based on the following circumstances:

  • A nondefault, favorable contested judgment against the school;
  • Breach of contract by the school; or
  • Substantial misrepresentation by the school—or by “any of its representatives, or any institution, organization, or person with whom the school has an agreement to provide educational programs, or to provide marketing, advertising, recruiting, or admissions services”—that the borrower “reasonably relied on to the borrower’s detriment when the borrower decided to attend, or to continue attending, the school or decided to take out a Direct loan.” The regulation gives examples of school conduct that may support the reasonableness of a borrower’s reliance on a misrepresentation, which generally involve unreasonably pressuring the borrower or taking advantage of the borrower’s distress or lack of knowledge or sophistication.

Current regulation includes in the definition of misrepresentation “any statement that has the likelihood or tendency to deceive.” The new rule replaces “deceive” with “mislead under the circumstances.” The new rule also adds “any statement that omits information in such a way as to make the statement false, erroneous, or misleading” to the definition of misrepresentation.

The final rules allow ED to identify groups of borrowers who may have a borrower defense. Borrowers who have not filed an application for discharge may be included in the group, but will be provided an opt-out opportunity. For defenses rooted in a substantial misrepresentation by the school that has been widely disseminated, there is a rebuttable presumption that each member reasonably relied on the misrepresentation.

The group discharge process is not limited to borrower defenses to repayment. For example, ED may also initiate a group process for closed school discharges. Being included in the group process will not prevent a borrower from pursuing discharge on an individual basis if the group claim is denied or limited. Further, ED may reopen a borrower defense application at any time to consider evidence that was not considered in making the original decision.

A discharge due to closed school, false certification, unpaid refund, or defense to repayment clears usage of any applicable interest subsidy; if that results in restored eligibility for an interest subsidy under the 150 percent subsidy usage rule, the borrower is no longer responsible for interest that accrues on past subsidized loans unless he or she loses it again based on usage.

ED may collect liability for a discharged loan amount from the school, with certain time limits that are broader than current rules, but still take into account record retention periods to a degree.

For claims that may form the basis for borrower defenses, the new rules ban pre-dispute arbitration or other measures to prevent students from bringing lawsuits or joining class action suits. Institutions may not require students to engage in the school’s internal complaint process, and may not use predispute arbitration agreements or class action lawsuit waivers.

Financial Responsibility

ED proposed new financial responsibility requirements “to identify, and take action regarding, material actions and events that are likely to have an adverse impact on the financial condition or operations of an institution” and to “develop more effective ways to identify events or conditions that signal impending financial problems and secure financial protection while the institution has resources sufficient to provide that protection….” Thus, ED framed the proposed rules to determine at the time a material action or event (a “trigger”) occurs that the institution is not financially responsible, rather than wait to see an institution’s annual audited financial statements.

The final rules revising financial responsibility regulations reflect changes from the proposed rule. The new rules still identify a number of circumstances that trigger a preemptive letter of credit or other financial guarantees or assurances, but some circumstances that would have been automatic triggers will be discretionary triggers instead. ED must demonstrate that a trigger listed under the discretionary category is reasonably likely to have a material adverse effect on the financial condition, business, or results of operations of the institution. Some of the proposed discretionary triggers were dropped in the final rule. ED clarifies in the preamble to the final rule that none of the triggers apply to public institutions; a public institution continues to be considered financially responsible by virtue of the full faith and credit of its state, as long as it does not violate any past performance provision.

The final rule specifies that a triggering event must have occurred on or after July 1, 2017, rather than permitting a look back after the final rules are published.

The proposed rule would have considered certain claims, losses, and lawsuits as triggering events if the resultant liability exceeded, or could exceed, more than the threshold amount for which an audit is required (currently $750,000) or 10 percent of the institution’s current assets. The final rule drops those caveats and instead considers these actions to be triggers if the actual or potential liabilities would lower the institution’s composite score under the financial responsibility regulations to below 1.0.

Included in this reassessment of financial responsibility based on the composite score are certain circumstances in which the school’s accrediting agency requires it to submit a teach-out plan. (Additionally, if a teach-out plan is submitted, the school will have certain disclosure requirements to its students, comparing the benefits of a borrower defense claim versus completion of the academic program under the teach-out plan.)

Disclosure and Warnings

The final rule requires institutions to make financial protection disclosures to students when triggering events occur, but modifies the proposed rule by subjecting this requirement to consumer testing to determine which triggers are most meaningful to students in their educational decision-making, and in what format. ED will announce in the Federal Register which events will require disclosures based on that consumer testing.

The additional warning regarding poor repayment rates required of proprietary schools has also been modified from the proposed rule. The proposed rule would have created a new rate calculation of repayment rate for this purpose. The final rule, instead, makes use of the existing gainful employment (GE) rate calculation. It also creates an exemption for schools that can show they have non-GE programs, which, if included in the repayment rate determination, would raise it above the value that requires warnings.

NASFAA will continue to analyze the final rules and post more detailed summaries in the coming days.


Publication Date: 11/1/2016

David S | 11/2/2016 11:31:31 AM

Thank you for an excellent summary, Joan. These regulations have generated a lot of controversy, in my opinion (I was on the Neg Reg committee that worked on them), a lot of it over-reacting. In my opinion, ED is looking for bad actors; they do not intend to use these regs as additional program review liabilities, and they recognize the difference between a school committing fraud and a dissatisfied student. Bottom line, schools must be ethical, compliant, honest, and only promise what you can deliver...which the majority of schools already are and do. ED needs more tools to prevent the next Corinthian before thousands more students are defrauded, which then hurts all T4 programs for everyone.

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