Proposed Rule From U.S. Department of Education Affects Changes of Ownership and Control, 90/10 Rule and Other Title IV Institutional Eligibility Matters

On July 28, 2022, the U.S. Department of Education (the Department) published in the Federal Register a Notice of Proposed Rulemaking (the Proposed Rule) to amend its regulations concerning changes in institutional ownership or control, revise its definition of “nonprofit institution” and other key terms related to institutional eligibility for federal student financial aid programs under Title IV of the Higher Education Act (Title IV), implement changes to the 90/10 rule for proprietary institutions’ Title IV eligibility, and establish regulations for Pell Grants to be awarded to incarcerated students. These and other Title IV eligibility matters were considered during negotiated rulemaking processes conducted by the Department in late 2021 and early 2022. Comments to the Proposed Rule must be submitted by August 26, 2022. Final regulations on the topics covered by the Proposed Rule must be published in the Federal Register on or before November 1, 2022, in order to take legal effect on July 1, 2023.

Changes in Institutional Ownership or Control

The Proposed Rule includes substantial amendments to the Department’s regulations concerning changes in institutional ownership or control. These regulations apply not only to proprietary institutions, but also to mergers, acquisitions and other control-related transactions for public and private nonprofit institutions. The Department’s proposals would, among other things:

• Clarify that “ownership” means any direct or indirect legal or beneficial interest in an institution or legal entity, which may include a voting interest or a right to share in the profits.
• Require 90-day prior notifications to the Department, and to enrolled and prospective students, of any change in ownership that would result in a change of control (as such terms are defined by the Department).
• Codify Department practice to require, as part of the “materially complete” application required to be submitted to the Department within 10 days following a change in ownership resulting in a change of control, not only documentation an institution’s most recently effective state authorization and accreditation, but also supplemental documentation that such state authorization and accreditation remained in effect as of the day before the change in ownership.
• Where the required financial statements are not available for the new owner or controlling party, codify Department practice to require financial protection (typically through an irrevocable letter of credit) as follows:
• At least 25% of the institution’s prior year Title IV volume if the institution’s new owner does not have two years of acceptable audited financial statements.
• At least 10% of the institution’s prior year volume of title IV aid if the institution’s new owner has only one year of acceptable audited financial statements.
• As deemed necessary in the Department’s discretion, financial protection in the amount of an additional 10% of the institution’s prior year Title IV volume, or such larger amount as determined by the Department.
• If any entity in the new ownership structure holds a 50% or greater direct or indirect voting or equity interest other institutions, the required financial protection may be based on a percentage of the prior year Title IV volume for all institutions under such common ownership.
• Clarify the process for extension of Title IV participation under a temporary provisional program participation agreement (TPPPA) following a change in ownership, and expressly permit the Department to include terms and conditions in the TPPPA that were not present in the institution’s previous Title IV program participation agreement.
• Clarify that the Department has the discretion to determine that an institution’s Title IV participation should not continue following a change of ownership and control.
• Distinguish between reportable changes in ownership on the one hand and changes of ownership that result in changes of control on the other hand, as well as between natural persons and legal entities.
• Require reporting when a natural person or entity acquires at least a 5% direct or indirect ownership interest of the institution but where that change in ownership interest does not result in a change of control as defined by the Department.
• Consider as a change in ownership and control the acquisition of an institution to become an additional location of another institution, excluding situations where the acquired institution closed or ceased to provide educational instruction.

Current regulations apply different standards and thresholds for identifying changes in ownership and control of based on whether an institution is public, nonprofit or private, and whether it is operated by a closely held corporation, public company, general partnership, sole proprietorship or “other entity.” While keeping these distinctions in place, the Proposed Rule would replace the current change in ownership and control standards for “other entities” with the following:

• A person, a combination of persons or a partner in a general partnership acquires or loses at least 50% of the total outstanding voting interests in the entity or partnership or otherwise acquires or loses 50% control;
• Any change of a general partner of a limited partnership or a managing member of a limited liability company if that person also holds an equity interest;
• A person becomes or is replaced as the sole member or shareholder of an entity that has a 100% or equivalent direct or indirect interest in the institution;
• An entity that has a member or members ceases to have any, or one that has no members becomes an entity with a member or members;
• The addition or removal of any entity that provides or will provide audited financial statements for the purposes of the Department assessing the institution’s financial responsibility;
• The transfer of 50% or more of the voting interests in the institution or an entity to an irrevocable trust, except where it meets the proposed definition of an excluded transaction; and
• Upon the death of an owner who previously transferred 50% or more of the voting interests in an institution or an entity to a revocable trust, except where it meets the proposed definition of an excluded transaction.

The Proposed Rule also preserves discretion for the Department to assess changes of control for “other entities” below the generally proposed 50% thresholds described above. Specifically, it provides that where a change in ownership results in a change of control, the Department retains authority to determine that there has been a change in control if a person holds less than a 50% interest in the institution but has actual control over the entity. Such control may be either alone or in combination with other individuals, such as through the establishment of voting agreements among multiple individuals, each with less than a 50% ownership interest. Control would also be identified where a person or combination of persons has the right to appoint a majority of any class of board members of an entity or institution.

Definitions of “Nonprofit Institution” and Other Key Terms

The Department proposes to materially revise its definition of “nonprofit institution” for purposes of institutional participation in Title IV programs. Although the Department explains that its changes are needed to “to ensure particularly that institutions converting from proprietary status meet the standards to qualify as a nonprofit,” the revised definition also would have potentially significant consequences for institutions that have always operated as a nonprofit entity and for mergers or acquisitions among existing nonprofit institutions. As written, the proposed definition could also impact public institutions. Specifically, the proposed definition would define a nonprofit institution as “a domestic public or private institution or foreign institution to which the Secretary determines that no part of the net earnings of the institution benefits any private entity or natural person.” In determining if an institution meets this definition, the Department would consider the relationship of the institution, the entities in its ownership structure and other parties, and generally not consider an institution to be nonprofit if it:

• Is an obligor (either directly or through any entity in its ownership chain) on a debt owed to a former owner of the institution or a natural person or entity related to or affiliated with the former owner of the institution;
• Either directly or through any entity in its ownership chain, enters into, or maintains, a revenue sharing agreement with:
• A former owner or current or former employee of the institution or member of its board; or
• A natural person or entity related to or affiliated with the former owner or current or former employee of the institution or member of its board, unless the Department determines that the payments and the terms under the revenue-sharing agreement are reasonable, based on the market price and terms for such services or materials, and the price bears a reasonable relationship to the cost of the services or materials provided;
• Is a party (either directly or indirectly) to any other agreements (including lease agreements) with:
• A former owner or current or former employee of the institution or member of its board; or
• A natural person or entity related to or affiliated with the former owner or current or former employee of the institution or member of its board under which the institution is obligated to make any payments, unless the Department determines that the payments and terms under the agreement are comparable to payments in an arm’s length transaction at fair market value; or
• Engages in an excess benefit transaction with any natural person or entity.

The Proposed Rule also clarifies the “location” from which the Department considers a distance education program to be offered. Reflecting an existing Department policy that has not always been consistently applied by either the Department or institutions, the Proposed Rule would codify that, for institutions offering both on-campus instruction and distance education, the distance education programs are associated with the main campus where one or more approved educational programs are offered. For institutions offering only distance education, the Department would consider the location of the institution as where its administrative offices are located and approved by its accrediting agency.

The Proposed Rule also includes mostly technical amendments to the Department’s definitions of “main campus,” “branch campus” and “additional location,” as well as the definitions of “closely-held corporation,” “ownership or ownership interest,” “parent,” “person” and “other entities” in the context of changes in ownership that result in a change in control.

90/10 Rule for Proprietary Institutions

Under the Higher Education Act, proprietary institutions historically cannot derive more than 90% of any fiscal year’s revenue from Title IV programs. This requirement was changed by the American Rescue Plan Act of 2021, such that for fiscal years starting on or after January 1, 2023, proprietary institutions cannot derive more than 90% of their annual revenue from Federal programs more generally. The Proposed Rule reflects a consensus reached by the negotiated rulemaking committee on that revised methodology, as well as certain other changes to the 90/10 regulations. In summary form, the most material changes are as follows:

• Federal funds applied to the 90/10 calculation are generally those provided by a Federal agency directly to an institution or a student including the Federal portion of any grant funds provided by or administered by a non-Federal agency, for the purposes of tuition, fees and other institutional charges. The Department intends to publish periodic notices in the Federal Register that will enumerate pertinent Federal funding sources.
• To be considered “non-Federal” under the calculation, grant funds from non-Federal agencies cannot comprise any pass-through Federal funds. Any such Federal portion of a non-Federal agency’s grant must be counted as “Federal funds” for 90/10 purposes, and if the Federal portion of such grant funds cannot be determined, then no portion of the grant funds may be included as “non-Federal” funds.
• Institutions on the advanced payment or heightened cash monitoring (level 1) method of Title IV processing must, before the end of its fiscal year, request pertinent Title IV funds from the Department for eligible students and further disburse those funds to students before the fiscal year end.
• Institutions on the reimbursement or heightened cash monitoring (level 2) form of Title IV funds processing must advance to students their eligible Title IV award by the end of the fiscal year and count such advances as Federal funds in the 90/10 calculation before requesting funds from the Department.
• Revenues from an institution’s non-Title IV eligible programs may be included only if they provide an industry-recognized credential or certification, or provide training for state licensing requirements, and if they: (1) do not include any courses offered in an eligible program at the institution; (2) are taught by one of its instructors of an eligible program; and (3) are located at its main campus, one of its approved additional locations, a location approved by the state agency or accrediting agency or at an employer facility.
• Disallowed from the 90/10 calculation is any revenue that:
• Is generated from a non-Title IV eligible program where the institution merely provides facilities or test preparation courses, acts as a proctor, or oversees a course of self-study; or
• Although generated at a site under the institution’s control and broadly related to activities performed by students at that site in order to complete their program, is revenue unrelated to services performed directly by students.

Consistent with the Department’s past sub-regulatory guidance, the Proposed Rule would clarify that any “private sources” for students’ payments of institutional charges, for purposes of the 90/10 calculation, must be unrelated to the institution, its owners or affiliates. Additionally, the Proposed Rule would codify certain 90/10 accounting practices regarding institutional loans and establish specific parameters for the inclusion of principal payments on Income Share Agreements and other alternative student financing agreements.

Pell Grants for Prison Education Programs

The Consolidated Appropriations Act of 2021 established Pell Grant eligibility for confined or incarcerated individuals, as long as they are enrolled in a Prison Education Program (PEP) as such term is defined under the Higher Education Act. The Proposed Rule sets forth, among other provisions, the regulatory criteria for an eligible PEP, the particular accreditation and state authorization requirements for an institution to offer an eligible PEP, and the application and reporting requirements for institutions that wish to award Pell Grants to confined or incarcerated individuals that enroll in an eligible PEP.

Please do not hesitate to contact Jonathan Tarnow, John Przypyszny, Cindy Irani or Sarah Pheasant if you have any questions regarding the Proposed Rule, this alert or other educational regulatory matters.