Revised ED Regulations on Borrower Defense, Other Student Loan Matters Take Effect July 1

Note: On August 7, 2023, the U.S. Court of Appeals for the Fifth Circuit issued a nationwide injunction in Career Colleges and Schools of Texas v. Cardona, which delays the effective date of the latest Borrower Defense to Repayment (BDR) regulations, as described by the alert below, until at least November 2023. Until the latest BDR regulations are reinstated, we understand the Department continues to process BDR claims under its previously effective regulations, and, where applicable, consistent with the settlement agreement in Sweet v. Cardona. Specifically, we understand that during the pendency of the injunction, BDR claims for federal student loans disbursed on or after July 1, 2020, are subject to the Department’s  2019 Final Rule, any federal student loans disbursed between July 1, 2017, and June 30, 2020, are subject to the BDR provisions of the Department’s 2016 Final Rule, and any federal student loans disbursed before July 1, 2017, are subject to the Department’s 1994 BDR regulations.

On November 1, 2022, the U.S. Department of Education (the Department) published in the Federal Register a final rule (the Final Rule) revising its regulations that govern multiple student loan discharge standards and processes, including but not limited to its borrower defense to repayment (BDR) regulations. Although the Final Rule is, as of this writing, subject to legal challenge under the Administrative Procedure Act, postsecondary institutions should prepare for the anticipated effective date, which is July 1, 2023.

The final rule covers topics that were addressed in the Department’s “Affordability and Student Loans” negotiated rulemaking committee, conducted in late 2021. On the select matters where that negotiated rulemaking committee reached consensus on a specific issue, the Final Rule reflects the language approved by the committee, with only minor modifications reflecting public comment in the interim.

The regulations set forth in the Final Rule apply to all higher education institutions that participate in the federal student financial aid programs under Title IV of the Higher Education Act, whether public, private nonprofit, or proprietary. This alert summarizes the Final Rule’s key provisions, with particular attention to changes from the proposed rule the Department published in July 2022, and for which our summary can be found online.

Borrower Defense to Repayment

Under the Department’s BDR framework, a federal student loan borrower may seek relief from loan repayment obligations based on certain acts or omissions of the postsecondary institution attended by the borrower and for which the borrower incurred that loan. These regulations, originally promulgated in 1994, were previously revised in both 2016 and 2019.

Standards for BDR Claims and Discharge Relief. The Final Rule again revises the standards for BDR claims and establishes five types of institutional conduct that may form the basis of a BDR claim. Specifically, a borrower’s claim could be based upon: 

• A substantial misrepresentation;
• A substantial omission of fact;
• Breach of contract for educational services;
• Aggressive or deceptive recruitment; or
• Federal or State judgment, or adverse Departmental action, against an institution, which inherently gives rise to a BDR claim.

While certain of these events may form the basis of a claim under existing BDR regulations, the Final Rule expands the definition of misrepresentation and provides an additional basis for BDR claims based on “aggressive or deceptive recruitment practices.” The Department broadly defines “aggressive or deceptive recruitment” to include:

• Pressuring a prospective student to make enrollment decisions “immediately;”
• Falsely claiming that failure to enroll “immediately” would adversely affect the student’s opportunity to attend the institution;
• Taking advantage of non-knowledgeable prospective students in order to pressure them into attendance or borrowing;
• Discouraging a student or prospective student from consulting outside advisors, including family or friends, prior to making enrollment decisions;
• Failing to respond to a prospective student’s request for more information, including information regarding program cost;
• Using threatening or abusive language toward the student or prospective student;
• Repeatedly soliciting a student for enrollment or re-enrollment after they have requested no further contact; or
• Obtaining the student’s information through websites that present themselves, the institution, or related employment opportunities in a false light.

The Final Rule emphasizes that this list is merely illustrative and does not enumerate all institutional conduct which may be deemed to constitute “aggressive or deceptive recruitment tactics or conduct” that would support a BDR claim and potential subsequent liability by an institution. The Final Rule does include limitations on the types of judgments or adverse actions which may form the basis of a claim: specifically, only actions culminating in fines, limitations, suspensions or termination proceedings (under 34 CFR Subpart G) are pertinent adverse Departmental actions under the rule, and a favorable Federal or State judgment may only be ground a BDR claim if the judgment itself relates to facts that would also support a BDR claim.

In an important departure from the proposed rule, the Final Rule requires that the borrower must suffer a detriment due to the institution’s conduct. Under the proposed rule, the Department would not have required even a facial showing of harm to ground a BDR claim. Although there must be a showing of borrower detriment, the Final Rule provides that all approved BDR claims, adjudicated under a “preponderance of the evidence” standard, will receive a full loan discharge. Such discharge may then support a Department recoupment from the institution, as described in more detail below.

Group Claims. The Final Rule provides that the Department may initiate a group claim based on its observation of common facts, or a group claim may be originated and referred to the Department by a newly defined “Third-Party Requestor,” which may be an attorney general, state educational regulator, state consumer protection agency or legal assistance organization. The addition of private legal assistance organizations as a permissible requesting party for group claims is a departure from the proposed rule, as is the removal of an institution’s losing Title IV eligibility due to a high cohort default rate as a presumptive basis for forming a group claim. The Final Rule continues to provide that the Department will consider its own prior actions, including final program review and audit determinations, or prior shortcomings relating to administrative capacity, when forming or adjudicating group claims.

Application of Prior BDR Frameworks and Limitations Periods. Under current regulations, the Department’s adjudication of a BDR claim is subject to one of three regulatory standards for relief, depending on the regulatory framework that was in effect at the time the federal student loan was made. Under the revised regulations, the Department will adjudicate all claims pending at the Department as of July 1, 2023, or filed thereafter, and whether to process claims on an individual or group basis, under the above standards. The Final Rule limits the Department’s BDR recoupment actions against institutions, however, to discharged amounts that would have been approved for discharge under the pertinent BDR claim standards in effect at the time the loan was first disbursed. The Final Rule also maintains a six-year limitation period for institutional liability in general, running from the student’s graduation or last attendance date, unless the institution receives actual or constructive notice of the claim through a class action lawsuit, state or federal investigation or enforcement action relating to facts that would support a BDR claim, or from the Department itself. 

Limited Application of State Law. Unlike the proposed rule, which permitted borrowers to ground a BDR claim in state law if they did not initially receive a full discharge of their loan(s), regardless of time period, the Final Rule only allows violations of state law to be considered in connection with a BDR claim if (1) the borrower’s initial application was denied, and (2) the subject loans were disbursed prior to July 1, 2017.

Institutional Responses. The Final Rule, like the proposed rule, allows for an institutional response during the Department’s adjudication of the borrower’s claim (whether an individual or group claim), but does not provide for direct rebuttal or appeal of the Department’s eventual decision on that claim. The Final Rule also adds a new opportunity for institutional input when a group claim has been requested by a third party (which, as noted above, now includes legal assistance organizations as well as state enforcement authorities). Institutions will now have 90 days to respond to the third party’s request to form a group claim, and the Department will weigh the institution’s response when determining whether to move forward on a group basis.

Class Action Waivers and Mandatory Arbitration Agreements

Currently, institutions wishing to include a class action waiver or mandatory arbitration clause in an enrollment agreement may do so, if the institution also discloses this information to students (other than in the agreement itself) and proactively notifies borrowers. As with the proposed rule, the Final Rule prohibits class action waivers and mandatory pre-dispute arbitration agreements. In addition, the Final Rule prohibits institutions from requiring students to exhaust any internal dispute resolution process before filing a complaint directly with the institution’s accreditor or other applicable regulatory or enforcement agency. For BDR claims against an institution which are ultimately subject to arbitration or to judicial process, the Final Rule requires that institutions provide those judicial or arbitral records to the Department, which will create a publicly searchable database containing all such records. 

Closed School Discharges

The Department has made several changes to its closed school discharge regulations, which under the Final Rule are available for eligible borrowers who do not accept, or who accept but do not complete, an approved teach-out.

The revised regulations provide the Department with greater discretion to determine the applicable lookback period under which a closed school discharge is available to federal student loan borrowers. (That period remains 180 days prior to closure.) For purposes of such discharges, an institution’s “closure date” is not necessarily the final date of operations, but rather may be the earlier of:

• The date on which the institution concludes educational instruction in “most” programs, or
• The date on which the institution concludes such instruction for “most” students, both as determined by the Department.

In response to comments on the proposed rule, however, the Department clarified in the Final Rule that it will only make such determinations about an institution’s earlier closure date after the institution has in fact ceased operations and will not preemptively determine that a “closure” has occurred while an institution continues to offer educational instruction.

The Department may also extend the general 180-day lookback period for closed school discharge eligibility if it determines that there are “exceptional circumstances” warranting broader relief to borrowers. Such circumstances include the discontinuation of a “significant share” of the institution’s academic programs, or issuance of a show-cause or probationary status by the institution’s accreditor, or revocation of accreditation, or the closure of most physical locations while maintaining online programs, or the Department placing the school on a heightened cash monitoring status, among other circumstances.

The Final Rule also make a significant change to the Department’s provisions for automatic closed school discharges without a borrower application. Specifically, automatic closed school discharges will occur one (1) year after the school closure date for borrowers who do not take a teach-out or a continuation of their program. For borrowers who accept a teach-out or a continuation of the program at another branch or location of the school but do not complete the program, the automatic discharge would occur one (1) year after their final date of enrollment in the teach-out or at the other branch or location of the school. 

False Certification Discharges

The Final Rule reflects the consensus reached by the negotiated rulemaking committee on this topic. It expands the availability of loan discharges based on an institution’s false certification of student eligibility and creates a group process for false certification discharges. Currently, a borrower who previously attested (to his or her institution) to having a high school diploma or its equivalent is precluded from pursuing false certification discharge. The Final Rule amends that policy and allows borrowers to report not actually having a high school diploma (or its equivalent), along with their institution’s falsification of their graduation status (or referral to a third party to obtain a false diploma). Borrowers whose falsely certified loans are placed into forbearance must apply for discharge within 60 days, with additional time permitted for emendation if the initial application is incomplete, or the borrower obtains additional evidence. 

The Final Rule also creates a new group process for false certification discharges. State and third-party requestors may initiate such group claims, upon their identification of falsely certified borrowers sharing substantial common facts. These regulations also permit the Department to discharge falsely certified loans without any application by an individual borrower, if it is in possession of evidence showing that the borrower is entitled to a full discharge on those grounds. Further, if an institution has falsified a student’s satisfactory academic progress (SAP) to support continued Title IV disbursements during the borrower’s period of enrollment, then the Department may discharge as “falsely certified” any loans covering the period during which that borrower’s SAP was falsified. 

Total and Permanent Disability Discharges

The Final Rule also amends longstanding regulations for federal student loan discharges based on a borrower’s total and permanent disability (TPD). The revised regulations on this topic reflect the consensus language from the negotiated rulemaking proceedings, which expanded the medical professionals who may certify discharge applications. Those professionals now include nurse practitioners, physician assistants and licensed psychologists in independent practice. The Final Rule also broadens the categories of disability status which could allow for TPD discharge as a threshold matter, including compassionate allowances for certain illnesses and for disabilities lasting over five years. In a change from the proposed rule, the Final Rule broadens the available basis of relief by no longer requiring that, for disabilities in which a “Medical Improvement Possible” assessment has been made, that status must have been renewed at least once on a three-year basis. In addition, if the Department is able to independently determine that TPD discharge is appropriate, based on information from the Department of Veterans’ Affairs or the Social Security Administration, the Final Rule allows the Department to discharge the pertinent loans proactively. The Final Rule also relaxes the post-discharge income monitoring requirements that previously applied to TPD discharge recipients, unless a given borrower obtains a new student loan within three years from discharge, in which case that borrower’s debt will be reinstated.

Public Service Loan Forgiveness

The Department has also made several changes to the Public Service Loan Forgiveness (PSLF) program in this Final Rule. The revised regulations lower to 30 the minimum number of average “full time” weekly hours that must be worked by a borrower, at a qualifying employer, for PSLF discharge after 120 qualifying payments. The Final Rule also notes that this revised definition of “full time” work for PSLF qualification may be implemented prior to the July 1, 2023, effective date, if the qualifying employer so chooses. (Under the current rule, full time employment is defined as the higher of 30 hours or the employer’s definition of full time.)

Importantly, the Final Rule also addresses a concern about PSLF availability that was discussed at length in the negotiated rulemaking sessions but was not included in the proposed rule. Specifically, under state law in California and Texas in particular, many physicians were ineligible for PSLF due to a state-mandated hiring structure in which they must be employed by private entities, even when working full time for public and non-profit hospital systems as contractors through that private entity. The Final Rule therefore maintains PSLF eligibility for borrowers who work as contractors for a qualifying employer if applicable state law prohibits that qualifying employer from hiring directly into that role.

Like the proposed rule, the Final Rule expands the definition of qualifying payments, such that late, partial and lump sum payments may be included. It also permits certain deferment or forbearance periods to count toward PSLF, including deferments for military service, Peace Corps service, cancer treatment, economic hardship, or forbearance due to AmeriCorps or National Guard duties, or other administrative forbearances not requested by the borrower. The Final Rule also creates a mechanism under which PSLF can be automatic, requiring no application by an individual borrower, in circumstances where adequate documentation of qualifying service and payment is already available to the Department. Lastly, the Final Rule creates a process for reconsidering PSLF applications which are denied, including for borrowers who were denied PSLF between October 1, 2017, and the July 1, 2023, effective date.

Interest Capitalization

The Department is statutorily permitted, and in certain cases required, to capitalize the interest on an existing federal student loan under certain circumstances, thereby adding capitalized interest to the borrower’s principal balance and utilizing that revised higher balance as a basis for future interest accrual and payment calculations. Consistent with the consensus reached during negotiated rulemaking, the Final Rule narrows the permissible instances of interest capitalization to those explicitly required — not merely permitted — by the underlying statute. Specifically, the Final Rule prevents the Department from capitalizing interest upon the occurrence of any of the following events: entry into repayment, including alternative repayment; expiration of a forbearance period; default; when the borrower is no longer in experiencing a “partial financial hardship” under the Pay As You Earn program; nor, finally, upon negative amortization or failure to recertify income for borrowers paying under the Department’s income-based repayment plans. Two of these conditions were added as prohibitions under the Final Rule based on public comment.

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