Update on Proposed Amendments to the Borrower Defense to Repayment Rule

shutterstock_79098160Introduction

The U.S. Department of Education (“USDE”) is continuing to move forward with issuing new regulations regarding the “Borrower Defense to Repayment Rule” (“BDRR”). The BDRR concerns the ability of a Direct Loan borrower to seek relief from his or her Direct Loan repayment obligations if the educational services provided by a college were in some way deficient. In the absence of the BDRR, the borrower’s obligation to repay a Direct Loan would arguably be entirely separate and independent of any grievances the borrower might have against the college. The BDRR links these two issues. However, the language of the BDRR is so vague that there currently are more questions than answers about how the regulation is meant to work in actual practice, and what relevance the regulation might have to borrowers, colleges, the loan servicing industry, and others.

The new BDRR regulations are intended to clarify, and will likely expand, the ability of Direct Loan borrowers to successfully seek BDR relief. The USDE has indicated that it plans to promulgate final regulations by November 2016. Two documents issued by the USDE over the past several months provide some insight into the USDE’s intent with respect to these amendments to the BDRR. The first is a report (the “Report”) issued by USDE Under-Secretary Joseph Smith on September 3, 2015. The second is a notice of intent to establish a negotiated rulemaking committee, which was issued by the USDE on October 20, 2015 (the “October Notice”). These items are discussed below.

Background

The BDRR in its current form is contained in regulations associated with the Higher Education Act. See 34 C.F.R. § 685.206(c). The BDRR provides that, in any proceeding to collect on a Direct Loan, a borrower may assert as a defense against repayment any act or omission of the school attended by the student that would give rise to a cause of action against the school under applicable state law. Interpretive guidance released by the USDE indicates the USDE would acknowledge a borrower’s state law cause of action as a defense to repayment only if the cause of action directly relates to the loan or to the school’s provision of educational services for which the loan was provided.

If a borrower successfully pleads such a defense, the USDE Secretary can provide further relief as deemed appropriate, including reimbursing the borrower for loan amounts already paid and determining that the borrower is not in default on the loan. The regulations authorize the USDE Secretary to initiate “an appropriate proceeding” against the applicable school to reimburse the USDE for the unpaid balance of the loan.

The BDRR contains a number of ambiguities. First, who decides whether the student’s grievance against the school is valid? The USDE? A court? Second, what specific types of claims against a school would be relevant for purposes of discharging a Direct Loan obligation? Third, does a borrower need to default and then wait to raise these issues in the context of a collection action, or can a borrower somehow seek a loan discharge affirmatively even if the borrower has not defaulted on the loan? Fourth, what specific standards and procedures apply when the USDE seeks reimbursement from a college, and what impact, if any, do such proceedings have on the servicers of these loans?

The BDRR has been little-used for most of its existence. Through early 2015, the USDE had received only five BDR Rule claims. The USDE’s current push to revise this regulation is in large part based on the recent collapse of Corinthian Colleges. All U.S. operations of Corinthian ceased in April 2015, followed by a bankruptcy filing in May 2015, which impacted thousands of Corinthian students and led to the USDE’s receipt of an unprecedented number of claims from aggrieved borrowers. Although eligibility to seek Direct Loan relief in the case of a closed school is typically limited to a 120-day window following the closing date, in June 2015, the USDE expanded eligibility for Corinthian students to apply for such relief by extending the eligibility window back to June 20, 2014, with the result being that approximately 15,000 students are now potentially eligible for such relief.

Recent Developments

The First Report states that, in the view of the USDE, some colleges have made “false and misleading statements to students or prospective students about the value of certain career college programs or the financing needed to pay for a program,” which has had “serious adverse effects for both students and taxpayers.” Under-Secretary Smith has stated that his “paramount goal” “is to develop a system for providing debt relief to borrowers that is fair, transparent, and efficient.” He also has stated that student borrowers should be able to pursue a BDRR defense “with as little burden as is possible, consistent with the development of facts sufficient to support the defense.” He has called for the establishment of an infrastructure that is “flexible and scalable” and that would allow the USDE to handle claims “in a way that is fair to students, effective, and efficient.”

On June 8, 2015, the USDE announced that it would, where appropriate, use existing evidence to ease the burden of borrowers in establishing eligibility for BDRR relief, stating that “[w]herever possible, the [USDE] will rely on evidence established by appropriate authorities in considering whether whole groups of students . . . are eligible for borrower defense relief.” In the First Report, Under Secretary Smith cited the need for “a set of rules for deciding cases in a consistent way,” “clear rules of decision about what evidence of wrongdoing is sufficient to provide relief for borrowers,” and “protocols for when similar claims can be treated together and alike.” Consistent with the June 8 announcement, he stated the rules of decision will be based not only a review of the factual allegations made by borrowers but also potentially on “[f]actual information established by state attorneys general, proceedings in state courts, and other federal enforcement agencies.”

The October Notice outlined the following tentative list of regulatory issues to be addressed by negotiating committees: (1) the procedures to be used for a borrower to establish BDR defense; (2) the criteria used to identify acts or omissions that constitute defenses to repayment; (3) the standards and procedures that will be used to determine the liability of the institutions; (4) the effect of borrower defenses on institutional capability assessments (which could directly affect eligibility to participate in the Title IV programs) and (5) other loan discharges.

While representatives of groups such as state attorneys general and consumer advocates have generally supported an expansive rule and broad relief, some industry representatives have advocated for a cautionary approach. In a hearing held by the USDE, Karen McCarthy, Senior Policy Analyst of the National Association of Student Financial Aid Administrators, stated that any approval of across-the-board loan discharges should only take place after clear evidence of “systemic fraudulent practices” has been established, and that loan discharge should be reserved for violations involving fraud or substantial misrepresentation which induced students to enroll in a program that provided little or no benefit. Ms. McCarthy also asserted that school closure or denial of student access to Title IV funds “is a step that should be imposed very carefully” and “not as the automatic result of an isolated claim against the school that does not indicate systemic fraud.”

Conclusion

As noted above, the USDE has concluded that career colleges are at fault for making “false and misleading statements to students or prospective students.” This finding is a red flag because it calls into question whether the USDE can be an objective arbiter of grievances between students and colleges. Furthermore, the USDE, as a federal agency, arguably is not the proper institution for deciding issues of state law. During the forthcoming rulemaking process, it may be in the best interest of the education and loan servicing industries to argue for a system that would look to a court of law, rather than a federal agency, to determine the validity and relevance of a borrower’s grievance against a college.

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Brent Ylvisaker

Brent Ylvisaker

As an associate in Dorsey’s Finance & Restructuring Group, the types of areas in which he works include: banking regulations (e.g., affiliate transaction rules), consumer financial protection laws, Bank Secrecy Act and anti-money laundering regulations, financial data privacy and protection, state financial laws (including lending license requirements and usury laws) and e-commerce (e.g., E-SIGN and virtual currency).

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