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Dept. of Education proposal allows use of pre-dispute arbitration agreements by schools receiving Title IV aid for student borrowers

The Department of Education has issued a proposal that would rescind the “Borrower Defense” final rule issued by the ED in November 2016 and replace it with the “Institutional Accountability regulations” contained in the proposal.  Among the major changes to the final rule that would be made by the proposal is the removal of the final rule’s ban on the use of pre-dispute arbitration agreements and class action waivers for borrower defense claims by schools receiving Title IV assistance under the Higher Education Act (HEA).  Comments on the proposal are due no later than 30 days after the date it is published in the Federal Register.

Although the final rule had an initial effective date of July 1, 2017, there has been a series of postponements of the effective date.  A final rule published by the ED in February 2018 established July 1, 2019 as the current effective date.  In the supplementary information accompanying the proposal, the ED indicates that the negotiated rulemaking committee it established to develop proposed revisions to the 2016 final rule did not reach a consensus on the proposal.

The proposal includes the following significant changes to the 2016 final rule:

  • The final rule created a new federal standard for a “borrower defense” asserted with respect to Direct Loans and Direct Consolidated Loans.  A Direct Loan is a federal student loan made by the ED under the Direct Loan Program and a Direct Consolidated Loan is a federal student loan made by the ED under the Direct Loan Program that repays multiple Direct Loans or other specified loans.  A “borrower defense” is an act or omission by a school relating to the making of a Direct Loan for enrollment or the provision of educational services for which the Direct Loan was provided.  It includes a defense to repayment of amounts owed on such loans and a right to recover amounts previously collected on such loans.  Before 2015, the ED interpreted the Higher Education Act (HEA) to only allow a borrower to raise a “borrower defense” as a defense to repayment in a collection action.  The final rule codified the ED’s new 2015 interpretation that also allowed a borrower to raise a borrower defense in an affirmative claim for loan relief.  In the proposal, the ED seeks comment on whether it should return to its pre-2015 interpretation and only allow “defensive” claims from defaulted borrowers who are in a collections proceeding or accept both “defensive” and “affirmative” claims, including claims from borrowers still in repayment.

  • Prior to the 2016 final rule, a borrower defense could only be asserted based on an act or omission of a school that would give rise to a cause of action against the school under applicable state law.  The final rule created a new federal standard under which a borrower defense could be a non-default, favorable contested judgment against a school, a school’s breach of contract, or a substantial misrepresentation made by a school on which the borrower reasonably relied to his or her detriment when deciding to attend or continue attending the school or deciding to take a Direct Loan.  The proposal would create a different federal standard for defenses to repayment based upon misrepresentations and would remove a breach of contract or a judgment as a basis for borrower defense relief. Instead, a judgment or breach could be considered evidence of a misrepresentation to the extent it bears on an  act or omission related to the educational services provided.  Under the proposed standard, a defense to payment could only be based on a statement, act, or omission by a school to a borrower upon which the borrower reasonably relies, that caused the borrower financial harm, and that is false, misleading, deceptive, and made with knowledge of its false, misleading, or deceptive nature or with reckless disregard for the truth and directly or clearly related to the making of a Direct Loan, or a loan repaid by a Direct Consolidation Loan, for enrollment at the school or to the provision of educational services for which the loan was made.

  • Under the 2016 final rule, a borrower defense claim based on a substantial misrepresentation could  be asserted at any time but to recover amounts previously collected on a Direct Loan, it had to be asserted not later than six years after the borrower discovered, or reasonably could have discovered, the information constituting the substantial misrepresentation.  The proposal would allow a borrower to assert a defense to payment at any time once the loan is in collections, including to recover amounts previously collected on a Direct Loan.  If the ED decides to continue to allow affirmative borrower defense claims, it proposes to only allow such claims to be filed within three-years after the end of the borrower’s enrollment at the institution alleged to have made the misrepresentation.

  • The 2016 final rule bans both mandatory and voluntary pre-dispute arbitration agreements, whether or not they contain opt-out clauses, and class action waivers for borrower defense claims by schools receiving Title IV assistance under the HEA.  In adopting the final rule, the ED rejected the argument that the Federal Arbitration Act (FAA) barred the ED from including a ban on class action waivers or mandatory pre-dispute arbitration agreements.  When the final rule was adopted, we expressed our strongly-held view that the ED’s position was incorrect and that the final rule’s arbitration provisions were preempted by the FAA.  In stark contrast, the proposal would allow schools to use pre-dispute arbitration agreements or class action waivers as a condition to enrollment.  Citing the U.S. Supreme Court’s May 2018 decision in Epic Systems, the ED states that it believes “the Supreme Court’s recent affirmation of the Federal policy in favor of arbitration may warrant a different approach to these regulations.”  The ED also references Congress’ disapproval of the CFPB’s arbitration rule pursuant to the Congressional Review Act and states that “[i]n light of Congress’ clear action, the Department believes a change in its position to align with the strong Federal policy in favor of arbitration is appropriate.”  The ED’s supplementary information describes the potential advantages of arbitration, including that it can be quicker than litigation and “allow borrowers to obtain greater relief than they would in a consumer class action case where attorneys often benefit most.”  The proposal would require schools using pre-dispute arbitration agreements or class action waivers to satisfy the following conditions:

    • The school must make available on its website where information about admissions and costs is presented (which cannot solely be an intranet website), a plain language disclosure that the agreement or waiver is a condition of enrollment.

    • As part of entrance counseling, a school must provide: a description of its dispute resolution process that the borrower has agreed to pursue as a condition of enrollment, including the name and contact information for the individual or office that the borrower can contact regarding a dispute; a written description of how and when the agreement or waiver applies, how the borrower enters into the arbitration process or, for class action waivers, alternative processes the borrower can pursue to seek redress; and who to contact with borrower questions.

The proposal also includes changes relating to an array of other subjects such as: the charging of collection costs to defaulted borrowers by guaranty agencies; the capitalization of interest on loans sold by guaranty agencies after the completion of loan rehabilitation: financial responsibility provisions that establish the conditions or events that have or may have an adverse material effect on a school’s financial condition and which warrant the school’s provision of a letter of credit or other financial protection to the ED; the circumstances under which borrowers can qualify for a closed school discharge; and actions by the ED against schools to collect loan amounts discharged based on successful borrower defense claims or to obtain reimbursement of discharge amounts repaid to borrowers by the ED based on such claims.

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Culhane, Ballard, Partner
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John L. Culhane, Jr., is known for his work advising on interstate direct and indirect consumer and residential mortgage loan and leasing programs, through both traditional brick-and-mortar facilities and e-commerce. Before joining Ballard Spahr, Mr. Culhane was associate counsel with Mellon Bank, N.A.; associate counsel with Bank of America NT&SA; and senior attorney (section chief) with the National Credit Union Administration, the federal agency regulating federal credit unions.

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