Institutions of higher education that participate in federal student aid programs (“FSA”) are required to meet financial responsibility standards established by the United States Department of Education (“ED”). Recently released ED regulations known as the Borrower Defense Regulations that are effective July 1, 2017, have added a new layer of complexity and uncertainty to the determination of the financial responsibility of higher education institutions. In simple terms, an institution’s financial responsibility is calculated by combining three financial ratios into a financial composite score. If an institution’s financial composite score meets ED’s standards then it is generally permitted to participate in ED’s FSA programs without extra restrictions. However, if the institution’s financial composite score does not meet ED’s standards,among other restrictions, it may be placed on provisional approval and subjected to heightened cash monitoring and the posting of a letter of credit. Composite scores are calculated annually by ED based upon the institution’s prior year financial statements. The posting of a letter of credit can be extremely expensive for institutions and institutions with low composite scores may naturally find letters of credit difficult to obtain due to their heightened credit risk.
Under ED’s new Borrower Defense Regulations an institution will be required to recalculate its composite score if it is (i) required to pay any debt or incur any liability arising from a final judgment in a judicial proceeding or from an administrative proceeding or determination, or from a settlement; (ii) the institution is sued in an action on or after July 1, 2017, by a federal or state authority for financial relief on claims related to making a student loan or the provision of education services and the suit has been pending for 120 days. Institutions will also be required to recalculate composite scores due to actions brought by private parties if the institution is being sued in an action brought on or after July 1, 2017 and (i) the institution has filed a motion for summary judgment or summary disposition and that motion has been denied or the court has issued an order reserving judgment on the motion; (ii) the institution has not filed a motion for summary judgment or summary disposition by the deadline set for such motions by the court or agreement of the parties; or (iii) if the court did not set a deadline for filing a motion for summary judgment and the institution did not file such a motion, the court has set a pretrial conference date or trial date and the case is pending on the earlier of those two dates.
Unless the institution can demonstrate to ED’s satisfaction that the litigation has had or will have no effect on the assets and the liabilities of the institution, ED will recognize and account for the actual or potential losses associated with the pending litigation and based upon that accounting will recalculate the institution’s most recent composite score. If the recalculation causes the institution to fail ED’s financial responsibility requirements then it will be subject to the consequences mentioned above.
For lawsuits brought by governmental agencies the amount of loss will be calculated as follows: (A) the amount of the debt; (B) for a lawsuit, the amount set by a court ruling, or if the lawsuit is still pending the amount or relief claimed in the complaint, or if the complaint demands no specific amount of relief the amount stated in any final written demand issued by the governmental agency bringing the action or a lesser amount that the agency offers to accept. However, if the governmental agency has not made a specific demand for damages, the damages will be assumed to be the tuition and fees received by the institution during the period, and for the program or location, described in the allegations in the complaint.
For other litigation the amount of loss will be calculated as follows: (a) the amount of relief claimed in the complaint; (b) if the complaint demands no specific amount of relief, the amount stated in any final written demand by the claimant to the institution prior to the suit or a lesser amount that the plaintiff offers to accept in settlement of any financial demand in the suit; or (c) if the complainant stated no specific demand in the complaint, in a pre-filing demand, or in a written offer of settlement, the amount of the claim as stated in a response to a discovery request, including an expert witness report.
ED’s new rules require that institutions notify ED of lawsuits brought by governmental agencies upon receiving a complaint and again 10 days after the suit has been pending for 120 days. For private lawsuits institutions must notify ED within 10 days after the institution is served with the complaint and 10 days after the occurrence of certain procedural events.
It is advisable that institutions of higher education utilize legal counsel familiar with the new Borrower Defense Regulations when they face potential litigation. Institutions who are faced with aggressive plaintiffs who make high settlement demands may find themselves subjected to ED’s financial responsibility penalties. As a result, it is important that defense counsel attempt to obtain reasonable settlement demands from plaintiff’s counsel early in any litigation. This step will become even more important when the plaintiff is a governmental agency, since if no settlement demand has been made, the damages will be assumed to be the tuition and fees received during the period, which could likely result in even the most financially responsible institutions failing ED’s financial responsibility composite score.
Further, in light of ED’s new Borrower Defense Regulations, leaders of higher education institutions should be mindful of litigation risk and take additional steps to mitigate such risk. Finally, prudent financial institutions and counter parties will begin performing additional diligence on an institutions litigation risk and should likewise retain counsel who is familiar with the operation and regulation of institutions of higher education.
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