NAICU Washington Update

Regulatory Efforts Underway to Expand Coverage for Borrower Defenses

January 26, 2016

The Department of Education recently held the first of three sessions of negotiated rule-making (January 12 through 14, 2016) focusing on the borrower defense to repayment (DTR) of student loans.

The issue has arisen as a result of the closing or selling of for-profit Corinthian Colleges Inc.’s various campuses which left many students with accumulating debt, but often without an ability to repay the loan or an appropriate way to complete their education. Although some cases have been settled, the Department wants to establish a process for dealing with future cases.

Background on Borrower Defense

Because some of the Corinthian campuses were sold, not closed, many borrowers may not use the more straight-forward closed school defense to loan repayment and must depend on the fact that they were misled by Corinthian as their defense. So far, about 7,000 borrowers have applied for forgiveness under the defense that they have been defrauded. Based on its own investigation, readily available information, and a review of 1,670 cases, the Department has agreed to forgive the debt of 1,312 former Corinthian students at Heald College campuses in California to the tune of $27.8 million. (The IRS has agreed that these students will not need to include the discharged amounts in their taxable income.)

As of November 2015, under the more straight-forward closed school defense, the Department agreed to discharge about 6000 additional borrowers who attended campuses that had closed, providing $75.5 million in relief. The cost to settle the new cases, currently being adjudicated by a “Special Master,” and the significant number of potential cases from any new regulations, is projected to be very costly. (Corinthian enrolled more than 100,000 students.)

A group of Democratic members of the Senate has also raised concern about this issue and were instrumental in obtaining the tax waiver.

First Round of Negotiations

There have only been a handful of DTR cases since the defense was established in law in 1994. Given the Department’s lack of experience with this issue, and anticipating additional cases, it is in the process of considering whether to “establish a new standard for the purpose of determining whether a borrower can establish a defense to repayment … based on an act or omission of a school.” Such a change would require developing a comprehensive system for doing so which raises questions about the appropriate legal authority for consumer resolution (federal/state), borrower eligibility, timing of claims, and the processes involved in such a regulation.

Of particular concern to the Department and the negotiators are the issues of the role of state law, currently the standard by which a borrower’s “cause of action” can be taken against a school. Because different states have different standards, borrowers who were victimized could be treated differently when seeking relief. The negotiations are also exploring if the potential risk of DTR cases should be incorporated into the assessment of a school’s financial responsibility.

The consumer advocates on the panel, particularly the attorneys general representatives, have strongly advocated that there should be some federal floor to provide equity to borrowers filing defense claims in different states. However, they also argue that the various state standards should remain to provide additional protection to borrowers in states with higher standards. The panel also proposed that the Department should give judgments by state attorneys general “heightened deference.”

In addition, the members of the panel suggested the risk of additional financial suits by borrowers should be taken into account in determining an institution’s financial responsibility status and that perhaps the institution be required to buy a letter of credit to cover such related costs.

According to the consumer advocates, the list of institutions required to purchase letters of credit also should be disclosed to the public. They went on to ask the Department for a list of all schools that currently have had to purchase letters of credit. The negotiator representing private, nonprofit colleges raised concern about the Department’s current accounting shortcomings in the calculation of financial responsibility composite scores, and questioned how new financial risks would be included.

The first neg-reg session reviewed and brain-stormed the set of issues presented by the Department. Language developed from these discussions will be provided at the next neg-reg session, February 17-19. (The negotiations will also include a set of technical amendments to existing regulations.) Issue papers are not yet available at the neg-reg website, although background and schedule information are available. The Department has also issued a fact sheet about the issue.

The Special Master, Joseph A. Smith, Jr., has issued his first and second reports explaining in detail the history of borrower defenses and what actions have been taken so far regarding the current situation.

A brief overview of the current status is also available.

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