In less than a year, pre-dispute arbitration agreements will be clearly permissible again now that the Department of Education has finalized its proposal to rescind the Obama administration’s “Borrower Defense” rule issued in November 2016 and replace it with “Institutional Accountability Regulations.” The final regulations are effective July 1, 2020 and apply to loans disbursed on or after that date.
Loans disbursed before July 1, 2020 are subject to the borrower defense provisions in either the pre-November 2016 regulations, which did not prohibit arbitration or class action waivers, or the Borrower Defense rule, which purported to prohibit arbitration and class action waivers, in our view, in violation of the Federal Arbitration Act. Because the Borrower Defense rule took effect in October 2018 after the D.C. federal district court refused to grant the renewed motion for a preliminary injunction filed by the California Association of Private Postsecondary Schools that sought to preliminarily enjoin the arbitration ban and class action waiver provisions in the Borrower Defense rule, the new final regulations, as a technical matter, amend but do not rescind the Borrower Defense rule.
The final Institutional Accountability Regulations include the following significant changes to the Borrower Defense rule:
- A school receiving Title IV assistance under the Higher Education Act can require federal student loan borrowers to sign pre-dispute arbitration agreements or class action waivers as a condition of enrollment if it makes a “plain language disclosure” available to prospective and enrolled students and the public. The ED did not provide a model notice for this disclosure.
- A new federal standard for a “borrower defense” asserted with respect to Direct Loans and loans repaid by Direct Consolidated Loans is created. (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 defense to payment (which can also support a request to recover payments previously made) must be based on a misrepresentation of material fact on which the borrower reasonably relied in deciding to obtain a Direct Loan, or a loan repaid by a Direct Consolidation Loan.
- The misrepresentation must directly and clearly relate to (a) (i) enrollment or continuing enrollment at the school or (ii) the provision of educational services for which the loan was made.
- The borrower must have been financially harmed by the misrepresentation.
- A “misrepresentation” is defined as a statement, act, or omission by a school to a borrower that is false, misleading, or deceptive, and made with knowledge of its false, misleading, or deceptive nature or with reckless disregard for the truth, and that directly and clearly relates to enrollment or continuing enrollment at the school or the provision of educational services for which the loan was made. The final regulations include examples of evidence that a misrepresentation may have occurred.
- Claims to recover payments previously made, referred to as “affirmative” or “offensive” claims, will be permitted. The ED sought comment on whether it should 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.
- The final regulations adopt a preponderance of the evidence standard for borrower defense claims.
- Both affirmative and defensive claims must be filed within three years of the end date of the borrower’s enrollment at the school alleged to have made the misrepresentation.
- The final regulations do not include a presumption of full borrower defense claim relief and instead give the ED flexibility to provide partial relief based on the amount of financial harm. The final regulations include examples of evidence of financial harm.
Other provisions in the final regulations include those dealing with closed-school discharges, school financial responsibility (such as mandatory and discretionary events that have or could have a materially adverse impact on a school’s financial condition and warrant the school’s provision of financial protection to the ED), and capitalization of interest on FFEL loans and collection costs.