Department of Education to Hold Owners and Investors Liable for College and University Liabilities

April 18, 2022

On March 23, 2022, the U.S. Department of Education (ED) announced its intention to hold corporate owners, investors and controlling parties of private institutions of higher education directly liable for the school’s conduct.

This announcement means the ED may take direct administrative action against the school’s corporate owners for the school’s liabilities, and other third parties may sue the corporate owners under various laws such as the federal False Claims Act, unfair and deceptive acts and practices statutes, or other consumer protection laws. Although the ED’s new policy applies to all private, postsecondary institutions, the policy targets proprietary colleges and universities, which typically are owned or controlled by publicly traded corporations or private equity firms.

To receive federal financial student aid under Title IV of the Higher Education of 1965, as amended, a participating school must enter into the ED’s program participation agreement, or PPA. (See 34 C.F.R. § 668.14.) A PPA outlines the terms by which the school must abide or risk termination of funding from the ED.

As acknowledged in the guidance, the ED has required that a PPA need only be signed by an authorized representative of the school itself. With the new policy, however, the ED could require a signature from any entity that has “or could have a direct or indirect effect on the institution’s administrative capability or financial responsibility.” The ED already has been selectively requiring corporate owners of certain proprietary colleges and universities to endorse an appendix to a PPA, including a provisional program participation agreement (PPPA) or temporary provisional program participation agreement (TPPPA). The appendix states that the corporate owners agree to be held jointly and severally liable for the conduct of schools they own or control.

The ED for the first time announced that it will use a rebuttable presumption to assume that entities have a direct or indirect effect on a school if they:

  • are the sole member of, or hold a 100 percent direct or indirect equity or voting interest in, the institution;
  • hold less than a 100 percent interest but otherwise exercise (directly or indirectly) substantial control over the institution, (“Substantial control is generally presumed to be any direct or indirect equity, membership, or voting interest of 50 percent or more in the institution, including in combination with other interest holders, whether by affiliation, contract, proxy, or other arrangement.”); or
  • provide the audited financial statements or other financial submissions on behalf of the institution.

If the ED requires an entity to sign a PPA, that entity’s signature will be a necessary condition of the ED’s approval or continuance of the institution’s participation in Title IV programs. To that end, the ED essentially creates a second rebuttable presumption that an entity will be required to sign a PPA in the following situations:

  • if the institution has had a financial responsibility composite score below 1.5 since its last certification (initial or recertification);
  • if the institution is on provisional certification status by the ED;
  • if the institution is on HCM2;
  • if the institution goes through a change of ownership;
  • if the ED has approved a significant number of borrower defense or false certification claims for the institution, or if there are a substantial number of these types of claims under review that, if approved, would result in the potential for significant liability;
  • if the ED has recently identified systemic or significant audit or program review findings, or has unpaid liabilities resulting from an audit or program review; or
  • if the institution or any of its principals or interest holders has consented to or has a judgment of fraud or misrepresentation entered against it by a federal or state court, foreign tribunal or arbitration body.

Like the first rebuttable presumption, the second is also non-exhaustive, and entities otherwise not covered by a clearly delineated presumption could still be required to sign a PPA.

The ED will not require a signature by an affected entity in all circumstances. Rather, when the school is up for its next recertification, the ED will make a determination as to whether the entity must still be required to be a co-signer with the school. Further, the new guidance provides that the secretary of education may exercise discretion as to whether an alternative to a signature is available, such as a letter of credit.

The ED intends to apply the new guidance immediately to PPAs issued on or after March 23, 2022, and which concern ownership, reinstatements and initial certification. The new guidance will apply to PPAs issued on are after July 1, 2022, and which concern recertification. The ED also may, effective immediately, apply the guidance to PPAs for schools that have already been informed of the new signature requirement.

Although the ED’s announcement has the appearance of a sweeping new series of requirements for PPA signatures, it is important to note that the announcement — at least for now — is just guidance and does not, in and of itself, have the force of law. Notably missing from the guidance is the ED’s typical disclaimer that guidance documents do not have the force and effect of law and are not meant to bind the public or regulated entities in any way. Because the guidance is presented as if it does have the effect of binding law, the ED’s announcement may arguably violate the Administrative Procedure Act, which requires that federal administrative agencies inform the public on proposed rules and allow for public comment before those rules take effect. Given that a guidance document may set forth an agency’s interpretation of a statute or regulation to provide further clarity, the ED likely will assert that this guidance is merely an interpretation of the regulation governing PPAs, which states that a PPA may include “any additional conditions specified in the program participation agreement that the Secretary requires the institution to meet.” (See 34 C.F.R. § 668.14(a)(1).)

Ironically, the ED recently faced — and cowed to — similar litigation challenging its guidance. In June 2020, plaintiffs filed a class action lawsuit, challenging a guidance document based on a rebuttable presumption as to loan relief for student-borrowers. (See Pratt v. Devos, No. 1:20-cv-1501, U.S. District Court, District of Columbia.) In November 2021, plaintiffs voluntarily dismissed the action following the ED’s decision to rescind its partial relief methodology as a result of allegations that this methodology, with its rebuttable presumption, ran afoul of the Administrative Procedure Act. Nonetheless, the ED retreads shaky ground with its March 23 announcement of a rebuttable presumption in the context of PPAs.

Additionally, Title IV requires the ED to go through negotiated rulemaking to promulgate regulations that have the force and effect of law, and the ED’s regulation about program participation agreements, 34 C.F.R. § 668.14, is promulgated under Title IV. The ED recently finished negotiations and proposed a policy that is even more detrimental with respect to liability for corporate owners and private equity firms during negotiations. The ED may go through notice-and-comment rulemaking to promulgate regulations that effectuate its policy position, but it has not yet issued a notice of proposed rulemaking setting forth its official proposal with respect to joint and several liability for corporate owners of proprietary schools.

Depending on how it attempts to enforce this guidance, the ED may run afoul of a key statutory limitation as to the secretary of education’s authority to impose liability over individuals who exercise “substantial control over” a qualifying school. (See 20 U.S.C. § 1099c(e)(4).) Title IV specifically delineates that the secretary of education cannot hold individuals liable if the institution has not been subject to a termination action within the last five years and has met additional requirements to bring it within Title IV compliance. (See 20 U.S.C. §§ 1099 (e)(4)(B)-(D).) At least one federal district court interprets this provision of Title IV as permitting the ED to hold corporate entities liable but forbidding the ED to hold individuals liable unless certain circumstances have been satisfied. For details, see Florida Coastal Sch. Of Law., Inc. v. Cardona, No. 3:21-cv-721, Order, 44-45 (M.D. Fla. Aug. 9, 2021).

The guidance also may in some circumstances conflict with the existing 2019 Borrower Defense to Repayment and Institutional Accountability Regulations, 84 Fed. Reg. 49,788, 49,860-78 (Sept. 23, 2019), which set forth the specific mandatory and discretionary triggering events that allow the ED to require a letter of credit. For example, the financial responsibility regulations specifically require that an institution actually incurs a liability from a settlement, final judgment or final determination arising from any administrative or judicial action, per 34 C.F.R. § 668.171(c)(1)(i)(A), whereas the ED’s guidance allows the ED to act when there are a substantial number of borrower defense or false certification claims that, if approved, would result in the potential for significant liability.

During these uncertain times, proprietary schools and their corporate owners would be wise to seek counsel before entering into a PPA, TPPPA or PPPA that holds a corporate entity or an individual jointly and severally liable.

McGuireWoods offers an interdisciplinary team of attorneys who focus on education law, private equity and business and securities law. McGuireWoods’ attorneys serve as trusted advisers to proprietary and nonprofit colleges and universities. For any questions concerning this alert, please contact any of its authors.