New U.S. Education Department Rules Will Affect University Mergers, Acquisitions

The U.S. Department of Education (ED) finalized new regulations last year that will take effect on July 1, 2024, directly impacting mergers and acquisitions involving higher education institutions. Specifically, the regulatory package will 1) adjust the minimum financial requirements in a change in control transaction and 2) identify the circumstances in which new owners must assume joint and several liability for federal student aid liabilities. These changes follow several years of increased scrutiny of change in control transactions, during which ED has expanded the types of transactions subject to review, issued more detailed information requests and imposed stricter conditions on institutional operations following the change. 

Key Provisions Taking Effect July 1

Financial Responsibility Requirements

ED is making a number of changes to its financial responsibility requirements in 34 C.F.R. § 668.171, including amending the mandatory and discretionary triggering requirements. As part of the changes to these provisions, ED is also relocating the financial responsibility requirements that apply to change in control transactions – previously held at 34 C.F.R. § 668.15 – to a new Section 668.176, as well as amending the financial tests it applies during such change in control reviews. New Section 668.176 outlines several key provisions:

• Although ED has always required that a new owner provide two years of historic audited financial statements as part of its change in control application, those statements must also now satisfy certain financial tests. Such metrics include a positive tangible net worth or net assets and a passing composite score, among other metrics.
• ED will retain the existing balance sheet and statement of financial position tests that apply to an institution changing control, including the acid test and the tangible net worth test.
• ED reserves the right to determine that an institution is not financially responsible after a change in control if the amount of debt assumed to complete the acquisition requires payments inconsistent with available cash.

If an institution fails to satisfy these financial requirements following a change in control, ED is likely to request a letter of credit (or multiple letters of credit) representing a percentage of Title IV funds that the acquired institution received in the previous fiscal year.

New Owner Liability and Guarantees

The new rule package will also formalize the obligation of controlling owners to cosign an institution's Title IV Program Participation Agreement (PPA), thereby guaranteeing the institution's performance of obligations under the PPA and imposing joint and several liability on the new owners for any federal student aid liabilities of the acquired institution. Consequently, a co-owner could now face potential liability for a broad range of student aid liabilities, including borrower defense claims or closed school loan discharges, among others. This cosigning requirement applies to proprietary, nonprofit and public institutions alike.

Under the final rule at Section 668.14(a)(3), an institution's PPA must be signed by a representative of 1) the institution and 2) an entity with direct or indirect ownership of the institution, if that entity has the power to exercise control over the institution. Examples of "control" include:

• the entity holds at least 50 percent control over the institution, whether by voting rights, the right to appoint board members, or in combination with any other affiliated entities or persons
• the power to block significant actions
• the entity is the 100 percent direct or indirect interest holder of the institution
• the entity provides or will provide financial statements to meet any of the financial responsibility requirements

This list represents examples only. ED retains the discretion to determine whether other circumstances constitute "control" for this purpose.

Although this rule is newly taking effect on July 1, this has been ED's practice for several years. In March 2022, the ED issued guidance outlining that certain owners of institutions may be asked to cosign institutional PPAs. The new rules will expand and formalize that practice and guidance.

Takeaways

This Holland & Knight alert addresses just two of many new regulatory changes ED will be applying to institutions of higher education starting this July, including its gainful employment regulations, as well as material changes to the administrative capability and certification requirements. The changes are significant and complex and could require fundamental changes to how institutions approach federal student aid compliance, especially when evaluating potential transactions and changes in control.

If you have any questions about how your institution should adapt its practices based on this guidance, please contact the authors or a member of Holland & Knight's Education Team.

Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.