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May 7, 1992

LAMAR ALEXANDER, SECRETARY OF EDUCATION, in his official capacity Defendant.


The opinion of the court was delivered by: LOUIS F. OBERDORFER

Plaintiffs, Atlanta College of Medical and Dental Careers, Inc. (Atlanta College) and Louisville College of Medical and Dental Careers, Inc. (Louisville College), have participated for more than eight years in the Guaranteed Student Loan (student loan) programs authorized by Title IV of the Higher Education Act (HEA) of 1965, 20 U.S.C. § 1070 et seq. Pursuant to § 435(a)(3) of the Higher Education Act, as amended, 20 U.S.C. § 1085(a)(3), the defendant, Lamar Alexander, Secretary of Education in his official capacity, has ruled that plaintiffs are ineligible to participate in those programs as of January 3, 1992. Plaintiffs sue here for a declaratory judgment that the regulations implementing the relevant statutes are unlawful and that the January 3 determination was arbitrary and capricious in violation of the Administrative Procedures Act. See 5 U.S.C. § 706. Defendant has moved to dismiss or, in the alternative, for summary judgment.

 Plaintiffs have demonstrated that the defendant's conduct is arbitrary and capricious for two reasons. First, the defendant failed to articulate a rational basis for the determinations contemporaneous with the decisions or to present these decisions in a reviewable format. Second, the defendant refused to consider material portions of plaintiffs' appeals because they did not contain information to which plaintiffs did not have access. Accordingly, the accompanying Order vacates the Secretary's January 3, 1992 decision and remands this case to the defendant for further consideration and action consistent with this opinion.


 The student loan programs are authorized by Title IV of the HEA, 20 U.S.C. § 1070, et seq. Under these programs, a student receives a loan from a participating lender such as a bank, savings and loan or credit union to pay the costs of education at an eligible postsecondary institution. See 20 U.S.C. § 1071 et seq. ; 34 C.F.R. § 682.100. Repayment of the loan is insured by a State or private non-profit institution, which is called a "guarantee agency." See 20 U.S.C. §§ 1078(b) & (c). The Department provides reinsurance for the guarantee agency. See 20 U.S.C. § 1078(c); 34 C.F.R. § 682.404. If a lending institution is unable to collect on a student loan, it submits a claim to the guarantee agency. Once the guarantee agency pays the claim, it is required to make specific collection efforts, which the regulations describe as "loan servicing," before submitting a claim for reinsurance to the Department. See 34 C.F.R. § 682.410. The Department will make a reinsurance payment only if the lending institution and the guarantee agency follow strict due diligence, servicing and collection requirements. See 34 C.F.R. § 682.406. After the Department pays reinsurance to the guarantee agency, the agency is permitted to continue to try to collect on the loan and may retain up to 30% of what it recovers. See 34 C.F.R. 682.404(e).

 To participate in the student loan programs, an educational institution must apply to the Department for eligibility and certification. The HEA and the Department's regulations establish certain requirements that must be satisfied by an educational institution. See 20 U.S.C. § 1085; 34 C.F.R. Part 600 and § 682.600. Moreover, to begin and to continue to participate in any Title IV, HEA program, the educational institution must demonstrate that it meets the standards of financial responsibility and administrative capability set forth in the Department's regulations. See 34 C.F.R. §§ 668.13-668.15.

 As part of the Omnibus Budget Reconciliation Act of 1990, P.L. 101-508, enacted November 5, 1990, Congress included the "Student Loan Default Prevention Initiative Act of 1990." Section 3004 of that Act, captioned "Ineligibility based on high default rates," amended § 435(a) of the Higher Education Act of 1965, 20 U.S.C. § 1085(a), by providing that educational institutions with cohort default rates *fn1" "for each of the three most recent fiscal years for which data are available" exceeding the statutory threshold of 35% *fn2" are not eligible to participate in the student loan programs. *fn3" 20 U.S.C. § 1085(a)(3). The Secretary calculates the cohort default rates from data supplied by the guarantee agencies. *fn4" After the Secretary determines that an institution's cohort default rates make it ineligible to participate in the student loan programs, an institution has a limited right of appeal, which is more akin to a request for reconsideration, to the Secretary. The Secretary can permit an institution to continue to participate in the student loan programs only if "the institution demonstrates to the satisfaction of the Secretary that the Secretary's calculation of its cohort default rate is not accurate, and that recalculation would reduce its cohort default rate for any of the three fiscal years below the threshold percentage" or if "there are, in the judgment of the Secretary, exceptional mitigating circumstances." Id.

 The Secretary has promulgated regulations governing appeals to him. See 56 Fed. Reg. 33,338 (Jul. 19, 1991) (to be codified at 34 C.F.R. Pt. 668). They require an institution appealing a cohort default rate determination to first "submit a written request to the guarantee agency or agencies that guaranteed the loans used in the calculation of the cohort default rate to verify the data used to calculate its cohort default rate." 56 Fed. Reg. 33340 (Jul. 19, 1991) (to be codified at 34 C.F.R. § 668.15(g)(7)(i)). The institution must then show that "[a] recalculation with corrected data verified by the cognizant guarantee agency or agencies would produce a cohort default rate for any of those fiscal years below the threshold percentage." 56 Fed. Reg. 33339 (to be codified at 34 C.F.R. § 668.15(g)(1)(i)(B)).


 On July 15, 1991, the Department sent a letter, signed by William L. Moran, Director, Student Financial Assistance Programs, to plaintiffs notifying them that their cohort default rates exceeded 35% for the relevant periods. Administrative Record [hereinafter A.R.], tabs 6 & 19. Attached to the letter was general information about the calculation of the cohort default rates and the specific backup data used to make the default calculations. See id.

 On August 29, 1991, Moran sent plaintiffs a second letter notifying them that, effective September 2, 1992, their "schools will no longer be eligible to participate in the [student loan] programs" for the remainder of fiscal year 1991 and in fiscal years 1992 and 1993. A.R., tabs 7 & 20 (emphasis added). The letter informed plaintiffs of their right to appeal if, inter alia, "the calculation of the school's cohort default rate for one or more of the relevant fiscal years is inaccurate and a recalculation based on corrected data, verified by the appropriate guarantee agency, would result in a cohort default rate for any one of the three years below 35 percent." Id. at 1. Plaintiffs would remain eligible during the appeal process provided they complied with the requirements and deadlines specified in the regulations. Id. Among other things, the letter informed plaintiffs that they "must provide the appropriate supporting documentation specified in the regulations in 34 CFR 668.15(g)(7), (8) and (9)." Id. at 2. Enclosed was a description of the required material:

 The school must request in writing that the [guarantee agency] verify the suspected inaccuracies in the school's default rate. The request must include the full name and SSN of each borrower, and a detailed explanation of the suspected inaccuracies . . . . The school must forward a copy of the request to the Secretary.

 Id., enclosure at 1.

 After receiving the first of these letters, plaintiffs contacted the appropriate guarantee agencies. Apparently unable to obtain certain information relevant to the calculation of default rates and the servicing of loans from the guarantee agencies, plaintiffs contacted the Department. By letter dated August 15, 1991, plaintiffs requested specific information on the default rates and the appeal process from Diane Sedicum, Section Chief, Default Management Section, Division of Audit and Program Review. Plaintiffs' Memorandum, Exhibit 6. For example, plaintiffs requested information regarding the servicing of loans *fn5" and possible procedures they could implement to reduce student defaults. *fn6" Plaintiffs had apparently submitted certain information to the guarantee agencies involving servicing errors that those agencies declined to consider, claiming servicing issues were to be resolved by the Department. *fn7" Having not received a response, plaintiffs sent another letter to Ms. Sedicum on September 3, 1991. See Plaintiffs' Memorandum, Exhibit 8; Coleman Declaration P 7, Plaintiffs' Motion, Exhibit 2. On November 5, 1991, plaintiffs sent yet another letter seeking a response to their August 15, 1992, inquiry. Plaintiffs did not receive a response to any of these requests. Id.

 By letter dated August 14, 1991, addressed to Alexia Roberts, Freedom of Information Officer, Department of Education, plaintiffs requested additional information pursuant to the Freedom of Information Act, 5 U.S.C. § 552. See Plaintiffs' Memorandum, Exhibit 9. Plaintiffs sent a follow up letter on September 3, 1991. Id., Exhibit 10. The Department did not respond to these requests either. Coleman Declaration P 7, Plaintiffs' Motion, Exhibit 2.

 Unsuccessful in their efforts to acquire additional information but believing defendant's calculation of their cohort default rates was inconsistent with information in plaintiffs' internal records, they requested that the appropriate guarantee agencies verify the data relied on by the Secretary to calculate the default rates. Plaintiffs included with these requests lists prepared by the accounting firm of Coopers & Lybrand from plaintiffs' academic and financial aid files. The lists identified specific student accounts that they believed were erroneously included in the Secretary's calculations of plaintiffs' cohort default rates. The errors identified by Coopers & Lybrand fell into seven categories or "types." Initially, the accountants calculated a projected repayment date *fn8" for each student based on that student's last date of attendance at plaintiffs' institutions. They noted numerous instances in which a student's projected repayment date indicated that the defendant had included the defaulting student in the wrong cohort period for calculation of the default rate. Applying the Department's regulations for loan servicing and collection to these projected repayment dates, Coopers & Lybrand identified several additional types of errors. *fn9"

 In total, Coopers & Lybrand identified several hundred potential errors. See Plaintiffs Motion for Preliminary Injunction, Exhibits 2A - 2G. Plaintiffs claim that if the Secretary were to recalculate their default rates, adjusting the guarantee agencies' data to account for these errors, they would continue to be eligible to participate in the student loan programs.

 In response to plaintiffs' submissions, the guarantee agencies partially revised their data. However, out of the hundreds of potential errors listed by plaintiffs, the guarantee agencies acknowledged only ten. The guarantee agencies did not explain why these ten errors were acknowledged and the others were not. Coleman Declaration P 6, Plaintiffs' Motion for Preliminary Injunction, Exhibit 2. In fact, one of the two agencies that guaranteed loans to plaintiffs' students indicated that it was simply confirming or denying its data based on information provided by the lending institutions and therefore that it would not be able to confirm certain types of errors identified by plaintiffs from their own internal records. Id. Instead, the guarantee agency suggested that plaintiffs "present[] these perceived error types to the Department of Education as part of [their] appeal documentation." Letter from Ms. Sally Hein, Manager, School and Lender Eligibility, USA Funds, to Mr. Joseph Whelan, Chief Financial Officer, Phillips Colleges, (Oct. 7, 1991), Plaintiffs Motion for Preliminary Injunction, Exhibit 17.

 On October 2, 1991 plaintiffs appealed their terminations to the Secretary and, following the advice of the guarantee agency, requested that the Secretary review the lists of students prepared by Coopers & Lybrand. In a letter from Ernest C. Canellos, Acting Deputy Assistant Secretary for Student Financial Assistance, dated January 3, 1992, the Secretary announced his final decisions. See Letter from Ernest C. Canellos, Acting Deputy Assistant Secretary for Student Financial Assistance to Mr. Joseph Whelan, Chief Financial Officer, Atlanta College of Medical and Dental Careers (Appeal Decision January 3, 1992), A.R., tab 18; Letter from Ernest C. Canellos to Mr. Joseph Whelan (Appeal Decision January 3, 1992), A.R., tab 33 [hereinafter "Decision Letters"]. The Canellos letter acknowledged only the ten errors that were verified by the guarantee agencies. Since adjusting for these ten errors did not lower plaintiffs' cohort default rates for any one of the relevant years, the Secretary rejected plaintiffs' appeals. *fn10" Compare id. with Letters from the guarantee agencies to Mr. Joseph Whelan, Plaintiffs' Memorandum, Exhibits 16-18. The Canellos letters did not discuss why the other errors identified by plaintiffs were not acknowledged. Moreover, the Canellos letters implied that the decisionmaker only considered "information confirmed by the guarantee agencies." Decision Letters at 1. Instead, the letters stated, inter alia, in conclusory terms that:

 The Department has determined that the accounts listed below were not properly treated in the calculation of the cohort default rates. Accounts not listed below were properly treated in the ...

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