Summer 2007

In This Issue

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Message from the General Counsel

Well, the kids are back in school, campuses across System are bustling with record enrollment, Friday nights and Sunday afternoons are filled with football (so are Sundays, Mondays, Tuesdays, Wednesdays, and Thursdays if you have the full ESPN/Fox Sports packages on cable), and in Austin we have even had our first cold front – it’s a blustery 86º here today. So, Fall is in the air, but it is still Summer until September 21st. Thus, I give you the Summer 2007 issue of The Foreseeable Future. It is no secret that a chunk of OGC’s bandwidth was absorbed this Spring and Summer by the student loan investigations, which garnered nationwide attention and still continue to have some legs in the media. Accordingly, the bulk of this issue of The Foreseeable Future is devoted to educating our audience on all that we have learned and the new rules of the game, including a guest piece by Jim Studer, our new Associate Vice Chancellor for Student Affairs. Hopefully, after reading this issue you’ll understand a bit better the waves that just washed over the student lending industry and the changed landscape left in their wake. Also, as always, we stand ready to assist with more particular questions you may have as you attempt to implement and monitor compliance with the Texas Higher Education Fair Lending Practices Agreement. In particular, OGC attorneys Karen Lundquist, Kent Kostka, and Hannah Huckaby have assisted me in navigating student loan issues and are knowledgeable about the current state of the student loan industry. We will continue to keep you apprised of this still evolving area of law and regulation. This issue also includes a couple of articles from our new tax expert Don Jansen who comes to us after a long and distinguished career at Fulbright & Jaworski L.L.P. Lannis Temple also highlights select features of Dr. Shine’s Code Red report. Enjoy reading.

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Immigration News

The Department of Labor has issued final rules regarding the labor certification process for the permanent employment of aliens in the United States. The stated purpose of the Final Rule, which was effective July 16, 2007, is to enhance program integrity and reduce the incentives and opportunities for fraud and abuse related to the permanent employment of aliens in the United States. One of the major changes affecting UT System institutions, as employers, is that an employer must pay all costs of the labor certification process including, but not limited to, advertising costs and attorneys’ fees for work done in pursuing the labor certification on behalf of the employer and may not seek reimbursement from the employee beneficiary for these costs. UT System institutions that file permanent labor certifications to retain the employment of foreign workers should review and, if necessary, modify their policies and/or practices so that they do not require or allow the foreign national to pay employer related attorneys’ fees.

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New Attorneys at OGC

Please join me in welcoming these new attorneys to OGC:

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Chancellor Issues Important Ethics and Compliance Guidelines for UT System Financial Aid Offices

by Kent Kostka (Claims and Bankruptcy)

In response to recent investigations and press reports regarding the relationships between student loan lenders and institutions of higher education, UT System’s Office of General Counsel (OGC) conducted an extensive investigation into the policies and activities of UT Austin’s Office of Student Financial Services and its relationships with student lenders. OGC issued a report summarizing the findings of the investigation, and recommendations for preventing future conflicts or the appearance thereof. Following the release of the report, UT Austin entered into the Texas Higher Education Fair Lending Practices Agreement (the “Agreement”) with the Attorney General of the State of Texas. The Agreement governs student lending and institutional conduct and policies, and sets forth clear rules to prevent conflicts of interest or the appearance of conflicts. As many of you know, OGC also conducted a general review of student financial aid practices at all UT institutions, and on July 31, 2007, UT System Chancellor Mark Yudof and Vice Chancellor and General Counsel Barry Burgdorf issued a memorandum mandating compliance with the terms of the Agreement by September 30, 2007, by all UT institutions, in anticipation of pending legislation and the likely requirement that all universities will be asked to sign the Agreement. Although OGC believes that most UT institutions are already substantially in compliance with the Agreement, it is important to understand the basic points of the Agreement and what they mean for your campus. The most critical part of the Agreement is implementation of “Fair Lending Practices,” which consist of 11 key elements. The Agreement also contains essential definitions that are important in understanding what activities are prohibited or restricted. Although all employees of student financial aid offices should carefully read the Agreement in its entirety, below is a brief summary of each of the 11 requirements.

First, a couple of key definitions:

  • Gift -- A gift means any money, favor, service, entertainment, travel expenses, lodging, discount, or item valued at $20 or greater, including in-kind benefits, computer software or hardware, printing costs, or reimbursement. It does not include a lender's own brochures or promotional literature, or training provided to an employee that is an integral part of a training session contributing to the professional development of the employee. It also does not mean philanthropic gifts to your institution provided outside the office of financial aid, which are not given for the purpose of soliciting or securing any benefit from your institution, and with no connection or benefit to any university employee. For a complete definition of “gift,” please see the Agreement, and if you are ever in doubt about whether something is a gift, consult your legal office, your ethics officer, or OGC for assistance.
  • Student Lender -- This definition includes any bank or institution that makes, brokers, arranges, accepts applications for, or guarantees student loans, as well as any professional or trade association that receives money from student lenders. The Texas Guaranteed Student Loan Corporation (TG) is exempt from this definition. Again, for a more comprehensive definition, please see the Agreement.

1. Prohibition Against Solicitation or Acceptance of Gifts by Institution -- No UT institution shall accept or solicit gifts from any student lender, with the exception of philanthropic donations, and those gifts may not benefit any employee or be factored into any assessment of a lender and its relationship with your institution.

2. Prohibition Against Solicitation or Acceptance of Gifts by Institution Employee -- No UT employee may solicit or accept any gift valued in excess of $20 from a student lender, and must report any such offered gift immediately. When in doubt regarding whether something is a “gift,” err on the side of caution, or contact OGC for assistance and clarification.

3. Prohibition Against Revenue Sharing -- No UT institution shall engage in any arrangement or agreement under which the institution engages in revenue sharing with a student lender. Revenue sharing means any arrangement, formal or informal, under which a lender pays the institution or an entity.

4. Prohibition Against Acceptance of Remuneration by Institution Employee for Service on Lender Board -- No UT employee may be compensated or receive reimbursement of expenses for service on an advisory board, board of directors, or other board associated with a student lender. Any participation on such boards shall require the written approval of the institution’s president. Application of this provision means that an institution must first determine that advisory board service benefits the institution and that such benefit warrants expenditure of institutional funds.

5. Prohibition Against Misleading Identification of Lender Employees and Representatives -- UT Institutions shall not allow employees or representatives of a student lender to appear, implicitly or explicitly, to be an employee or representative of the institution. For example, student lender employees cannot staff a student call center sponsored by the university.

6. Prohibition Against High Risk Student Loan Agreements -- UT institutions may not enter into certain high risk loan agreements in which the institution makes concessions or promises to the lender that could prejudice borrowers or prospective borrowers. “High risk loans” are loans provided to students who would not otherwise qualify for student loans and who have poor or no credit history.

7. Prohibition Against Directing Potential Borrowers to Certain Electronic Loan Agreements -- UT institutions shall may not direct potential borrowers to an electronic promissory note that does not allow the borrower to choose any lender of their choice. Electronic promissory notes must allow students to enter the lender code or name for any student lender offering the relevant loan. For additional details, please see the Agreement.

8. Disclosure of Financing Options Required -- Students must be provided with certain information regarding available financing options, including terms and conditions of available loans that are more favorable than those on the schools lender lists. This information must be provided in a clear and conspicuous manner, a requirement that may be satisfied with a conspicuous posting on an official website available to borrowers, prospective borrowers, and their parents.

9. Requirements Relating to Lender Lists -- Lender lists must be constructed carefully, using clearly identified, objective criteria that are disclosed to parents and students. The primary consideration must be the students’ best interests, and lists must be reviewed and updated at least annually. Before compiling a lender list, institutions must make a reasonable inquiry into the availability of zero-interest and non-profit loan providers. Other important restrictions apply, and administrators as well as financial aid staff should be well versed in the specifics of this section. This is perhaps the most significant and complicated part of the Agreement, and UT institutions should not hesitate to contact OGC for clarification and assistance.

10. Prohibition Against Stock Ownership -- Employees of the student financial aid office may not hold stock or an ownership interest in a student lender, with exceptions for mutual funds and other common investments. When in doubt about this provision, please consult OGC.

11. Training -- Every institution shall provide annual training to all financial aid employees regarding this agreement and ethics rules. Again, if you require assistance or guidance in this regard, please contact OGC.

The Bottom Line:  In order to show leadership and help restore confidence in our ability to serve the best interests of our students and the people of the State of Texas, UT institutions are committing not only to following the “letter of the law” contained in the Agreement, but also to projecting a positive and forceful “tone at the top” that embodies the spirit of the highest ethical standards. OGC can provide guidance and significant resources as we work together towards a common goal of restoring complete trust in the student financial services of UT institutions, and you should not hesitate to contact us with questions or for assistance.

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State Law and the Student Loan Scandal

by Karen Lundquist (General Law)

The investigations into the student loan industry conducted by the New York Attorney General, the Texas Attorney General, and UT System’s Office of General Counsel focused on alleged practices of student loan lenders whereby student lenders gave benefits to universities and individuals employed by student financial aid offices in exchange for being listed or favorably placed on the university’s preferred lender list for other benefits, such as preferred access to students. Some of the practices investigated include:

  • Gifts and other perks provided by student loan lenders to employees of student financial aid offices, including athletic event tickets, food and beverage, and resort travel;
  • Purchases (perhaps discounted) of equity in student loan lenders doing business with student financial aid offices;
  • Advisory board service by employees of student financial aid offices in which the employee’s travel expenses were paid by the student loan lender;
  • Complimentary products and services by student loan lenders to student financial aid offices, such as operational software and processing facilities; and
  • Co-branding/co-marketing activities undertaken by and between student lenders and universities.

This article analyzes the application of Texas ethics laws to those alleged practices. This analysis is not in response to a specific fact situation but is meant as a general summary of the types of issues raised by the above practices. Many of those practices are now prohibited or restricted by the Texas Higher Education Fair Lending Practices Agreement (the "Agreement") discussed above.

A general overview of Texas ethics laws is helpful in understanding the principles that govern ethics and conflicts of interest. The first rule is that a state employee may never take anything as consideration for an official act. To do so would constitute the criminal offense of bribery (Section 36.02, Texas Penal Code). The second rule prohibits a state employee from accepting an honorarium for services that he or she would not have been asked to provide but for his or her official status as a state employee (Section 36.07, Texas Penal Code).

Even if the proposed gift is not in consideration for an official act and does not constitute an honorarium, the acceptance may nonetheless be prohibited by the gift laws in the Penal Code. (In some situations, the prohibitions in the lobby law – Chapter 305, Texas Government Code – may be relevant.) Under the Penal Code gift laws, a state employee may not accept any benefit from any individual or entity that is interested or is likely to become interested in a contract or other type of pecuniary transaction with the agency involving the exercise of the employee’s discretion (Section 36.08(d), Texas Penal Code). This general prohibition against accepting gifts or other benefits from prohibited sources is subject to several exceptions, including the following two exceptions that are relevant to this discussion:

  • A state employee may accept an item with a value of less than $50, unless it is cash, a check, or a negotiable instrument (Section 36.10(a)(6), Texas Penal Code).
  • A state employee may accept benefits in the form of food, lodging, transportation, or entertainment regardless of value if accepted by the state employee as a guest and properly reported according to state law reporting requirements. In order for a state employee to accept something as a guest, the donor must be present (Section 36.10(b), Texas Penal Code).

(Remember that there is a $20 limit on any gift to any employee from a student loan lender under the more restrictive Agreement, including a gift of food, lodging, transportation, or entertainment.)

The standards of conduct for state officers and employees provide additional guidance for ethical conduct (Section 572.051, Texas Government Code). The standards are in furtherance of the state policy to avoid substantial conflicts between public duties and private interests, and provide that a state employee should not accept a gift that might reasonably tend to influence the employee or that the employee knows or should know is being offered with the intent to influence the employee’s official conduct. The standards also provide that a state employee should not make personal investments that could reasonably be expected to create a substantial conflict between the employee’s private interest and the public interest. Although there are no civil or criminal penalties for a violation, both the law and the Regents’ Rules and Regulations provide that failure to adhere to the standards of conduct may be grounds for disciplinary action. (Rule 30104, Regents’ Rules and Regulations; Section 572.051, Texas Government Code) (The 80th Legislature required all state agencies to adopt an ethics policy consistent with the standards of conduct by January 1, 2008. OGC will be communicating with all campuses about this requirement in the near future.)

Finally, in some instances, the gift is not being offered to the employee individually but rather is being offered to the state agency to assist the agency in performing its duties. In that case, the Penal Code and the standards of conduct are not relevant. Rather, the question is whether the agency has statutory authority to accept the gift. It is clear that a public university has very broad authority to accept gifts that are reasonably related to the university’s purpose as an educational institution and that can be used in carrying out its mission (Section 65.31, Texas Education Code; Attorney General Opinion Nos. MW-373 (1981); GA-0163 (2004)).

The application of these ethics laws to the practices being investigated in the student loan industry is dependent on a complete development of specific facts. However, a few general observations are appropriate.

Concerning the acceptance of gifts, including food and beverage, by university employees, assuming there is not quid pro quo, the acceptance would not constitute a crime under the Penal Code if (1) the non-cash gift was worth less than $50, or (2) the gift consisted of food, lodging, transportation, or entertainment at which the lender was present. Many of the gifts to employees of student financial aid offices that were widely reported in the press would fall into one of those categories. However, the inquiry should never end with an analysis of permissibility under the Penal Code. In maintaining the public trust, it is crucial that university employees consider whether the acceptance of a gift, or a series of gifts, would appear to influence the employee’s conduct and, if so, decline the gift in order to avoid even the appearance of impropriety. Indeed, because of the appearance of impropriety issue, gifts to employees from student loan lenders may not exceed $20 under the Agreement, even though the Penal Code might permit a higher value. In the area of ethics, state employees are frequently admonished to ask themselves if they would want to read about themselves on the front page of the newspaper. We have an easier test: if you don’t want the gift under $50, it’s probably okay to take it. Conversely, if it’s something you do want, it’s probably not okay to take it.

Concerning the purchase of equity in student loan lenders, and again assuming no quid pro quo, the purchase would not constitute a crime under the Penal Code as long as there was no discounted price or special opportunity to purchase. Even if there were a discount or special opportunity, a full development of the facts would be necessary to determine whether the student loan lender was a prohibited source as to that employee. However, once again, university employees must be mindful of appearances, and particularly mindful of the standards of conduct concerning making personal investments that conflict with the public interest. Failure to comply with this standard can and sometimes does result in the loss of state employment.

Concerning the acceptance of travel reimbursement for service on a student loan lender’s advisory board, this would be a gift to the university if the university determined that it received a benefit from that service, such as the enhanced opportunity to have input into the development of a product used by the university. In general, if the university itself would pay for the employee’s travel to serve on the advisory board, the lender’s payment of the travel expenses would be a gift to the university, and the Penal Code and standards of conduct would not be relevant. Rather, the question is whether the gift can be used in carrying out the agency’s mission. However, even though the gift is not to an individual employee, some might perceive that the gift would influence the university’s decisions about that student loan lender, thus giving rise to a perception of an institutional conflict of interest. Because of this perception, this practice is no longer permissible for service on advisory boards of student loan lenders. Each campus should carefully consider any perception issues that may arise from allowing other types of industry to pay expenses connected with advisory board service and should consider whether it is more appropriate for the university to pay those expenses.

Concerning the acceptance of products and services, such as operational software and processing facilities, this again would be considered a gift to the university, and raises the same possible perception issues as those discussed above.

The Bottom Line:  The application of state ethics laws to a particular situation depends on a complete development of the specific facts. However, in order to maintain the public trust, it is crucial to go beyond a legal analysis of a particular situation and to act in a way that avoids even the appearance of impropriety.

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Ethical Issues in the Workplace:  Lessons Learned in Financial Aid

by Jim Studer, Associate Vice Chancellor for Student Affairs

Many higher education professional associations have statements of ethical practice, codes of conduct, standards of professional practice, etc. Recently, in response to the higher education guaranteed student loan controversy, the Board of Directors of the National Association of Student Financial Aid Administrators ( “NASFAA”) updated their Statement of Ethical Principles to include a new Code of Conduct that gives guidance to “financial aid administrators in carrying out (their) obligations, particularly with regard to ensuring transparency in the administration of the student financial aid programs, and to avoid the harm that may arise from actual, potential, or perceived conflicts of interest.”

The Code of Conduct specifically discusses six statements of ethical conduct and gives an explanation of what is meant by each statement. The six elements are:

  1. “Refrain from taking any action for his or her personal benefit.”
  2. “Refrain from taking any action he or she believes is contrary to law, regulation, or the best interests of the students and parents he or she serves.”
  3. “Ensure that the information he or she provides is accurate, unbiased, and does not reflect any preference arising from actual or potential personal gain.”
  4. “Be objective in making decisions and advising his or her institution regarding relationships with any entity involved in any aspect of student financial aid.”
  5. “Refrain from soliciting or accepting anything of other than nominal value from any entity (other than an institution of higher education or a governmental entity such as the U.S. Department of Education) involved in the making, holding, consolidating or processing of any student loans, including anything of value (including reimbursement of expenses) for serving on an advisory body or as part of a training activity of or sponsored by any such entity.”
  6. “Disclose to his or her institution in such manner as his or her institution may prescribe any involvement with or interest in any entity involved in any aspect of student financial aid.”

The Code of Conduct was adopted by the NASFAA Board of Directors in May 2007 and was a point of several discussions at the July annual conference of NASFAA.

A discussion or reading and signing statements about ethical behavior at the beginning of an employment relationship or re-signing a similar statement every five years is not enough to ensure appropriate, ethical behavior. Department heads, on at least an annual basis, should discuss with all their staff, in one form or another, what is expected ethically of the specific profession, The University of Texas System, The University, and the State of Texas. Perhaps the best form of conversation is to discuss case studies of problematic ethical situations and what the expected and desired response should be. As evidenced by the recent “loan upheaval,” one cannot assume that even the most seasoned professional knows what to do when various questionable situations are presented. For sure, assuming that “everyone knows what the right thing to do is” will lead to new headlines in the newspaper or, minimally, be the subject of an auditor’s report.

The Bottom Line:  The issue of vigilance concerning ethical behavior is not just one for financial aid administrators. All administrators, staff, and faculty in our institutions need to be aware of their responsibility to act lawfully, ethically, and be familiar with The University of Texas System, institutional, and professional expectations related to ethical and professional behavior and standards.

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Existing Anti-Inducement Laws and Proposed Legislation and Regulations

by Hannah Huckaby (Claims and Bankruptcy)

Sparked by the Attorney General of New York’s investigation of illegal and unethical practices by some private lenders and institutions of higher education, Congress and the U.S. Department of Education (“DoE”) have proposed new legislation and regulations concerning the conduct of lenders, schools, and other parties who make, administer, service, and otherwise handle student loans. What follows is a summary of existing and proposed federal laws that regulate such activities. Developments in Congress may change proposed legislation and place increased restrictions on the conduct of student financial aid offices and student lenders.

First, during the loan certification process, a school cannot discriminate against particular lenders and guaranty agencies. This means that the borrower may choose his/her lender, and a school may not refuse to certify a loan because of the lender selected. 34 C.F.R. § 682.603(e) (2006).

Second, federal law prohibits schools from making inducements, such as points, premiums, or payments, to eligible lenders to make loans to borrowers. 34 C.F.R. § 682.212 (2006).

Third, federal law prohibits inducements, such as points, premiums, or payments, from lenders or guaranty agencies to institutions of higher education, individuals, or other parties to secure FFEL applicants. This applies to direct and indirect inducements as well as the offering of inducements, with an emphasis on quid pro quo relationships (that is, something has been provided in return for something else). See 34 C.F.R. §§ 682.200(b) “Lender” (5) (2006), 682.401(e) (2006), and 20 U.S.C. 1085(d) (2006). The DoE has emphasized “the desirability of having students’ borrowing decisions made on the merits of the loans rather than extraneous marketing incentives to students and their schools” and that loan “decisions should be based on the merits of the loans and not on extraneous factors, particularly not on monetary benefits given to the schools on which students often rely in such matters. In this respect it does not matter whether the lender offers the monetary benefit to the school directly or simply arranges for the school to receive the benefit from a third party.” U.S. Department of Education, Dear Colleague Letter, 95-G-278 (March 1, 1995).

Fourth, on June 12, 2007, the DoE’s proposed regulations on prohibited inducements and preferred lender lists were published in the Federal Register. Noteworthy provisions are:

  • schools’ preferred lender lists must include at least three unaffiliated lenders
  • schools must disclose the method and criteria used to compile preferred lender lists
  • schools’ preferred lender lists must include comparative information about the lenders’ borrower benefits and loan terms
  • schools’ preferred lender lists must include a statement that borrowers are not required to choose a preferred lender
  • schools must not delay loan certification based on the borrower’s choice of lender or based on the borrower’s choice of a lender not on the preferred lender list
  • adds the definition of a school-affiliated organization to the illegal inducement regulation (34 C.F.R. § 682.200) to include, but not limited to, alumni organizations, foundations, athletic organizations, and social, academic, and professional organizations
  • prohibit lenders and guaranty agencies from offering, directly or indirectly, any points, premiums, payments, or other benefits to any school or other party to secure FFEL loan applications or loan volume
  • prohibit lenders and guaranty agencies from undertaking philanthropic activities to secure loan applications or placement on preferred lender lists
  • prohibit lenders and guaranty agencies from paying conference or training registration, travel or entertainment expenses for school employees
  • prohibit lenders and guaranty agencies from providing schools with staffing services for financial aid functions except on a short-term, nonrecurring emergency basis
  • prohibit lenders from offering schools computer hardware or non-financial aid-related software at below market rental or purchase cost in exchange for FFEL applications or referrals, specified loan volume or dollar amount of loans made, or placement on preferred lender lists
  • prohibit lenders from offering schools printing and distribution of college catalogs and other materials at reduced or no cost in exchange for FFEL applications or referrals, specified loan volume or dollar amount of loans made, or placement on preferred lender lists
  • allow guaranty agencies to pay reasonable costs for school officials to participate on agencies’ governing boards and standing official advisory committees

The proposed regulations become effective on July 1, 2008. However, in an August 9, 2007 letter, DoE Secretary Margaret Spellings asked schools to adopt them voluntarily immediately.

Fifth, Congress has proposed legislation in this area as well. On May 9, 2007, the U.S. House of Representatives overwhelmingly passed the Student Loan Sunshine Act (H.R. 890). A spokesperson for Rep. George Miller (D-CA) said, “the intent of the act is clear – any and all financial arrangements between schools and lenders should be made in the interest of providing students with full and fair information about the types of loans available to them.” Elia Powers, Interpreting the Sunshine Act, Inside Higher Ed (June 18, 2007). On July 24, 2007, the U.S. Senate unanimously passed legislation, designated S. 1642, to renew the Higher Education Act that includes many of the provisions of H.R. 890 and the similar Financial Aid Accountability and Transparency Act of 2007 (H.R. 1994). Highlights from the two bills’ provisions are:

  • the legislation covers schools and their employees or agents/affiliates
  • prohibit revenue sharing agreements between schools and lenders
  • ban co-branding between schools and lenders
  • ban school employees from consulting for lenders
  • ban on lender gifts of more than a nominal value
  • ban on call centers
  • preferred lender lists must include at least three unaffiliated lenders
  • schools must inform students of their right to choose any lender
  • schools must develop and disclose a process for compilation of preferred lender lists based on consideration of the borrowers’ best interests
  • H.R. 890 prohibits financial aid administrators from serving on lenders’ advisory boards, whereas S. 1642 permits it with reimbursement for reasonable expenses only
  • schools must establish codes of conduct and designate a high level officer to be responsible for an annual attestation of compliance with the code; at a minimum the codes must include the prohibitions against revenue sharing, lender gifts, consultation for lenders
  • prohibit lenders and guarantors from offering securities, prizes, travel, entertainment expenses, and tuition repayment to schools or their employees in order to secure loan applicants

The House and Senate will have to agree on a single bill before the legislation is submitted to the President for consideration.

Finally, other notable bills that have much in common with H.R. 890 and S. 1642 include the Student Loan Accountability and Disclosure Reform Act (S. 1262), which prohibits schools from using preferred lender lists, and the Private Student Loan Transparency and Improvement Act of 2007 (that in August passed the Senate Committee on Banking, Housing and Urban Affairs), which focuses on the private student loan industry. Keep in mind that these bills and proposed regulations are evolving, new bills may be introduced, investigations into student loan practices are ongoing, and we will notify you of significant events and changes.

The Bottom Line:  UT System policies and changes in the law, together with the public’s interest in student loan corruption, mandate leadership and response from the highest levels. It is important that you comport with the agreement that UT System made with the Attorney General of Texas and follow Secretary Spellings’ recommendation to adopt the proposed DoE regulations now. It is crucial that in both substance and appearance, UT institutions administer student loans legally, ethically, and without conflicts of interest.

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New Regulations Impact UTSaver, TSA, and ORP

by Donald O. Jansen (Business Law)

The long-awaited final regulations for tax sheltered annuities (TSAs) under Section 403(b) of the Internal Revenue Code were issued in July. The new regulations are the first comprehensive update of the Section 403(b) regulations in 43 years. They reflect numerous changes in law during that period of time and many of the positions that have been taken in interpretive guidance issued under that section. TSAs are available only for public educational institutions and tax exempt organizations under 501(c)(3). There are three categories of funding arrangements for TSAs:

  • Annuity contracts,
  • Custodial accounts - invested solely in mutual funds
  • Retirement income accounts - permitted for church employees and certain ministers

Contributions to these plans are excluded from income and apply to employer non-elective contributions (including matching contributions), and employee elective deferrals. Roth contributions can be made to TSAs but they are not excluded from income at the date of contribution.

UTSaver, TSA, and the Optional Retirement Program (ORP) sponsored by The University of Texas System are TSAs. The plans must be amended to reflect the new final regulations by January 1, 2009.

The following are some of the major provisions of the final regulations:

  1. Written plan document. Every 403 (b) plan must now have a written plan document. Previously, the annuity contracts sufficed. However, the new written plan document may incorporate by reference other documents including the annuity contracts or custodial accounts. The annuity contracts and custodial accounts have to include more tax provisions. The plan must designate the employer or another person who has responsibility for administering the plan.
  2. Annuity contract exchanges and transfers. The regulations establish more formal rules for exchanging annuity contracts within a plan, exchanging annuity contracts in connection with plan to plan transfers and transfer of assets to purchase permissive service credit in a defined benefit plan. The regulations prohibit a plan-to-plan transfer to a 457(b), a 401(k) or any other qualified plan.
  3. Reduces the difference from 401(k) and profit sharing plans. Continuing the trend of the last several decades, the regulation imposes on the TSAs many of the requirements which apply to other qualified defined contribution plans including limitations on contributions by the employer and the participant, timing of distributions and benefits (not earlier than severance from employment, hardship, disability or attaining age 59 ½), minimum distribution rules (generally after age 70 ½), loans, hardship distributions, and qualified domestic relation orders. The final regulations clarify that catch-up contributions by an employee after age 50 will apply only after maximum 403(b) catch up contributions have been made.
  4. Universal availability for elective deferrals. Under this requirement, all employees must be permitted to elect to make Section 403(b) elective deferrals and Roth contributions if any employee has the right to make such deferrals and contributions. Several of the previous permissible exclusions from the universal availability rules have been eliminated.
  5. Plan terminations. The final regulations permit an employer to freeze or terminate its Section 403(b) plan and, in the case of a termination, allow the participant to rollover distributions to an eligible retirement plan such as an IRA. However, the employer cannot make contributions to a new Section 403(b) plan for 12 months after the distribution of all assets from the terminated plan.
  6. Incidental life insurance contracts. Section 403(b) plans are now prohibited from purchasing stand alone incidental life insurance policies. Existing contracts are grandfathered.

The Bottom Line:  Although the final 403(b) regulations may require considerable changes to UTSaver, TSA, and ORP plan documents, particularly the written plan requirement, the final regulations should have relatively little practical impact upon the participants in the plans.

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Construction Contracting Issues:  Waiver of Consequential Damages--Just Say No

by Edwin Smith (Business Law)


One of the basic functions of contracting, generally, is to identify the risks associated with a particular transaction and to assign responsibility for those risks to one party or the other. Contract negotiations should include an analysis of who should bear the risk of a loss (typically the party whose acts or omissions cause the loss); who can afford the risk of a loss (often a function of available insurance); and, ultimately, who will bear the risk of a loss (which is usually reflected in the financial balance of the transaction).

Construction projects are risky ventures and architects, contractors, and owners routinely try to minimize their exposure to risk through their contracts. The most direct approach is to contractually limit the amounts or types of damages for which they can be held liable. For instance, standard UT System construction agreements contain a very explicit “no damages for delay” clause in order to eliminate construction delay claims which are common on construction projects. Architects and contractors often request contract terms such as limitations of liability, exclusive remedies and waivers of consequential damages in order to shift risk from them to the owner.

This article addresses one specific risk shifting strategy: waivers of consequential damages.

What are Consequential Damages?

Unfortunately, there is no predictable or uniform legal answer to this question. While damages such as lost future profits, loss of use, financing costs, business and reputation damage, loss of productivity and home office overhead costs are commonly identified as consequential damages1, legal holdings are inconsistent and the characterization of the loss often depends on the circumstances of a case and may not be known until a dispute is ultimately resolved. This uncertainty is a significant reason why agreements to waive consequential damages should be evaluated very carefully. Some definitions and some examples may help.

Legal Definition

Under contract law, damages for breach of contract are limited to actual damages that are a natural, probable and foreseeable consequence of the other party’s breach. The law further divides recoverable contract damages into two general classes: Direct Damages and Consequential or Special Damages.2 In Texas law, the difference between the two has been defined as follows:

Direct damages are the necessary and usual result of the defendant’s wrongful act; they flow naturally and necessarily from the wrong. Direct damages compensate plaintiff for the loss that is conclusively presumed to have been foreseen by defendant from his wrongful act.

Consequential damages, on the other hand, result naturally, but not necessarily, from the defendant’s wrongful acts. Under the common law, consequential damages need not be the usual result of the wrong, but must be foreseeable, and must be directly traceable to the wrongful act and result from it.3

The critical difference is that direct damages are so typical and expected that they are “conclusively presumed” to be foreseeable whereas consequential damages arise from special circumstances and are only foreseeable if the contracting parties are aware of or contemplated the special circumstances at the time the contract was formed. In order to recover consequential damages, you must be able to prove that the breaching party had knowledge of the special circumstances. That knowledge can be shown through the ordinary course of dealings between the parties or through direct communication of the special circumstances.

Knowing whether or not particular damages are general or consequential would be extremely important in deciding whether to agree to waive consequential damages. But as the definitions indicate, conclusions about what damages are presumed foreseeable and what damages are only foreseeable with the benefit of special information may depend on the facts of the case.

An Example

The Project -- You contract for a stand-alone freshman housing complex with 200 units. The project is scheduled for completion by July 15, giving you six weeks to install furniture and make sure all systems are working properly before the students arrive on September 1. However, it is now August 15 and the contractor informs you that it will be September 15 before he will have half of the units ready to occupy, and the other half will not be ready until October 15. Most of the delay has been caused by the contractor’s failure to prosecute the work as needed, but you also learn that a design error by the architect caused a defect in the air conditioning system that requires a retro-fit to every apartment. This design error accounts for ten days of the delay and costs $100 per unit to repair. Meanwhile, you are storing 200 units worth of furniture in a warehouse and are now faced with the prospect of notifying 200 enrolled students and their concerned parents that the safe and convenient housing you promised them when you took their deposits will not be ready on time.

The Damages -- Assuming the contractor is able to meet the revised schedule and you are able to move the furniture and students in on the day the units are ready for occupancy, you will have to house 100 students in a hotel for 15 days and 100 students for 45 days. At $50 each per day (including transportation to and from campus) that equals $300,000. In addition you will have stored half the furniture for an extra 60 days and the other half for an extra 90 days. At $85 per month per unit, storage costs would be $42,500. The cost to repair the air conditioners is $20,000. What if 15% of the students decide to opt out of their housing contracts? You would save $67,500 in hotel costs, but at $4,000 per student per semester, you might lose $120,000 in housing fees for the fall semester alone. The housing problems have been reported in the local and the campus papers and the University president is fielding calls from irate parents and school donors.

Direct or Consequential -- Since the contractor ultimately delivered the building that was promised in the original deal, the owner has received the benefit of the bargain. The only direct damage suffered by the owner is probably the $20,000 additional cost of the building caused by the architect’s design error. The other damages, $342,500-395,000, are most likely consequential damages. If the architect’s mistake caused 10 days of the 90 day delay, he should be responsible for 1/9th of the consequential delay damages and the contractor should be liable for the balance. However, if the owner has agreed to waive consequential damages in either contract, its claims for those portions of its injury may be barred.

Recovery of Consequential Damages -- The non-direct damages noted above do flow naturally, if not necessarily, from the architect’s and contractor’s wrongful acts but it is a fact question whether the architect and contractor were aware of the possibility of these damages occurring when they entered into their agreements with the owner. In this case it probably would not be too difficult to demonstrate that the architect and the contractor knew, either directly or through course of dealing, that the construction schedule was tied to having the housing units ready in time for renting them to students for the entire school year and that the owner would incur additional costs if the project was delayed. Therefore, in the absence of a waiver agreement, the consequential damages for loss of use and additional expenses may be recoverable. Note, however, a court might rule that losses due to students opting out of their housing agreements and any damages to the reputation of the school were too speculative and remote to be compensable under any circumstances.

Consider a different scenario where the project is a research or medical facility rather than student housing. There the consequences of delayed performance might not be as readily apparent to the architect or the contractor although the damages to the owner could be considerably greater. For instance, it is not uncommon to have donations or research grants tied to completion of a building or laboratory before a certain date. Failure to finish the project on time could cost the owner millions of dollars. But if the architect and contractor are not made expressly aware of that possibility at the time they enter into their contacts, the owner may not have a cause of action to recover those unforeseeable consequential damages.

Liquidated Damages

While the vagaries and pitfalls of enforcing liquidated damage clauses is beyond the scope of this article, it is worth noting that an agreement to waive consequential damages does not generally invalidate an enforceable liquidated damages provision, even if the liquidated damages amount was calculated to include possible consequential damages. It is also worth noting that in the housing example above, the liquidated damages amount would have to exceed $4,500 per day to provide adequate compensation to the owner.

Should a Waiver of Consequential Damages Ever be Considered?

In the construction arena it is clear that the owner has a much greater risk of suffering consequential damages than any other party. At the same time, architects and contractors who ask for waivers of consequential damages rarely, if ever, offer a meaningful benefit to the owner in return. (Often the proposal is for a mutual waiver of consequential damages, but this is hardly a fair trade because the owner bears almost all of the risk.) Three common rationales offered to promote waivers of consequential damages are discussed below.

Lower Cost Project -- An architect or contractor may assert that a waiver of consequential damages allows them to reduce or eliminate their financial risk factors and, therefore, they can perform their services on the project for a lower fee and the owner gets the project at a lower cost. It sounds promising but in practice there is usually no way to confirm the discount or to gauge whether the reduced fee is sufficiently beneficial to the owner to justify the risk. Particularly in the case of architects, with whom Texas state agencies are prohibited from obtaining competitive fee proposals, a claim of lower fees would be hard to verify. Even with contractors it would be difficult to structure requests for proposals to get pricing with and without a waiver of consequential damages in order to compare costs and benefits. Of course, with contractor agreements the owner can often build in additional protection against delay damages by including an adequate and enforceable liquidated damages clause.

Insurance Problems -- Architects and contractors sometimes assert that their insurance company requires them to obtain waivers of consequential damages. If presented with that argument, the owner should demand to see a copy of the policy or the relevant provisions or exclusions. Insurance companies do not usually require such waivers but they do encourage their clients to try and obtain them to avoid exposure to consequential damage claims. Professional liability policies and commercial general liability polices typically cover consequential damages in the absence of a waiver.

The Small Fee Does Not Justify the Risk -- In this rationale it is asserted that the potential risks associated with a project are disproportionate to the low fees that will be earned. This may appear to be a compelling argument on some very high risk but relatively small projects, but it too should generally be rejected. Owners hire architects and contractors to provide particular expertise on their construction projects and architects and contractors market themselves as having the skills to perform those services. An owner should be concerned when an architect’s or contractor’s contract negotiation strategy reveals a reluctance to be responsible for the services for which it is being hired. Rather than compromising future rights, the better approach would be to consider increasing the fee if that is appropriate or find another service provider who will stand behind its work.


1These particular types of damages are expressly identified in the waiver of consequential damages clause that the American Institute of Architects introduced in the 1997 editions of its standard agreements.

2The seminal case establishing this distinction is Hadley v. Baxendale, 156 Eng. Rep. 145 (1854). In Hadley, a mill operator sued a delivery company for not taking a broken crankshaft to its manufacturer for repair when promised and was awarded various damages at trial, including lost profits for the time the mill was idle waiting for the return of the crankshaft. On appeal, the court threw out the lost profit damages saying they were too remote and not anticipated by the defendant. The court held that the fact that Hadley could not operate the mill until the shaft was returned was a “special circumstance” and since Hadley had not told Baxendale about this special circumstance he was not entitled to the consequential damages of lost profits.

3Henry S. Miller Co. v. Bynum, 836 S.W.2d 160 (Tex. 1992) (Phillips, J., concurring) Emphasis added.

The Bottom Line:  On construction projects, the owner has the greatest risk of suffering consequential damages but those damages are usually caused by actions of the architect or the contractor. Responsibility for those damages should stay with the responsible party and the architect or contractor can obtain insurance coverage for those risks. In circumstances where an owner considers absorbing the risk of its consequential damages through a waiver, it should carefully evaluate the potential magnitude of the risk against the benefits of the waiver, if any.

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The IRS Cuts Slack for Salary Annualization Agreements for Faculty and Teachers

by Donald O. Jansen (Business Law)

It is common practice in The University of Texas System and for many other educational institutions to allow teachers to elect to receive their 9 months of pay during the school year over a 12 month period of time. This is accomplished by deferring ¼ of the paychecks for the first 9 months of the school year for payment in the last 3 months.

Such a practice, strictly interpreted, runs afoul of the new deferred compensation rules under Internal Revenue Code Section 409A. The new tax rules require that employee deferral elections generally be made in the year before the compensation is deferred. Because the annualization elections are made just before the beginning of the school year, the requirements of Section 409A would not be met for the deferrals from September through December of the school year. Violation of the new statute would result in such deferrals being subject to immediate taxation, plus a twenty percent tax penalty.

In a recent news release, the IRS set up the ground rules which would exclude most of the annualization payment elections from the new 409A statute:

  • Section 409A will not apply to the 2007-2008 school year.
  • Starting with the 2008-2009 school year, the teacher must make a written or electronic election to defer his//her compensation over a 12 month period of time.
  • The election must be made before the beginning of the school year.
  • The election must be irrevocable so that it cannot be changed during a particular school year.
  • The election must state how the compensation is going to be paid if the election is made (for example, ratably over 12 months starting with the beginning of the school year).
  • It is not necessary to make an election before each school year. The initial election can provide that it will remain in place, year by year, until the employee elects a change. However, the change in the election must be for a future year and not the current school year.

The Bottom Line:   Starting the 2007-2008 school year, elections by faculty members to spread 9 months of school year pay over 12 months have to meet new IRS requirements.

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Code Red Task Force Legislative Report - Part 1

by Lannis Temple (Health Law)

In July, 2004, the ten major Texas academic health centers, including the six University of Texas health institutions, sponsored the Task Force for Access to Health Care in Texas to analyze access to health care and health insurance issues in Texas.

Nineteen Task Force members, including four from University of Texas health facilities, as well as representatives from other academic health centers, small and large businesses, insurers, consumers, and non-academic health care providers, deliberated for 18 months and released their final report, “Code Red: The Critical Condition of Health in Texas” on April 17, 2006.

The University of Texas System’s Executive Vice Chancellor for Health Affairs, Dr. Kenneth Shine, served as Senior Advisor to this Task Force and Amy Shaw Thomas and Maggie Floores from the System’s Office of Health Affairs served as staff members.

The Task Force report decried our state’s growing chasm between health needs and the availability of affordable health insurance and outlined ten major recommendations as proposed solutions to this challenge. This OGC article will summarize the legislative activities from the recently concluded 80th Texas Legislature on the first five recommendations; the next OGC newsletter will highlight recommendations six through ten. (More detailed analyses of these healthcare bills are available on the OGC website under the Legislative Summaries link).

Recommendation One: Texas should adopt a principle that all individuals living in Texas should have access to adequate levels of health care.

HB 109 lowers the eligibility requirements for CHIP (for children who do not qualify for Medicaid and do not have private health insurance), extends the enrollment period from 6 to 12 months, and modifies the 90 day waiting period. HHSC estimates CHIP enrollment will increase by almost 130,000 children. SB 10 extensively reforms Medicaid in Texas. Medicaid patients, under pilot programs or subject to feasibility studies, will now be rewarded for participation in preventative health programs, have more customized benefit plans tailored to their individual health needs, and have the option to create a Health Savings Account. Patients will also be able to opt out of Medicaid, with the state paying the employee’s share of premiums for his employer’s coverage up to the estimated Medicaid cost for that patient. As for the uninsured, a statewide trust fund will be established for low income persons to increase their healthcare coverage access. The Fund may assist with premium payments and contributions to health savings accounts, while also reimbursing providers for uncompensated care. A committee will recommend incentives to increase the offer of employer health and long-term care insurance. HB 15 funds the settlement of Frew vs. Hawkins, which claimed the State of Texas provided inadequate care for Medicaid program children. That case’s consent decree improves children's access to and awareness of the Medicaid Early and Periodic Screening, Diagnostic, and Treatment (EPSDT) program (also, physicians and dentists who provide Medicaid services to children will see an increase in payment rates).

Recommendation Two: Texas should provide more resources and aggressively seek more efficient and effective methods to support health care to the indigent and uninsured with the goal of reducing rising health care costs.

HB 3154 establishes a committee of North Central Texas counties to study the implications of implementing regional healthcare services. SB 10, in addition to the reforms listed under Recommendation One, allows a hospital emergency room to collect co-pays from Medicaid patients for non-emergency visits if alternative health care options are available (thus reducing the burden of overcrowding in emergency rooms, allowing hospitals more funds and space to treat indigent emergency cases).

Recommendation Three: A “Quality Assurance Fee” of 3% should be assessed on revenues of all hospitals and free standing surgery centers in Texas in order to obtain a federal match to enhance overall finances for provider reimbursement and the quality and efficiency of health care.

No funding was passed.

Recommendation Four: The state should significantly increase its capacity and commitment to conduct experiments in health care delivery and funding (e.g. 1115 Waivers for R&D projects, funding pools, employer subsidies).

SB 10 establishes the Texas Health Opportunity Pool Trust Fund, to be created pursuant to a federal Medicaid waiver (1115 waivers are for research projects). HHSC will develop methodologies to allocate these federal and state monies for new and innovative programs to reduce the uninsured via private healthcare coverage, to develop tailored Medicaid benefit packages, and to defray costs for healthcare providers for uncompensated care. SB 10 creates a committee to recommend incentives for employers, especially small businesses, to offer health insurance and requires HHSC and TDI to jointly develop a premium payment assistance program.

SB 10 also expands the Texas Three-Share Program, which includes cost-sharing among the state, employers, and employees for employer-provided health insurance.

SB 24 requires HHSC to pay physicians for telemedicine visits with Medicaid patients.

HB 2702 establishes a monthly health insurance subsidy to parents who adopt foster children who do not qualify for Medicaid.

Recommendation Five: The concept of “virtual care coordination” for the uninsured (including them in a structured and connected system of care) should be developed by local communities and by the Texas Health and Human Services Commission.

SB 40 creates an Electronic Health Information Coordinating Committee to advise the Department of State Health Services regarding the coordination of state agency health information technology activities and the facilitation of sharing health information among providers. HB 1066 establishes the Texas Health Service Authority, a public-private collaborative, to support regional health information exchange initiatives. HB 2042 requires HHSC to administer a searchable on-line database of Medicaid providers. SB 204 requires electronic medical software sold in Texas to interface with the State Immunization Registry. SB 10 authorizes HHSC to adopt rules implementing Health Information Technology initiatives for Medicaid.

HB 321 establishes a pilot program to determine the feasibility of a collaborative electronic system between a local or regional indigent care system and the HHSC.

HB 1060 allows healthcare providers to put information from a person's drivers license into a database that is used to provide healthcare information.

The Bottom Line:  Dr. Shine of the UT System states: “The Task Force for Access to Healthcare in Texas can point to a number of legislative achievements in the 80th Texas Legislature which take effect immediately. As for the future, the pilot programs and feasibility studies under SB 10 will hopefully result in permanent future programs. Further, SB 10 maintains the Medicaid Reform Legislative Oversight Committee and creates a Health and Human Services Transition Legislative Oversight Committee, which will recommend additional future legislation to address these recommendations. The Task Force, which is committed to healthcare access and is continuing, expects future legislatures to build on this session’s gains.”

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Resources from this e-Newsletter

Resources in Articles Related to Student Financial Aid:

Other Resources:

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