IN THE MATTER OF
PHILLIPS COLLEGES, INC., Docket No. 94-27-ST
Respondent. Assistance Proceeding
Appearances: Leslie H. Wiesenfelder, Esq., Dow, Lohnes & Albertson of Washington, D.C., for Phillips Colleges, Inc.
Carol S. Bengle, Esq. and Donald C. Philips, Esq., Office of the General Counsel, for the Office of Student Financial Assistance Programs, United States Department of Education.
Before: Judge Ernest C. Canellos.
In accordance with the direction of the Secretary and the ruling issued by United States
District Judge Charles R. Richey in Phillips Colleges, Inc. v. Riley, No. 94 Civ. 179
(D.D.C. Feb. 18, 1994), a termination hearing pursuant to 34 C.F.R. Part 668, Subpart G
was held in the above-captioned case on March 14, and March 15, 1994. Although the
procedural history of this case is somewhat circuitous, the substantive issue before me is
limited to the sole question of whether the appropriate sanction against Phillips Colleges,
Inc. (PCI), for the material breach of a Financial Responsibility Agreement (FRA) between
PCI and the United States Department of Education (ED), is the termination of eligibility
of PCI and its educational institutions to participate in the Federal student financial
assistance programs authorized under Title IV of the Higher Education Act of 1965, as
For the reasons stated below, I find that the imposition of termination of the eligibility of
PCI and its educational institutions to participate in programs authorized under Title IV
of the HEA is unwarranted under the circumstances of this case.
The material facts of this case are both uncontested and clearly established.See footnote 1
On July 24, 1992, ED and PCI entered into a Financial Responsibility Agreement that,
things, required the establishment of a $5,000,000 Letter of Credit (LOC) in favor of the
Department of Education.See footnote 2
Based on a report produced by a certified public accounting firm hired by PCI, Weworski
& Associates, which identified approximately $2,200,000 in
potential liabilities owed by PCI, ED drew approximately $2,200,000 on the LOC in
August 1993. PCI failed to restore the value of the LOC within 20 days of ED's draw as
required by the FRA claiming that the draw was improper because it was not based on
an administrative determination of liability as required by Title IV of the HEA.
A "Final Agency Decision" was issued on January 28, 1994 by Donald R. Wurtz, the
designated agency official. In that decision, Wurtz concluded that PCI was in material
breach of the FRA because PCI had not replenished the LOC as required by the FRA. In
a collateral action in Phillips Colleges, Inc. v. Riley, No. 93 Civ. 1703 (D.D.C. Feb. 15,
1994), Judge Richey granted ED's motion for summary judgment and held that ED's draw
on the LOC was proper because the draw complied with the terms and conditions of the
LOC. In addition, Judge Richey noted that paragraph E of Article I of the FRA explicitly
stated that ED's right to draw on the LOC was set forth in the LOC and was not
conditioned upon or subject to any term in the FRA except the condition, not at issue
here, requiring that ED afford PCI an opportunity to make a direct payment to ED prior
to the draw on the LOC. The parties do not challenge the rule that requires me to
follow Donald Wurtz' final agency decision and the decision of the district court.
Accordingly, the binding precedent of those two decisions establishes that PCI's failure to
replenish the LOC under the terms of the FRA put PCI in material breach of the FRA.
According to ED, PCI should be terminated from eligibility to participate in programs authorized under Title IV of the HEA because the Department has the right to choose to cancel the FRA, and, with this cancellation, PCI's Title IV program eligibility.See footnote 3 3
Undoubtedly, the effective termination of the FRA could have a pivotal bearing on
whether the termination remedy was warranted in this case. Consequently, as an initial
matter, I must determine whether ED has canceled the FRA.
ED argues that PCI's material breach permits the Department to exercise its right to
cancel a contract, and when it initiated termination proceedings against PCI on January
28, 1994, it concomitantly notified PCI of its intent to terminate the FRA. According to
ED, on January 28, 1994 the Acting Deputy Assistant Secretary, William Moran, issued a
letter of termination, and that letter, ostensibly attempting to terminate PCI from
eligibility to participate in programs authorized under Title IV of the HEA, also had the
effect of terminating the FRA. I do not agree.
It is axiomatic that a material breach does not automatically and ipso facto end a
contract. Cities Service Helex, Inc. v. United States, 543 F.2d 1306, 1313 (Ct. Cl. 1976).
PCI's material breach of the FRA merely gave ED the right to cancel the agreement. Id.
Nothing in the record shows that ED has canceled the FRA. To the contrary, during the
hearing, I inquired whether the FRA remained in force on the date of the second day of
the hearing and counsel for ED reluctantly conceded that the FRA had not been canceled
as of March 15, 1994. I find the court's observation in Cities Service Helex, Inc., supra,
particularly relevant here, wherein the court observed:
[w]e cannot understand how, after a material breach, the injured
can continue its own performance as well as compel the other side to
perform, and still, at the same time, claim that it ended the contract upon
that material breach. The inconsistency between the actual course of
conduct and the verbal claim is too stark. The contemporaneous action
belies the hollow words.
Id. at 1316. More important, ED's contention that the termination of the FRA somehow relates back to the January 28, 1994 letter is insupportable because Judge Richey's ruling in Phillips Colleges, Inc. v. Riley, No. 94 Civ. 179 (D.D.C. Feb. 18, 1994) plainly found that the January 28, 1994 letter was facially invalid because the letter summarily terminated PCI from participation in Title IV programs without providing PCI with an obligatory pre-termination evidentiary hearing. Judge Richey nullified the effect of the letter by requiring ED to provide PCI with a Subpart G termination hearing. Nor am I persuaded that the January 28, 1994 letter can be construed as notice to PCI of ED's election to cancel the FRA. It is inconceivable how a notice of termination, itself found
improper, could nonetheless be interpreted as an effective notice of ED's intent to
terminate the FRA.See footnote 4
Significantly, nothing in the January 28, 1994 letter refers to ED's intent to terminate the
FRA. Accordingly, the January 28, 1994 letter attempting to
terminate PCI from eligibility to participate in programs authorized under Title IV of the
HEA did not have the effect of terminating the FRA or putting PCI on notice of ED's
intent to terminate the FRA.
In its posthearing brief, ED argues that the imposition of termination is appropriate for
the following reasons: PCI's material breach of the FRA put ED at an unnecessary risk of
loss of Federal funds, PCI has had a history of breaching the FRA, and the administrative
burdens that flow from those breaches have been too significant to justify continuing the
FRA. In addition, ED argues that PCI's attempted cure of its material breach of the FRA
on February 25, 1994 was permissibly rejected by ED because PCI's opportunity to cure
lasted no later than 20 days from the Department's August 26, 1994 draw.
For its part, PCI argues that since ED had neither terminated the FRA nor put PCI on
notice of its intent to terminate the FRA before PCI's attempted cure of its material
breach on February 25, 1994, PCI's replenishment of the LOC could not be rejected by
ED, and constitutes an effective cure of its material brief.
An election to continue the contract is frequently called a waiver of the material breach. Under the election doctrine, any act indicating an intent to continue the contract is an election, and [an] election to continue may occur simply by failure of the injured party to take action to end the agreement within a reasonable time after becoming aware of the material breach. Cities Service Helex, Inc., supra, 543 F.2d 1313 (citing 5 Samuel Williston, A Treatise on the Law of Contracts §§ 683 - 685 (3d ed. 1961)). If the injured party continues to perform the contract, the right to end the contract is waived. Id. The crucial element of the election doctrine is that the injured party must be deemed to have elected to continue, not to end, the contract. As I have noted above, ED concedes that it has not canceled the FRA. In addition, ED did not rebut PCI's claim that both parties have continued to perform under the agreement notwithstanding ED's March 3, 1994 letter rejecting PCI's February 25, 1994 replenishment of LOC. Furthermore, as I have determined above, the January 28, 1994 letter from William Moran, attempting to terminate PCI from eligibility to participate in programs authorized under Title IV of the
HEA, does not explicitly express ED's intent to cancel the FRA. Consequently, under the
law of contracts, PCI's replenishment of the LOC duly cured its material breach of the
FRA.See footnote 5
However, regardless of whether PCI's February 25, 1994 replenishment of the LOC cut
off ED's right to cancel the FRA, it remains a fact that PCI materially breached the FRA,
and although the remedy of canceling the FRA may no longer be available to ED, ED
may bring a termination action pursuant to 34 C.F.R. Part 668, Subpart G seeking to
terminate PCI from eligibility to participate in Title IV programs based on the violation.
Significantly, under the law of contracts, even though an injured party may be precluded
from unilaterally canceling a contract because of the operation of the doctrine of waiver,
the injured party retains a claim for damages for the breach. See, Cities Service Helex,
Inc., supra, 543 F.2d 1313 (citing 5 Samuel Williston, A Treatise on the Law of Contracts
§§ 683 - 688 (3d ed. 1961)). Similarly, pursuant to 34 C.F.R. § 668.86(a), ED
to terminate an institution's eligibility to participate in Title IV programs for the violation
of any agreement, notwithstanding that ED's conduct may have precluded it from
unilaterally canceling the agreement. Accordingly, notwithstanding PCI's right to cure
its material breach of the FRA, the question remains whether the material breach, ab
initio, warrants the remedy ED is seeking.
The procedures for initiating the termination of eligibility of an institution to participate
in programs authorized under Title IV of the HEA are set forth at 34 C.F.R. § 668.86.
Section 668.86(a) provides that the Secretary may terminate or limit the eligibility of an
institution to participate in programs authorized under Title IV of the HEA, if the
institution violates any provision of Title IV or any regulation or agreement implementing
Title IV. However, since the imposition of termination is the most serious form of
sanction available to ED, it does not follow, a fortiori, that the termination remedy
should be imposed in every case where it may be imposed. See, e.g., In the Matter of
Mr. Arnold's Excellence Beauty School, Dkt. No. 92-121-ST, U.S. Dep't of Education
(Decision of the Administrative Judge Jan. 3, 1994). In evaluating whether the
termination remedy is appropriate, factors such as the severity or seriousness of the
violation, the pervasiveness or numerosity of the violation, and the existence of good
faith efforts to resolve the violation by the institution are clearly relevant.
In the case at bar, I find that the termination remedy is not warranted.See footnote 6 6 My finding is
based on four conclusions:  the material breach of the FRA is but one instance of a
violation of the FRA,  PCI had at least a colorable good faith challenge to ED's draw
on the LOC,  PCI replenished the LOC on February 25, 1994, and  ED's failure to
prove that the Federal government had been harmed by PCI's material breach of the
ED asserts that PCI has breached the FRA on at least two prior occasions. According to
ED, both of the alleged breaches involved the timeliness of PCI's filing of financial
statements as required by the FRA. But, as ED concedes, both breaches were cured by
PCI. More important, as I often repeated during the hearing, the issue before me is the
material breach of the FRA resulting from PCI's failure to replenish the LOC in
accordance with the requirements of the FRA. Under normal circumstances, the
existence of prior breaches of an agreement, if proven, could support ED's assertion that
the present breach is significant because of a history of prior breaches of the same
agreement. However, in the case at bar, the prior breaches that ED alleges are predicate
acts that form the basis, in part, of a termination proceeding before another judge. See,
In the Matter of Phillips Colleges, Inc., Dkt. No. 94-26-ST.
In addition, I find that PCI had at least a colorable good faith claim that ED's draw on
the LOC was improper. In its challenge against ED's draw, PCI argued that the question
whether ED's draw on the LOC was proper involves more than a perfunctory evaluation
of whether ED followed the formalities required by the LOC, itself. According to PCI, it
challenged ED's draw on the LOC because the amount drawn by ED was not based on
an accurate determination of liability and a final agency determination had not been
issued confirming the conclusions of the Weworski report, which was the basis of ED's
determination that a draw on the LOC should be made. Notably, I review these
arguments not to reconsider the issue of whether ED's draw on the LOC was proper; that
has already been decided. Instead, I review PCI's arguments to show why I have
concluded that PCI's challenge to ED's draw was not frivolous, but in good faith.
As the record plainly shows, ED drew on the LOC because of a report issued by an accounting firm hired by PCI, Weworski & Associates, which concluded that PCI had not made timely refunds of Title IV program funds to its students. At the time of the draw, ED certified to Bankers Trust Company, the issuer of the LOC, that the drawn funds would be used to pay refunds owed by PCI. During the hearing, ED conceded that notwithstanding that the draw was made in August 1993, ED had only paid approximately $25,000 in refunds to those who were supposed to receive the benefit of the approximately $2,200,000 draw on the LOC. Notably, ED had to withdraw an earlier threat to draw on the LOC in the amount of $4,400,000 because ED's decision to draw on the LOC at that time had been based on an erroneous interpretation of one of the reports issued by Weworski & Associates. Given just these facts, clearly PCI had at
least a colorable good faith challenge to the amount of ED's draw on the LOC.See footnote 7
Additionally, in a February 25, 1994 letter from the Bankers Trust Company, it stated that
the letter of credit amount reinstated effective February 25, 1994 to its original amount of
U.S. $5,000,000.00. Although ED "reject[ed]" PCI's replenishment of the LOC, it is
uncontrovertible that PCI attempted to cure its breach of the FRA while the FRA was still
in force. This is significant because, as I have noted above, PCI's material breach of the
FRA evaporated on February 25, 1994 when it cured the breach. Consequently, the
replenishment of the LOC on February 25, 1994 clearly mitigates against imposing the
harshest penalty on PCI.
Finally, ED's failure to prove that the Federal government has been harmed by PCI's
material breach of the FRA also mitigates against imposing termination.See footnote 8
According to ED, allowing PCI to go unpunished would have two devastating
consequences. First, ED
argues, if PCI goes unpunished, the provision of the FRA defining PCI's failure to
replenish the LOC as a material breach of the FRA would be rendered meaningless. The
second consequence, according to ED, is that PCI's continued participation in Title IV
programs would encourage other institutions subject to limitation/settlement agreements
with the Department to make light of their responsibilities under the [a]greement. I find
that these arguments are unavailing.See footnote 9
ED's first "devastating" consequence has already been answered. As I noted supra,
material breach of an agreement does not ipso facto end a contract. The breaching party
may, as occurred here, cure the material breach prior to the injured party canceling the
contract. Or, the injured party may simply decide to continue performance of the
contract. More important, whether PCI goes "unpunished" depends on factors other
the material breach provision of the FRA. As Judge Richey's decision, in Phillips
Colleges, Inc. v. Riley, No. 94 Civ. 179, supra, pointed out, ED could have easily
ensured that it could summarily terminate PCI from eligibility to participate in Title IV
programs, upon the finding of a material breach of the FRA, by including a clause in the
FRA that would have waived PCI's right to a Subpart G hearing, just as it has done in
other limitation agreements. Consequently, it simply does not follow that because PCI is
not sanctioned for its material breach of the FRA, the material breach provision is, itself,
rendered meaningless. Nor does this decision give the green light to other institutions
under limitation agreements to make light of their responsibilities under those
agreements. As with any administrative decision, if an institution chooses to violate its
limitation agreement with the Department, it does so at its own peril.
On the basis of the foregoing findings of fact and conclusions of law, it is hereby
ORDERED, that the eligibility of Phillips Colleges, Inc. and its educational institutions to
participate in the student financial assistance programs under Title IV of the Higher
Education Act of 1965, as amended, is not terminated.
Judge Ernest C. Canellos
Issued: March 24, 1994
Article III courts to defer to an executive branch agency's interpretation of a statute it administers when the words of a statute are ambiguous. See, Larry Evans, Jarrell Wright & Neal Devins, Congressional Procedure and Statutory Interpretation, 45 ADMIN. L. REV. 239, 240 - 241. Consequently, Chevron is inapposite to this case, which is, itself, a part of the administrative process which ultimately results in a final agency action.