Two Courts Clear the Way for Bankruptcy Trustees to Avoid Tuition Payments Made by Parents on Behalf of Children as Fraudulent Transfers | Financial Services Perspectives

by Bradley Arant Boult Cummings LLP
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Bradley Arant Boult Cummings LLP

Two bankruptcy courts recently cleared the way for bankruptcy trustees to avoid college tuition payments made by debtor-parents on behalf of their children as fraudulent transfers, potentially affecting the college’s ability to keep such tuition payments. Following up on our prior coverage, these decisions set up a split among the bankruptcy courts as to whether a parent receives “reasonably equivalent value” as a result of their child’s college education such that those tuition payments should remain in the creditor university’s hands as opposed to being recovered for the benefit of the parent’s creditors. With these two decisions, a consensus opinion is emerging that such transfers may be recouped by the parent’s bankruptcy estate, absent tangible evidence of benefit to the debtor-parent.

In Boscarino v. Bd. of Trs. of Conn. State Univ. System (In re Knight), the bankruptcy court denied a motion for summary judgment filed by Central Connecticut State University. The Chapter 7 trustee sought to recover approximately $21,000 of tuition payments made by the debtor on behalf of her son. The facts of the case were undisputed, and the parties agreed that the tuition payments would qualify as constructively fraudulent transfers if the trustee could establish that the debtor received less than reasonably equivalent value in exchange.

To determine whether reasonably equivalent value was received, courts must first determine whether the debtor received any “value” at all in exchange for the transfer and then whether the value received was reasonably equivalent to the value the debtor gave up. The debtor offered testimony that she made the tuition payments because she wanted to reduce the amount of debt her son had at graduation and to fulfill her Expected Family Contribution, as calculated in federal determinations of financial aid. The debtor also believed that subsidizing her son’s college tuition would help him become financially self-sufficient, which would ultimately benefit her because he would be less likely to rely upon her for his living expenses and more likely to someday provide financial support to her, if necessary.

Although other bankruptcy courts have credited such concerns in the reasonably equivalent value analysis, the Knight court took a harder line, reasoning that moral or family obligations cannot be considered in the reasonably equivalent value analysis “for the obvious reason that the depletion of resources available to creditors cannot be offset by the satisfaction of moral obligations.” The court noted that to the extent courts have held otherwise, the benefit received by the parent-debtor has not been economic, concrete or quantifiable – the parent has not received “any legally cognizable value, much less reasonably equivalent value” in exchange for tuition payments.

It further opined that contrary rulings violated the separation of powers because the well-founded concerns of the judiciary about the wisdom of allowing trustees to claw back college tuition payments must yield to the clear intent of Congress, as articulated by the Bankruptcy Code’s fraudulent transfer provisions. The court likened the tuition clawbacks to the split in authority over whether tithes and donations to religious institutions were constructively fraudulent transfers, a question that was resolved when Congress passed the Religious Liberty and Charitable Donation Protection Act of 1998, which amended Bankruptcy Code section 548 to expressly shield charitable donations to qualifying institutions from a trustee’s avoidance powers.

The court also rejected arguments that a child’s promise to repay their parent’s tuition outlays could qualify as reasonably equivalent value because the mere expectation of economic benefit was not legitimate and reasonable such that it could confer “value” for purposes of a fraudulent transfer analysis.

Similarly in Slobodian v. Penn. State Univ. (In re Fisher), the Chapter 7 trustee filed an adversary proceeding alleging that within two years of filing for bankruptcy protection, the parent made tuition payments totaling approximately $5,800 on behalf of her son. Penn State moved to dismiss the adversary complaint on the grounds that it did not state a claim upon which relief could be granted. The bankruptcy court issued a report recommending that Penn State University’s motion to dismiss the adversary complaint be denied.

The bankruptcy court reviewed a handful of conflicting prior decisions and ultimately concluded that it lacked sufficient proof to overcome the allegation that the debtor received less than reasonably equivalent value. The bankruptcy court found that the debtor received “at least some intangible value” in exchange for the tuition payments in that she was “less worried about her son’s future economic prospects,” but without evidence of the son’s graduation, employment or financial status, the bankruptcy court could not determine whether the debtor received reasonably equivalent value in exchange for the tuition payments.

As in our prior coverage, the Fisher court distinguished a case where the tuition payments at issue had been made to the university from pre-petition loans the debtor obtained from the Department of Education (e.g., Parent PLUS loans). According to the Fisher court, the fact that the tuition payments were made to the university without passing through either the debtor or his children meant that the loan proceeds were never the debtor’s property and so could not be subject to the trustee’s recovery action.

The Knight and Fisher decisions signal a trend that likely dismays higher education institutions and makes it harder to track and service student loans. As bankruptcy courts increasingly demand tangible proof of reasonably equivalent value, it will be harder for colleges and universities to avoid these lawsuits on procedural grounds. The Knight court is likely correct that a legislative fix is the most efficient solution, but in the meantime, we can expect the unsettled state of the law to result in varied and often contradictory decisions regarding reasonably equivalent value.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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