Bankruptcy Courts throughout the country are split on the socially charged issue of whether tuition payments made by parents for their adult children can be recovered by a bankruptcy trustee as “constructively fraudulent” transfers.1 The result of avoidance is commonly that the educational institution has to turn over the tuition payments to a bankruptcy trustee for distribution to creditors. This blog focuses on the disparity among courts and nuances in the case law.
A majority of the decisional law stems from actions where a Chapter 7 bankruptcy trustee seeks to avoid certain transfers as constructively fraudulent under § 548 of the Bankruptcy Code and/or applicable state specific fraudulent transfer law. 2 A constructively fraudulent transfer is made within 2 years (or 4 years under some States’ law) prior to the date the bankruptcy was filed, at a time the debtor was insolvent, and when the debtor did not receive “reasonably equivalent value” for the transfer. In looking at the totality of the circumstances reasonably equivalent value is essentially “whether the debtor got roughly the value it gave.”3Whether the debtor received “reasonably equivalent value” is unique in these circumstances because when a parent pays tuition of a child, the child receives the direct benefit, i.e. the education, degree, and hopefully eventual employment. Generally, parents have no legal obligation to support or provide an education for their adult children.4 Therefore, it must be determined whether (1) the parent receives any value at all for paying tuition for an adult child; and (2) whether that value constitutes “reasonably equivalent value.”5
In looking at constructively fraudulent transfers, courts hold that a debtor can receive indirect value for a transfer including “the mere opportunity to receive an economic benefit in the future.6 However, “[t]here must be some realized commercial value to the value of what was
transferred.”7 To show an indirect benefit the debtor must have received (1) economic benefit (2) that is concrete and (3) quantifiable. 8
Moral/Social Obligation Approach – Cases Holding that Tuition Payments are Not Avoidable
Several courts 9 have held that, notwithstanding the lack of a legal obligation to pay for adult children, college tuition payments are not avoidable. Two opinions commonly cited, Cohen 10 and Oberdick,11 denied avoidance sought by a Chapter 7 trustee under Pennsylvania fraudulent transfer law 12 finding the payments were “reasonable and necessary for the maintenance of the[d]debtor’s family . . . .” 13 and because “there is something of a societal expectation and reasonable parental obligation underlying such payments.” 14 Other courts have found value when parents believe that the education will result in a self-sufficient child, less likely to require support from the parents after graduation.15 In Palladino, the court held “[a] parent can reasonably assume that paying for a child to obtain an undergraduate degree will enhance the financial well-being of the child which in turn will confer an economic benefit on the parent.”16
Plain Language Approach – Cases Holding Tuition Payments are Avoidable
Other courts hold that tuition payments are avoidable because the parents do not receive reasonably equivalent value.17 Under § 548, “value” is defined as “property, or satisfaction or securing of a present or antecedent debt of the debtor, but does not include an unperformed promise to furnish support to the debtor or to a relative of the debtor.” 18 Following this language, courts holding tuition payments are avoidable find that moral obligations of supporting adult children do not constitute value, because “value is limited to economic benefits that preserve the net worth of the debtor’s estate for the benefit of creditors.”19 As the court in Knight stated “carving out an exception for transfers that satisfied intangible social obligations would also violate the plain language of the Bankruptcy Code.”20 The Knight court noted that Congress has not amended the Bankruptcy Code to protect tuition payments from avoidance, as it did in 1998 for religious/charitable contributions,21and declined to read such a protection into the code stating “the separation of powers dictates that even well founded concerns of the judiciary must yield to clear intent of Congress. Congress may someday amend the Bankruptcy Code . . .‘but it is not for us to speculate, much less act, on whether Congress would have altered its stance . . ..”22 In 2015, a bill was proposed to protect college tuition payments but was not passed. 23 Following, inter alia, the Knight court and noting that it was “constrained by the language of the Bankruptcy Code and the [New York fraudulent transfer laws]” the Court in Sterman found that debtor received neither fair consideration nor value for tuition payments for her adult daughter. 24
The Determination of Reasonably Equivalent Value
Even when a court determines that a debtor receives some value for tuition payments for their adult children, that value is not always reasonably equivalent value. The court in Fisher, after finding the debtor received some intangible value for tuition payments, stated “there is an insufficient record for me to determine equivalence of value.”25 The Fisher court proposed some questions determine whether “reasonably equivalent” value was received, including: “Has the Debtor’s son graduated? If so, in what is his degree? Is he presently employed? If so, what is his position and does it require an undergraduate degree? Is the Debtor currently providing any financial support to her son?” 26The questions contemplate an exploration to the actual value and career prospects the tuition payments yield the student and the parent, an area not specifically addressed by other courts.
Limitations on Avoidance Powers for Tuition Payments.
There are some limitations on avoidance powers even before a determination of value. Generally, Chapter 7 trustees have been precluded from avoiding tuition payments made on behalf of minor children. 27 Also, the holding in Cohen is limited “to payments the [debtor] made for the children’s undergraduate education as such children in graduate school are well into adulthood.” 28
When a parent co-signs a Grad-Plus loan and the funds are delivered directly to the institution, courts have found that no transfer of the debtor’s property occurred, and therefore the payment could not be avoided. 29 Also, payments are not avoidable when the funds are placed in a student controlled account with the school, the tuition is not withdrawn until the student registers for classes and is refundable to the student if he/she withdraws from the school. 30 In these circumstances, the school acts as a mere conduit to the transfer from the parent to the child. 31
To date, no Circuit Courts of Appeal have ruled on this issue and Congress has yet to amend the Bankruptcy Code to provide express protections for college tuition payments for adult children. Accordingly, the above detailed disparity in decisional law demonstrates the unsettled nature of these disputes. Institutions faced with an avoidance action brought by a Chapter 7 trustee should contact bankruptcy counsel before formulating a strategy to defend the action so as to become aware of the applicable decisions in the jurisdiction in which they are litigating.
1 For cases finding tuition payments avoidable see generally In re Sterman, 594 B.R. 229 (Bankr. S.D.N.Y. 2018); In re Knight, 2017 WL 4410455 (Bankr. D. Conn. Sept. 29, 2017); Matter of Dunston, 566 B.R. 624 (Bankr. S.D. Ga. 2017); In re Leonard, 454 B.R. 444 (Bankr. E.D. Mich. 2011); In re Lindsay, 2010 WL 1780065 (Bankr. S.D.N.Y. May 4, 2010).
For cases finding tuition payments not avoidable see generally In re Adamo, 582 B.R. 267 (Bankr. E.D.N.Y. 2018) (subsequent history omitted); In re Palladino, 556 B.R. 10 (Bankr. D. Mass. 2016); In re Oberdick, 490 B.R. 687 (Bankr. W.D. Pa. 2013); In re Cohen, 2012 WL 5360956 (Bankr. W.D. Pa. Oct. 31, 2012), rev’d in part on other grounds, 487 B.R. 615 (W.D. Pa. 2013); In re Lewis, 2017 WL 1344622 (Bankr. E.D. Pa. Apr. 7, 2017).
2 11 U.S.C. § 544 incorporates state specific fraudulent transfer laws.
3 In re Fisher, 575 B.R. 640, 648 (Bankr. M.D. Pa. 2017) (citations omitted).
4 In re Leonard, 454 B.R. 444, 457 (Bankr. E.D. Mich. 2011); see also In re Cohen, 2012 WL 5360956, at *9–10 (noting that Pennsylvania legislature has not enacted any statues requiring parents to pay for post-secondary education for their adult children).
5 See In re Palladino, 556 B.R. 10, 15 (Bankr. D. Mass. 2016) (noting that litigation to recover tuition payments for adult children “is really about value.”).
6 In re R.M.L. Inc., 92 F.3d at 148.
7 Metro Communications, Inc., 945 F.2d 635 at 647 (3d Cir. 1991).
8 In re Leonard, 454 B.R. 444.
9 See supra Footnote 1.
10 2012 WL 5360956 (Bankr. W.D. Pa. Oct. 31, 2012).
11 490 B.R. 687 (Bankr. W.D. Pa. 2013).
12 The nuanced circumstances of Oberdick and Cohen need to be considered before applied generally to this issue. In both cases, the trustee sought avoidance under 12 Pa. C.S.A. § 5104(a)(2), using 11 U.S.C. § 544(b), to get the longer 4 year look back period. Oberdick involved transfers for minor children’s educational expenses which are exempt “necessity”, unavoidable payments under Pennsylvania law. Also, both cases sought avoidance of transfers that were initially wage transfers from the employer accounts into debtors’ entireties accounts and then used for education expenses.
13 Cohen, AD, 2012 WL 5360956, at *10.
14 Oberdick, 490 B.R. 687, 712 (Bankr. W.D. Pa. 2013).
15 In re Palladino, 556 B.R. 10, 16 (Bankr. D. Mass. 2016).
17 See supra Footnote 1.
18 11 U.S.C. § 548(d)(2)(A).
19 In re Knight, 2017 WL 4410455, at *3 (citations omitted); In re Leonard, 454 B.R. 444, 459 (Bankr. E.D. Mich. 2011) (holding that moral obligation and peace of mind of educating an adult child do not provide economic, concrete or quantifiable benefits.); In re Sterman, 594 B.R. 229, 236 (Bankr. S.D.N.Y. 2018).
20 In re Knight, 15-21646 (JJT), 2017 WL 4410455, at *3.
21 Id. at *5 (discussing the Religious Liberty and Charitable Donation Protection Act of 1998, which protects qualified chartable contributions made by a debtor within the avoidance windows of section 548 and applicable state law).
22 In re Knight, 2017 WL 4410455, at *4 (citing TVA v. Hill, 437 U.S. 153, 194–95, 98 S. Ct. 2279, 2302, 57 L.Ed. 2d 117 (1978); Kelly v. Robinson, 479 U.S. 36, 58, 107 S. Ct. 353, 365, 93 L.Ed. 2d 216 (1986)).
23 See H.R. 2267, 114th Cong. (2015); see also Elizabeth E. Stephens, Pact Will Not Prevent Trustees from Attempting to Claw Back College Tuition Payments, 35 AM. BANKR. INST. J. 16, 62 (February 2016).
24 In re Sterman, 594 B.R. 229, 236 (Bankr. S.D.N.Y. 2018).
25 In re Fisher, 575 B.R. 640, 647 (Bankr. M.D. Pa. 2017).
26 Id. at 647–48.
27 In re Sterman, 594 B.R. 229, 239 (Bankr. S.D.N.Y. 2018)(avoiding tuition payments made after debtor’s daughter reached majority age, but denying avoidance of college tuition payments made when the daughter was still a minor); In re Akanmu, 502 B.R. 124 (Bankr. E.D.N.Y. 2013); In re Karolak, 12-61378, 2013 WL 4786861, at *4 (Bankr. E.D. Mich. Sept. 6, 2013).
28 In re Cohen, 2012 WL 5360956, at *9–10.
29 In re Lewis, 574 B.R. 536 (Bankr. E.D. Pa. 2017); Novak v. University of Miami, 2018 WL 1121589 (Bankr. D. Conn. Feb. 27, 2018); In re Demitrus, 586 B.R. 88 (Bankr. D. Conn. 2018); but see In re Leonard, 454 B.R. 444 (Bankr. E.D. Mich. 2011) (transfer of debtors’ property occurred where proceeds of student loan co-signed by parents were first deposited in parents joint bank account and then paid to school.).
30 See In re Adamo, 582 B.R. 267 (Bankr. E.D.N.Y. 2018) (subsequent history omitted) (Holding universities were not initial transferees but simply conduits for the transfers. Much like a financial institution with depository accounts).