United States: Trustee Litigation Trend: Tuition Clawback

"An investment in knowledge always pays the best interest." Benjamin Franklin, The Way to Wealth: Ben Franklin on Money and Success (1758). For parents paying their adult child's college education costs, however, this investment may not be worth (to them) the cost of tuition — at least according to some bankruptcy courts. With increasing frequency, chapter 7 trustees are looking to insolvent parents as well as colleges and universities to avoid and recover for estate creditors payments made by insolvent debtors for the benefit of the debtors' dependents. These cases are premised on the theory that the tuition payments being made by insolvent parents for the benefit of their children are avoidable as constructively fraudulent transfers because the parents do not receive reasonably equivalent value in exchange for the payment of such tuition. The principal issue in these cases is whether the payment of a child's tuition provides reasonably equivalent value to the insolvent parents. Courts are divided, with some holding that parents do receive reasonably equivalent value for the tuition payments and others holding that the parents do not. The courts that find reasonably equivalent value do so by finding economic value conferred upon the parents. See, e.g., Sikirica v. Cohen (In re Cohen), 2012 Bankr. LEXIS 5097 28-29 (Bankr. W.D. Pa. 2012); see also, DeGiacomo v. Sacred Heart Univ., Inc. (In re Palladino), 556 B.R. 10 (Bankr. D. Mass. 2016). In contrast, the courts that do not find reasonably equivalent value do so based on the absence of legal responsibility on the part of the parents to educate their child. See, e.g., Gold v. Marquette Univ. (In re Leonard), 454 B.R. 444 (Bankr. E.D. Mich. 2011); see also, Banner v. Lindsay (In re Lindsay), 2010 Bankr. LEXIS 1554 (Bankr. S.D.N.Y. 2010). Recent decisions in the Second Circuit adopt the reasoning of the latter line of decisions and hold that the value analysis turns whether there is a legal obligation to educate. See, e.g., Mangan v. Univ. of Conn. (In re Hamadi), 597 B.R. 67 (Bankr. D. Conn. 2019); Pergament v. Brooklyn Law Sch. (In re Adamo), 595 B.R. 6 (E.D.N.Y. 2019); In re Sterman, 594 B.R. 229 (Bankr. S.D.N.Y. 2018). Another issue that arises in tuition clawback litigation cases, particularly where the universities are defendants, is whether, and to what extent, the educational institutions may be considered initial transferees or mere conduits.

Tuition Payments As Constructively Fraudulent Transfers

Section 548(a)(1)(B) of the Bankruptcy Code empowers a trustee to avoid a transfer of an interest in property of the debtor under a constructive fraud theory to set aside transactions that improperly deplete a debtor's estate. See, 11 U.S.C. §548(a)(1)(B). A constructive fraudulent transfer has two basic elements: 1) whether reasonably equivalent value was received by the debtor; and 2) insolvency. The Bankruptcy Code does not define "reasonably equivalent value"; however, the term "value" is defined and is given an economic meaning. Specifically, the Bankruptcy Code provides that "value" means "property, or satisfaction or securing of a present or antecedent debt of the debtor, but ... not ... an unperformed promise to furnish support to the debtor or to a relative of the debtor." 11 U.S.C. §548(d)(2)(A). Similarly, courts have held that bonds of love and affection do not constitute reasonably equivalent value. See, e.g., Harris v. Burrell (In re Burrell), 159 B.R. 365, 370 (Bankr. M.D. Ga. 1993); see also, Kramer v. Mahia (In re Khan), 2015 U.S. LEXIS 133241 42 (E.D.N.Y. 2015). Whether the debtor received "reasonably equivalent value" is unique in the tuition clawback cases because when a parent pays tuition of a child, the child receives the direct benefits of an education, a degree, and eventual employment. Thus, 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." The courts that have examined the issue have considered whether the parents had a legal obligation to provide financial support or an education for their children as dispositive of value being provided.

Equivalent Value

Tuition payments made to or for the benefit of an adult child may change the analysis and may be deemed to be less than reasonably equivalent value. Last year, the Bankruptcy Court for the Southern District of New York rejected the debtor-parents' argument that they received an economic benefit from paying the education costs of their adult children because paying for an adult child to obtain an undergraduate degree will enhance such child's financial wellbeing which will in turn confer an economic benefit on the parents. See, Sterman, 594 B.R. 229. In Sterman, the bankruptcy court held that such asserted economic benefit did not constitute value under the New York Debtor Creditor Law or the Bankruptcy Code. The court in Sterman explained that arriving at this value conclusion was not a simple matter. 594 B.R. 229, 236. In contrast, tuition payments made to or for the benefit of minor children differ in that the parents satisfy their legal obligation to educate their child and in doing so they received reasonably equivalent value and fair consideration. The age of majority is determined by applicable state law and, therefore, a different result may have been reached had the facts of Sterman been governed by Connecticut law, providing that the age of majority is 18 as opposed to New York law under which the age of majority is 21. 594 B.R. 229, 236.

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