A growing number of bankruptcy cases have situations where the Chapter 7 trustee has taken legal action to seek recovery of tuition payments made by debtors to colleges before the bankruptcy filing. Some cases have even dealt with payments made to private elementary or parochial schools for tuition payments for debtors’ children.
The basis for these lawsuits is that the children were not the debtors themselves, and the schools therefore received a preferential payment from the parents, which amounts to either a fraudulent transfer of funds or a fraudulent conveyance. While not all of the decisions have been reported, there are several and the rulings have gone both ways, sometimes with the debtors prevailing, but often with the colleges having to refund the payments, leaving both the parents and students in a precarious situation with the schools, which will then look for repayment.
In cases where the trustee prevailed, examples include In re Leonard, a Michigan case in 2011, where the court held that $20,000 in tuition payments made to Marquette University by parents on behalf of their minor dependent son were fraudulent transfers because the parents themselves received no economic value for the tuition payments. While the college argued that the parents had received “value” in obtaining a quality education for their child, and that in turn would allow the child to become financially independent in the future, the court opined that because the debtors had no legal obligation to provide their son with a college education, the trustee would prevail in his lawsuit. A similar result occurred in New York in the 2010 case of In re Lindsay, where the court also found that the tuition payments were avoidable, since the debtors themselves did not receive the actual and fair consideration.
However, not all cases support the trustee, as several courts have rejected the trustee’s claims to recover tuition payments, and examples include the 2012 case of In re Cohen in PA, which rejected the trustee’s preference theories, as well as the case of In re Oberdick, also a PA case decided in 2013, where the court found the tuition payments were expenditures for necessities and something that parents are expected to assist with as a societal expectation, nor did the court find any indication of the parents having made the educational expenditures as part of a strategy or with the ulterior motive of shielding funds from their creditors.
At this point in time, no appellate courts have ruled on these bankruptcy court decisions, so there remains a conflict of opinion over the trustee’s rights to seek recovery of tuition payments made by debtors before they seek bankruptcy protection. A prudent thing for counsel to do would be to discuss with their clients the risks of an avoidance action if any pre-petition tuition payment has been made and to carefully review the timing of the filing, in order to seek to minimize the likelihood of a trustee seeking to recover those payments from the educational institution.
Michael B. Katz, Esq.
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