On November 12, the U.S. Court of Appeals for the First Circuit reversed a decision of the Bankruptcy Court for the District of Massachusetts addressing the constructively fraudulent transfer of assets. The court ruled that a bankruptcy trustee could “claw back,” or recover, payments made to an institution from a parent paying for his or her adult child’s education when the parent has filed for bankruptcy or files within two years of such payment.
The bankruptcy trustee in the case argued that parents have no legal obligation to pay their adult children’s college tuition and receive no “reasonably equivalent value” for tuition payments, making them eligible for recovery in bankruptcy proceedings. The First Circuit agreed with this argument, while conceding that the outcome may be different in cases of tuition payments for minors who have a more reasonable expectation of financial support.
The U.S. Bankruptcy Code currently recognizes five classes of transactions that confer value under the “reasonably equivalent value” standard:
- The exchange of property.
- The satisfaction of a present debt.
- The satisfaction of an antecedent debt.
- The securing or collateralizing of a present debt.
- The granting of security for the purpose of securing an antecedent debt.
While the decision acknowledges that paying an adult child’s tuition may indeed be a worthy cause and a justifiable expenditure for an otherwise solvent person, in the cases of an insolvent person it depletes the parent’s pool of assets that would eventually be otherwise available to satisfy creditors’ claims.
Since this is the first U.S. Court of Appeals decision on higher education tuition claw backs in cases of parental bankruptcy, the frequency of claw backs from bankruptcy trustees is likely to increase. Institutions will have few options to deal with these situations beyond passing along the loss to the affected student.
In one recent case, however, a university successfully defended against a claw back. Tuition and fees paid by parents were placed into an account controlled by the student at the school. Therefore, the student was the initial recipient of the funds. When the school withdrew funds from the account when payment was due, the school was considered a subsequent transferee. Bankruptcy law prohibits trustees from recovering funds from a subsequent transferee if the transferee takes the payments for value, in good faith, and without knowledge of the voidability of the transfer. The bankruptcy court found that the institution met those three requirements and denied the claw back.
In 2017, NACUBO joined the American Council on Education and 18 other higher education associations in filing an amicus brief on the matter. The brief argued that parents do receive “reasonably equivalent value” when they help pay for their children’s college education and that institutions cannot anticipate a parent’s potential insolvency or absorb the loss of clawed-back payments for the education they have already provided.