Tuition payments as Fraudulent Transfers
TUITION CLAWBACK IN THE FIRST CIRCUIT
In the First Circuit, the payment of an adult child’s college tuition my be avoided and recovered from the University by an insolvent parent/payor’s trustee in bankruptcy. In re Palladino, 942 F.3d 55 (1st Cir. 2019). In Palladino the trustee recovered $66,275.18 in tuition as a constructively fraudulent transfer under 11 U.S.C. §548 (a) (1)(B).[1]
A parent paying for their child’s education is a good and caring parent, and the bankruptcy code does not seemingly involve itself in parenting. However, if that same parent then files a bankruptcy petition, in effect, the risk is that the parent paid for the child’s education at the expense of creditors and so the law of fraudulent conveyance applies.
A transfer is constructively fraudulent and avoidable by a trustee in bankruptcy if the transferor (the parent) [1] “received less than a reasonably equivalent value in exchange for such transfer … and [2] was insolvent on the date that such transfer was made…” 11 U.S.C.A. § 548 (West). Two elements are required: (a) the receipt of less than reasonably equivalent value and (b) insolvency. Where the parent is debtor under the code insolvency is frequently apparent. So the ability to recover the transfer depends on whether the parent “received less than a reasonably equivalent value in exchange” for the tuition payment.
“Reasonably equivalent value” is not a test of whether the tuition is fair. Rather, the test is whether the parent, as opposed to the child, received value. One might suggest that value is subjective: the happiness obtained by knowing your child is in school, but that subjective measure of value was rejected by both the bankruptcy court[2] and the First Circuit. Instead, the First Circuit held that value can be only one of five things:
(1) the exchange of property; (2) the satisfaction of a present debt; (3) the satisfaction of an antecedent debt; (4) the securing or collateralizing of a present debt; and (5) the granting of security for the purpose of securing an antecedent debt.[3]
Because the payment of tuition for an adult child is not a payment made on account of a debt or as an exchange of property, the benefit of an education of a child is not a reasonably equivalent value and if the now bankrupt parent was insolvent at the time, the tuition may be recovered by the bankruptcy trustee.
The First Circuit is the only appeals court to rule on the issue. Before its decision, bankruptcy courts were split.[4] In Palladino, the Bankruptcy Court had denied recovery, holding that the likelihood that the child would become financially self sufficient and not a dependent on the parents in the future was sufficient:
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. This, it seems to me, constitutes a quid pro quo that is reasonable and reasonable equivalence is all that is required.[5]
The First Circuit reserved the possibility that it might be different if the child is a minor and other bankruptcy courts have held that such tuition for a minor child is in satisfaction of a duty imposed on a parent.[6] But without a legal duty, the First Circuit held that the emotional benefit of knowing that your adult child is receiving an education is not reasonably equivalent value.
Edmond J. Ford
Ford, McDonald & Borden, P.A.
10 Pleasant Street
Suite 400
Portsmouth, NH 03801
603-373-1737
July 13, 2020
[1] DeGiacomo v. Sacred Heart University, Adv. P. No. 15-01126, United States Bankruptcy Court for the District of Massachusetts, Agreement for Judgment, DE 108, 1/15/2020.
[2] “Ethereal or emotional rewards, such as love and affection, do not qualify as value for purposes of defeating a constructive fraudulent conveyance claim.” In re Palladino, 556 B.R. 10, 15 (Bankr. D. Mass. 2016), rev’d and remanded, 942 F.3d 55 (1st Cir. 2019)
[3] In re Palladino, 942 F.3d 55, 59 (1st Cir. 2019)
[4] In re Palladino, 942 F.3d 55, 59 (1st Cir. 2019) provided the following citations: “Compare Sikirica v. Cohen (In re Cohen), 2012 WL 5360956, 2012 Bankr. LEXIS 5097 (Bankr. W.D. Pa. 2012), and Shearer v. Oberdick (In re Oberdick), 490 B.R. 687, 711-12 (Bankr. W.D. Pa. 2013) (holding for parents and universities), with Roach v. Skidmore Coll. (In Re Dunston), 566 B.R. 624, 637 (Bankr. S.D. Ga. 2017), Boscarino v. Bd. of Trs. of Conn. State Univ. Sys. (In re Knight), 2017 WL 4410455, 2017 Bankr. LEXIS 3324 (Bankr. D. Conn. 2017), and Geltzer, 594 B.R. 229 (holding in favor of trustees).”
[5] In re Palladino, 556 B.R. 10, 16 (Bankr. D. Mass. 2016), rev’d and remanded, 942 F.3d 55 (1st Cir. 2019)
[6] In re Akanmu, 502 B.R. 124 (Bankr. E.D.N.Y. 2013)