A developing trend in our nation’s bankruptcy courts has been the number of lawsuits filed or threatened by bankruptcy trustees to recover tuition payments made by a student’s parents when the parents later file for bankruptcy protection. According to a recent article in The Wall Street Journal, a search of public filings across the country, dating back to 2008, revealed that at least 25 colleges have been asked to return money, with more than a dozen complying. (Katy Stech, “Bankruptcy Trustees Claw Back College Tuition Paid for Filers’ Kids,” The Wall Street Journal, May 5, 2015.) The theory of recovery, which is typically directed against the school that received the tuition payments, is that such payments constitute constructively fraudulent transfers that may be recovered by a bankruptcy trustee for the parents’ creditors.
To establish this type of fraudulent transfer, the trustee must show that the parents did not receive “reasonably equivalent value,” in economic terms, for the payments, and that the parents were insolvent at the time the payments were made or rendered insolvent by the payments. The look-back period for recovery is two years prior to the bankruptcy filing under the Bankruptcy Code’s fraudulent transfer statute and is typically longer – up to six years – under applicable state fraudulent transfer law, which is incorporated in the Bankruptcy Code.
The bankruptcy courts that have addressed this particular type of lawsuit are divided. Some have held that if, under state law, a parent does not have a legal obligation to support a child who is 18 years of age or older, the parent does not receive “reasonably equivalent value” for making tuition payments for that child, which may be recovered from the school that received them. See e.g. Gold v. Marquette (In re Leonard), 454 B.R. 444 (Bankr. E.D. Mich. 2011). Others have held that tuition payments may not be recovered, even after the legal obligation of parental support ends, on the basis that they are “reasonable and necessary,” Sikirica v. Cohen (In re Cohen), 2012 WL 5360956 (Bankr. W.D. Pa. Oct. 31, 2012), rev’d on other grounds 487 B.R. 615 (W.D. Pa. 2013), or are grounded on a “societal expectation” that the parents will assist with higher education expense if they are able to do so. Shearer v. Oberdick (In re Oberdick), 490 B.R. 687 (Bankr. W.D. Pa. 2013). The question of the parents’ insolvency at the time of the tuition payment was never addressed in these cases and seems to have been presumed or established.
The consequences of allowing this type of lawsuit to succeed are rather profound. The school that is compelled to refund a tuition payment could suspend the student’s ability to take courses or sue the student for recovery of the tuition that had to be refunded.
To address the perceived inequity flowing from these so-called tuition clawback suits, on May 12, 2015, Representatives Collins (R – N.Y.) and Farenthold (R – Tex.) introduced a bill known as “The PACT (Protecting All College Tuition) Act of 2015.” It provides an exception to the avoidance of transactions by a bankruptcy trustee, under the Bankruptcy Code’s fraudulent transfer provision, where the transaction was a good faith payment by a parent of post secondary education tuition for that parent’s child. In an apparent oversight, however, the proposed legislation does not address avoidability of tuition payments under state fraudulent transfer law.
With many families already strapped by the mounting costs of higher education, the idea that a trustee of parents who file for personal bankruptcy can recover tuition they previously paid, putting their student-child at financial and educational risk, seems quite unsettling. It remains to be seen whether Congress or the courts will allow this burgeoning type of suit to continue.
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