While the bankruptcy court’s decision in Palladino represents a notable step toward barring these types of avoidance claims, it does not settle the issue.

College students across the country have begun returning to campus for the start of the fall semester. This arrival heralds new opportunities, new friends and new classes. It also means new tuition payments. Given the soaring price of college tuition, many students will rely on their parents to assist them with the cost of attendance. This parental support may take many forms, from co-signing or guarantying undergraduate loans to directly funding tuition costs. While generally supported, if not encouraged by, lenders, schools, parents and students alike, a developing trend among bankruptcy trustees may undermine this arrangement in cases where the supporting parent later files for bankruptcy.

Pursuant to section 548 of the Bankruptcy Code, the trustee of a debtor’s bankruptcy estate may avoid a fraudulent transfer of property made by the debtor in the two years preceding the debtor’s bankruptcy filing. Section 544 of the Bankruptcy Code allows the trustee to look back even further (often four years) if permitted by applicable state fraudulent transfer law. A transfer will be “actually” fraudulent where it is made with the intent to hinder, delay or defraud creditors. Likewise, a transfer will be “constructively” fraudulent where the transferor does not receive reasonably equivalent value and the debtor was insolvent at the time of the transfer or became insolvent as a result thereof. Once avoided, the trustee may recover the value of the fraudulent transfer from the transferee for the benefit of the debtor’s bankruptcy estate pursuant to section 550 of the Bankruptcy Code.

Increasingly, chapter 7 trustees have employed these avoidance powers in an effort to claw-back payments made by debtor-parents to colleges and universities on account of their child’s tuition. In many of these cases, the trustees seek to avoid the tuition payments as constructively fraudulent transfers. According to these trustees, the debtor-parents, who are the ones making the tuition payments, fail to receive reasonably equivalent value since their child is the one ultimately receiving the educational benefit.

Courts have issued conflicting opinions concerning these types of avoidance actions. For example, some courts have relied upon the “societal expectation” that parents assist with the cost of their child’s post-secondary education. See, e.g., Trizechahn Gateway, LLC v. Oberdick (In re Oberdick), 490 B.R. 687, 712 (Bankr. W.D. Pa. 2013). Conversely, some courts have held that such payments are avoidable because the benefits received by parents in exchange are not “concrete” or “quantifiable,” or because the parents are under no legal obligation to cover these types of costs for adult children. See, e.g., Gold v. Marquette Univ. (In re Leonard), 454 B.R. 444, 457 (Bankr. E.D. Mich. 2011).

Recently, in DeGiacomo v. Sacred Heart University, Inc. (In re Palladino), Adv. Pro. No. 15-01126, 2016 Bankr. LEXIS 2938 (Bankr. Mass. Aug. 10, 2016), the Massachusetts bankruptcy court concluded that the debtors’ pre-bankruptcy payment of their child’s college tuition was not avoidable as a constructively fraudulent transfer because the debtors received reasonably equivalent value. Between March 2012 and March 2014, Steve and Lori Palladino paid approximately $65,000 to Sacred Heart University to cover the tuition costs of their adult daughter. The Palladinos subsequently filed for chapter 7 bankruptcy. Their bankruptcy trustee filed an adversary complaint seeking to avoid, as a fraudulent transfer, the Palladinos’ pre-bankruptcy tuition payments to Sacred Heart. The trustee argued that the Palladinos were not legally required to pay their daughter’s college tuition because Massachusetts state law does not impose such an obligation. Further, he argued that any emotional benefit the Palladinos received by paying their daughter’s tuition did not qualify as “value” for purposes of defeating a constructive fraudulent transfer claim.

In its response to the complaint, Sacred Heart disputed that the Palladinos failed to receive reasonably equivalent value in exchange for the tuition payments. In support of its motion for summary judgment, the university submitted, among other evidence, an affidavit of Lori Palladino attesting that as a mother she felt obligated to pay her daughter’s tuition. Mrs. Palladino also testified that she believed that assisting her daughter with paying for college gave her daughter the best chance of graduating and ultimately becoming financially self-sufficient.

The bankruptcy court credited this testimony and entered summary judgment in favor of Sacred Heart. In its opinion, the bankruptcy court recognized that, at the time the Palladinos paid their daughter’s tuition, “they believed that a financially self-sufficient daughter offered them an economic benefit and that a college degree would directly contribute to financial self-sufficiency.” The bankruptcy court further held that “[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.” Accordingly, the court concluded that this benefit “constitutes a quid pro quo that is reasonable and reasonable equivalence is all that is required” to shield a transfer from avoidance as a constructively fraudulent transfer.

While the bankruptcy court’s decision in Palladino represents a notable step toward barring these types of avoidance claims, it does not settle the issue. In fact, on August 18, 2016, the trustee appealed the bankruptcy court’s decision and has sought direct certification to the United States Court of Appeals for the First Circuit. At the same time, legislation aimed at amending the Bankruptcy Code to exempt these types of transfers from avoidance continues to make its way through Congress. Whether this issue is ultimately resolved by the courts or the legislature remains to be seen. Until then, educational institutions should consider measures that mitigate the risks that payments made to them by parents on behalf of students may later be avoided.

For Further Information

If you have any questions about this Alert, please contact Paul D. Moore, Michael R. Lastowski, Jarret P. Hitchings, any of the attorneys in the Business Reorganization and Financial Restructuring Practice Group or the attorney in the firm with whom you are regularly in contact.

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