Recovering Tuition Payments as Constructively Fraudulent Transfers

In the many years I have spent representing Chapter 7 Trustees one of the dilemmas that I and my clients have repeatedly faced is the question of what to do about a debtor’s tuition payments towards a child’s education, especially tuition payments for children over the age of 18.

Do we seek to recover the tuition payment as either a preferential or fraudulent transfer? Some bankruptcy courts have found that constructively fraudulent transfers occurred, while others have not. In Pergament v. Hofstra Univ. (In re Adamo), 16-8122 (Bankr. E.D.N.Y. March 28, 2018), Chief Bankruptcy Judge Carla E. Craig of Brooklyn, N.Y., examined and collected cases coming down on both sides of this pesky issue.

In Pergament, a parent paid tuition for his children both before and after he filed for bankruptcy protection under Chapter 11. The case was then converted to Chapter 7, and the Trustee sued the universities to recover the pre- and post-petition tuition payments. The Trustee contended that pre-petition payments were constructively fraudulent transfers under both the Bankruptcy Code and applicable state law. The Trustee further argued that the post-petition payments were unauthorized post-petition transfers pursuant to Section 549.

Judge Craig granted summary judgment to the universities dismissing the adversary proceedings. Specifically, Judge Craig held that the universities were not the initial transferees, and, therefore they were entitled to the good faith defense as subsequent transferees under Section 550(b). It is important to note, however, that the winning, initial transferee argument hinged on how the universities structured tuition payments.

The universities created accounts for and in the name of the students. Payments by parents went into the accounts and were applied toward tuition only when the students registered for classes. Parents, even though they may have supplied the funds, had no right to access the accounts without the students’ permission. If the students were to withdraw, refunds went to the students, and not to parents who may have made the deposits initially. Accordingly, the university defendants were not the initial transferees because the parent / debtor did not have dominion or control over the accounts when the debtor made transfers. Rather, it was the students that had dominion and control over their accounts. Judge Craig found that the accounts were “akin to bank accounts” and the universities “were mere conduits in the initial transfer from the debtor to his children.” The universities had dominion and control only after the students took actions that resulted in the payment of tuition, but then the schools were subsequent transferees. As subsequent transferees, the universities were entitled to the good faith defense in Section 550(b).

One key takeaway is that while the theory advanced in Pergament lets the university defendants off the hook it puts similarly situated debtor’s children in line as potential defendants to claims that they are the initial recipients of fraudulent transfers. As initial transferees, such children would not be able to raise the good-faith defense. This ruling is certainly one for both Trustees and educational institutions to take note of in the continuing battle over pre- and post-petition tuition payments. For more information on this topic, call on of our experienced banking attorneys at our Omaha law firm, Sioux City law firm, or Sioux Falls law firm today!