Update: Recovering Tuition Payments as Constructively Fraudulent Transfers

In May 2018, this Blog covered the issue of whether a bankruptcy Trustee can recover tuition payments made by debtor on behalf of the debtor’s child as either a preferential or fraudulent transfer. Some bankruptcy courts have found constructively fraudulent transfers exits, while others have not. In DeGiacomo v. Sacred Heart Univ. Inc. (In re Palladino), 17-1334 (1st Cir. Nov. 12, 2019), the First Circuit Court of Appeals clearly held the college tuition paid by a debtor parent on behalf of an adult child is a constructively fraudulent transfer. While lower courts in other circuits remain divided on the issue, the ruling in DeGiacomo leaves no doubt as to the issue in the First Circuit where the college is the initial transferee.

In the case at issue, the Debtor had been sentenced to 10 years in prison related to his part in a Ponzi scheme and also had a $9.7 million judgment against him by the Securities and Exchange Commission for securities law violations. While the Debtor was insolvent, he paid almost $65,000 over two years for the college tuition of his adult child.

Following the Debtor’s filing of a chapter 7 bankruptcy petition, the bankruptcy Trustee sued the college for both actual and constructively fraudulent transfer. On cross motions for summary judgment, the college contended that the Debtor received equivalent value because an educated child will not be an economic burden on the parents. Of note, the parties apparently conceded the college was the initial recipient of the transfer, which had the effect of precluding the college from claiming it was a subsequent transferee and meant the college could not raise a good faith defense under Section 550(b).

The bankruptcy court ruled in favor of the college, finding the Debtor received reasonably equivalent value, but certified a direct appeal to the circuit. On appeal, Judge Jeffrey Howard reversed the bankruptcy court and ruled the payments were constructively fraudulent transfers under Section 548(a)(1)(B) of the Bankruptcy Code.

According to Judge Howard, while the lower courts might be divided, the answer to the issue is “straightforward,” because the tuition payments “depleted the estate and furnished nothing of direct value to the creditors who are the central concern of the code provisions at issue.” Judge Howard went on to find that none of the exceptions in Section 548(d)(2)(A) were applicable, nor did the Debtor have any legal obligation to pay college tuition for the adult child. Judge Howard then reversed and remanded the case back to the bankruptcy court.

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.