Alert12.04.2019

First Circuit Holds that Parents' Payment of Tuition for an Adult Child Can Be Avoided as a Fraudulent Transfer

Colleges, Universities and Other Service Providers Should Consider Steps to Protect Themselves from Fraudulent Conveyance Claims
By Elizabeth J. Austin and Irve J. Goldman

Bankruptcy trustees continue to vigorously pursue actions in which they sue colleges, universities and other institutions of higher education to recover tuition payments made by parents for their children when the parents later file for bankruptcy relief.  The trustee’s legal authority to support “tuition claw backs” is based on bankruptcy and state fraudulent transfer law, where a variety of payments can be recovered if the transferor does not recover reasonably equivalent value for payments that were made while the transferor was insolvent.  Trustees argue that it is the children, and not the parents, who receive a direct economic value in exchange for the payments they made for their children’s college education, and that the payments should thus be “clawed back” for the benefit of the parents’ creditors.  The lower courts are divided on the viability of these so-called “tuition clawback suits,” but the First Circuit Court of Appeals recently ruled on the issue in DeGiacomo v. Sacred Heart University, Inc., 942 F.3d 55 (1st Cir. Nov. 12, 2019). [1]

Last month, the First Circuit reversed the bankruptcy court’s decision which found the parent received “concrete and quantifiable” value and, as such, the tuition payments made by the parents did not constitute fraudulent conveyances.  The First Circuit is the first court of appeals in the country to weigh in on this issue.

In its decision, the First Circuit bluntly said that the answer 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.”  The bare bones decision provides no analysis of the evidence and arguments asserted by the college or the Amici parties.  The First Circuit found that even if payments by insolvent debtors were made to assist elderly parents or needful siblings or for other worthy causes, such payments do not constitute reasonably equivalent value and can be undone by the rules that allow bankruptcy trustees to recover tuition payments. 

Because the schools are usually the initial recipient of the tuition funds, the schools are deemed to be the “initial transferee” of the so-called fraudulent transfer. Under the rules for recovery of fraudulent transfers under the Bankruptcy Code, a Trustee can recover against “an initial transferee” or the person “for whose benefit [the] transfer was made.”  Trustees rarely pursue the party who gets the actual benefit of the tuition payments, i.e., the student.

One viable defense to these types of suits, which has been upheld in several court decisions, has to do with whether the schools can be considered “initial transferees.”  If not, and they are instead considered to be a transferee of the tuition payments from some other “initial transferee,” the Bankruptcy Code provides an absolute defense to recovery if the payments are received “for value,” “in good faith, and without knowledge of the voidability of the transfer.” 

Schools may be able to avoid “initial transferee” status by setting up accounts for the students through which the tuition payments flow.  Take for example the case of Mangan v. University of Connecticut[2] where UConn maintained an online portal, in the student’s name alone, through which it billed the student for tuition, fees and expenses and held or accounted for tuition payments that were made for or on behalf of the student.  By school policy, if the student chooses not to register for classes or withdraws from UConn within a limited period to time, e.g., one or two weeks into the school year, then UConn will issue a refund of all or a percentage of the  tuition paid directly to the student, regardless of who paid the money into the student’s account.  The amount of the refund gradually decreases the longer a student waits to withdraw, until eventually no refund will be due.

The Court held, following the reasoning in Pergament v. Hofstra Univ., [3] that as to the tuition payments that remained “refundable” at the time they were made, UConn was not an initial transferee but a “mere conduit,” similar to a bank, that was, in effect, holding the money for the student.  The Court explained that to qualify as an “initial transferee,” one must have “dominion over the money or other asset, the right to put money to one’s own purposes,” and that an entity that acts as a mere conduit for funds and performs its role in accord with its contractual undertaking is not an initial transferee.  Under this definition, it was held that because UConn did not have the right to put the money in the student’s tuition account to its own purposes until after the tuition became non-refundable, it was a “mere conduit” for the student, who in that case, was considered to be the “initial transferee.”  UConn was thus able to successfully assert a “good faith” defense to the recovery of the “refundable” tuition payments.    It would be well-advised for colleges and universities to take the same steps that UConn and Hofstra took to shield themselves from tuition clawback claims.

However, the First Circuit’s ruling that no matter how worthy the cause, the transfer can be undone, raises concerns for institutions that are not just colleges and universities.  Nursing homes, hospitals and other health care agencies, as well as landlords and other service providers are at risk if, for example, a family member pays for the care of an elderly parent or sick adult child and that family member subsequently files bankruptcy in the fraudulent conveyance lookback period.  So, other service providers should also consider developing procedures that would prevent them from being deemed initial transferees and vulnerable to fraudulent conveyance claims. 

[1] The lower courts ruling in favor of the schools are In re Eisenberg v. Penn. State University (In re Lewis), 574 B.R. 536 (Bankr. E.D. Pa. 2017); DeGiacomo v. Sacred Heart University, Inc. (In re Paladino), 556 B.R. 10 (Bankr. D. Mass. 2016) (reversed on appeal); Shearer v. Oberdick (In re Oberdick) 490 B.R. 687 (Bankr. W.D. Pa. 2013); and Sikirica v. Cohen (In re Cohen) 2012 WL 5360956 (Bankr. W.D.Pa. 2012) The lower courts holding in favor of the trustees are Geltzer v. Oberlin College (In re Sherman) 594 B.R. 229 (Bankr. S.D.N.Y. 2018); Boscarino v. Board of Trustees of Connecticut State University System (In re Knight) 2016 WL 6134143 (Bankr. D. Conn. Oct. 20, 2016); Roach v. Skidmore College (Matter of Dunston), 566 B.R. 624 (Bankr. S.D. Ga. 2017); Banner v. Lindsey (In re Lindsey) 2010 WL 1780065 (Bankr. S.D.N.Y. May 4, 2016); Gold v. Marquette Univ. (In re Leonard) 454 B.R. 444 (Bankr. E.D. Mich. 2011). 

[2] Mangan v. University of Connecticut (in re Hanadi), 597 B.R. 67 (Bankr. D Conn. Jan. 31, 2019) (Tancredi, J.) 

[3] Pergament v. Hofstra Univ., (in re Adamo), 582 B.R. 267 (Bankr. E.D.N.Y 2018), vacated and remanded on other grounds sub nom. Pergament v. Brooklyn Law School, 595 B.R. 6 (E.D.N.Y 2019)

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