Another bankruptcy trustee catches another hapless college unaware. In Roach v. Skidmore College (In re Dunston), Bankr. S.D. Ga. (Jan 31, 2017), a trustee appears to win the next battle of “bankruptcy estates v. child’s college,” ruling that an insolvent parent who paid the college tuition of an adult child made a fraudulent transfer to the college. Thus, the unsuspecting college will likely have to return the tuition to the parent’s bankruptcy estate.
The theory is simple (albeit unsettling to some). Under Section 548 of the Bankruptcy Code (and applicable state law, as a back-up), if any debtor makes a transfer to a third party while insolvent, and does not receive reasonably equivalent value in return, the debtor’s bankruptcy trustee may reclaim such transfer for the benefit of unsecured creditors (and for the benefit of the trustee’s fees, of course). In plain English, the recipient got the money, and didn’t provide anything to the insolvent party which made the payment. That’s unfair to the insolvent payor’s other creditors (who are left with crumbs, or nothing), and thus a “fraudulent transfer” can be reclaimed for all such other creditors. Congress has excluded some charitable contributions and tithes from attack. 11 U.S.C. § 548(a)(2). But Congress did not include tuition paid for an adult child in the list of exceptions, and so it is not the place of courts to graft a “adult child college tuition” exclusion to the statute.
We had a prior post on this, here. In that post, we went over a contrary ruling from the District of Massachusetts, DeGiacomo, as Chapter 7 Trustee v. Sacred Heart Univ. (In re Palladino), Bankr. D. Mass. (Aug. 10, 2016). In that case, the Bankruptcy Court ruled against the Chapter 7 trustee by holding that the future benefits an adult child may get from a college education can provide “reasonably equivalent value” such that the parent’s tuition payment to the college is not voidable. As the Palladino Court held, “[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. This, it seems to me, constitutes a quid pro quo that is reasonable and reasonable equivalence is all that is required.” (Other coverage of Palladino and opinions like it, including this recent ruling from Georgia, can be found in the outstanding coverage of Katy Stech of the Wall Street Journal here, here, and here (alas, WSJ subscriptions required)).
Now, in Roach v. Skidmore College (In re Dunston), the Bankruptcy Court for the Southern District of Georgia has ruled to the contrary. In Dunston, the Court rejected the argument that an indirect economic benefit of having a well-educated and (hopefully) a gainfully employed adult child is “reasonably equivalent value.” Instead, according to Dunston, paying an adult child’s tuition is simply honoring a “moral obligation,” and not any legal duty or actual, monetary obligation of the parent. The college – in this case, the august institution Skidmore College, near beautiful Saratoga Springs and home to some seriously rockin’ a cappella – provided no value to the debtor parent. Thus, the Dunston court allowed the fraudulent transfer action to go forward – and its will eventually be successful, in The Bankruptcy Cave’s view.
Our previous post on this issue criticized what we believed was a results-oriented decision in Palladino. To be sure, few like the idea of our educational institutions having to fully refund tuition payments which they accepted innocently, without knowing of the parent’s insolvency. But despite these misgivings, Palladino was incorrect under a plain reading of the statute – any time an insolvent debtor gives money to a third party, and receives nothing in return, that money should come back to the bankruptcy estate to benefit all other innocent creditors. The Dunston decision is right.
This problem cries out for a legislative solution. Until then, bankruptcy courts will honor the wording of the fraudulent transfer status and require colleges to return the tuition (Dunston) or find “future economic value” to the parent that is, in the view of The Bankruptcy Cave, entirely speculative (Palladino). While there are many problems with our current bankruptcy statutes, this one really needs a solution.