Universities successfully used concepts from structured finance in fending off suits to recover tuition payments as constructively fraudulent transfers.
Bankruptcy trustees around the country have sued colleges and universities to recover fraudulent transfers when parents file bankruptcy and have paid tuition for children over age 18. The March 28 opinion by Chief Bankruptcy Judge Carla E. Craig of Brooklyn, N.Y., collects cases coming out both ways. Some find constructively fraudulent transfers, while others do not.
In the case before Judge Craig, a parent paid tuition for his children both before and after he filed a chapter 11 petition. Following conversion to chapter 7, the trustee sued the universities to recover pre- and post-petition tuition payments. The trustee contended that pre-petition payments were constructively fraudulent transfers under the Bankruptcy Code and state law and that post-petition payments were unauthorized post-petition transfers under Section 549.
Judge Craig granted summary judgment to the universities dismissing the adversary proceedings. She held that the universities were not the initial transferees and were therefore entitled to the good faith defense as subsequent transferees under Section 550(b).
The successful defense hinged on how the universities structured tuition payments.
The universities all created accounts for and in the name of the students. Payments by parents went into the accounts and were applied toward tuition 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.
Judge Craig ruled that the universities were not the initial transferees because undisputed facts showed that the parent did not have dominion or control over the students’ accounts when the debtor made transfers into the accounts. After the initial transfers, she said, the debtor could not access the accounts without the students’ authorization. Rather, she said, the students had dominion and control over their accounts.
Judge Craig said that the accounts were “akin to bank accounts,” meaning that the universities, in their roles with respect to the accounts, “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.
Since the universities were subsequent transferees, they were entitled to the good faith defense in Section 550(b). The trustee did not question the universities’ good faith, making them eligible for summary judgment.
Judge Craig’s theory lets the universities off the hook but puts the debtor’s children in the firing line as initial recipients of fraudulent transfers. As initial transferees, the children cannot raise the good faith defense.
Even though the children may have exposure, a trustee might not sue the children because they are likely judgment proof and themselves may be able to discharge liability by filing chapter 7. Or, the children could raise the theories cited by Judge Craig that have been relied upon by courts finding no fraudulent transfer resulting from tuition payments. Given the familial relationship, children likely have a better shot at beating a suit on the merits than would a college or university.