The First Circuit starkly held – without any ifs, ands, or buts – that college tuition paid by an insolvent parent for an adult child is a constructive fraudulent transfer.
The lower courts are divided on the issue, but the First Circuit is the first court of appeals to decide the question.
The debtor was a fraudster sentenced to 10 years in prison for perpetrating a Ponzi scheme and was slapped with a $9.7 million judgment by the Securities and Exchange Commission for securities law violations. As usual, the college was an innocent bystander.
Insolvent at the time, the fraudster-parent had paid almost $65,000 in college tuition for an adult child over two years. The last payment was some two months before the father copped a guilty plea. Two months after the plea, he filed a chapter 7 petition.
The chapter 7 trustee sued the college on theories of actual and constructive fraudulent transfer. On cross motions for summary judgment, the college contended that the debtor-father received equivalent value because an educated child will not be an economic burden on the parents.
The bankruptcy court ruled in favor of the college, finding that the debtor received reasonably equivalent value. The bankruptcy court certified a direct appeal to the circuit.
In an eight-page opinion on November 12, Chief Circuit Judge Jeffrey R. Howard reversed, ruling de novo on a question of law that the payments were constructively fraudulent transfers under Section 548(a)(1)(B).
Judge Howard explained that courts “evaluate transfers from the creditors’ perspective . . . , measuring value at the time of transfer.” He conceded that lower courts are divided on the issue, “although the recent cases have mostly ruled for trustees.”
Judge Howard said 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.”
Judge Howard said that none of the exceptions in Section 548(d)(2)(A) were applicable, nor did the debtor have any legal obligation in Massachusetts to pay “college” tuition for an adult child. He was not swayed even if payments were for “worthy causes,” such as caring for “elderly parents or needful siblings.”
Judge Howard reversed and remanded the case to the bankruptcy court, saying that the Bankruptcy Code “is the end of the matter” when there is “a clear statutory command.”
What the Opinion Does Not Consider
Evidently, the parties conceded that the college was the initial recipient of the fraudulent transfer, thus preventing the college from claiming to be a subsequent transferee who could raise a good faith defense under Section 550(b).
Aware of the threat of being sued, colleges and universities are getting smart. We have reported cases where colleges set up accounts for each student. The parents make payments to the students’ accounts, not to the colleges. If the child is the initial recipient, the college is in a better position to claim the good faith defense. Click here and here for ABI reports on district court and bankruptcy court decisions where colleges crafted partial protection for themselves.
Until Congress or state legislatures confer immunity, colleges and universities may be able to adopt concepts of structured finance to provide near total protection from fraudulent transfer suits. In the process, however, schools and colleges will be making adult children liable to bankruptcy trustees.
Curiously, we have not come across any reported cases where a trustee has sued a child for being the recipient of a fraudulent transfer resulting from a tuition payment. Perhaps trustees see no reason for suing penurious college-age children. Anyway, a student or recent graduate would likely be eligible to discharge a fraudulent transfer debt in chapter 7.
The opinion is DeGiacomo v. Sacred Heart Univ. Inc. (In re Palladino), 17-1334 (1st Cir. Nov. 12, 2019).
The lower courts are divided on the issue, but the First Circuit is the first court of appeals to decide the question.
The debtor was a fraudster sentenced to 10 years in prison for perpetrating a Ponzi scheme and was slapped with a $9.7 million judgment by the Securities and Exchange Commission for securities law violations. As usual, the college was an innocent bystander.
Insolvent at the time, the fraudster-parent had paid almost $65,000 in college tuition for an adult child over two years. The last payment was some two months before the father copped a guilty plea. Two months after the plea, he filed a chapter 7 petition.
The chapter 7 trustee sued the college on theories of actual and constructive fraudulent transfer. On cross motions for summary judgment, the college contended that the debtor-father received equivalent value because an educated child will not be an economic burden on the parents.
The bankruptcy court ruled in favor of the college, finding that the debtor received reasonably equivalent value. The bankruptcy court certified a direct appeal to the circuit.
In an eight-page opinion on November 12, Chief Circuit Judge Jeffrey R. Howard reversed, ruling de novo on a question of law that the payments were constructively fraudulent transfers under Section 548(a)(1)(B).