Are Tuition Payments Fraudulent Transfers?

The First Circuit issued a brief and clear opinion as to whether college tuition payments for adult children, by legally insolvent parents, are fraudulent transfers and thereby recoverable by a Chapter 7 Trustee. In a recent case, parents paid their adult child’s university over $64,000 in the two years prior to filing Chapter 7 bankruptcy. The parent were legally insolvent at the time of those payments because in January 2014, they had pled guilty in state court to fraud for participating in a multi-million dollar Ponzi scheme.

Initially, the parents were successful in defending against the trustee’s intentional and constructive fraud allegations. The court ruled that the parents had received reasonably equivalent value for payment of the tuition because they believed that a ‘financially self-sufficient daughter’ offered them an economic benefit. Subsequently, there was a direct appeal to the First Circuit.

The Court analyzed the defenses to intentional or constructive fraud allegations and concluded that intangible, emotional, and non-economic benefits did not meet the “reasonably equivalent value” test. Further, the Court held that parents had no obligation to support an adult child’s education. The tuition payments depleted the bankruptcy estate and furnished nothing of value to creditors, which is central to the defenses available to under fraudulent transfer law.

This decision will strike fear in the hearts of debtors who assist their adult children going to college. Perhaps this is another reason to look at Chapter 11 or 13 instead of Chapter 7, for parents who might face a trustee’s efforts to claw back tuition payments. At least in a reorganization, the opportunity to pay back fraudulent transfers can be made over a long time period and not disrupt the child’s education.