CHAPTER 7, A. Trustee Avoidance Cases to Recover Debtor Payments for Their Children's Education

• Jurisdiction: United States

A. Trustee Avoidance Cases to Recover Debtor Payments for Their Children's Education

ABI Journal

November 2019

Michael R. Herz

Fox Rothschild LLP

Morristown, NJ.

Always in search of potential sources of recovery, chapter 7 trustees have increasingly brought claims to avoid education-related payments, most notably for tuition, made by debtors on behalf of their children as fraudulent transfers under 11 U.S.C. §§ 544 and 548 and state fraudulent-conveyance statutes. This trend is not surprising given the rising cost of higher education,¹ resulting in parents spending significant funds to support their childrens' education to alleviate their children's future debt burden,² potentially at the expense of the parents' creditors.

Case Survey

To state a plausible claim under § 548(a)(1)(B), the trustee must allege four elements: (1) a transfer of a debtor's interest in property; (2) that was made within two years prior to the petition filing; (3) on which the debtor received less than reasonably equivalent value in exchange; and (4) the debtor was insolvent on the date that such transfer was made or such obligation was incurred, or became insolvent as a result of such transfer or obligation.³ Trustees that have brought actions to avoid and recover these types of payments generally argue that the debtor did not receive "reasonably equivalent value" in exchange for the payments.

Such avoidance claims have been brought against the debtor, the institution that received the payments and the child for whose education the payments were made. The outcome varies depending on particular circumstances, and the courts' disposition of trustee claims is guided by factors such as the application of fraudulent-transfer state law, the age of the child, the level of education paid for, and the definition of the economic benefit flowing to the debtor.

Funds Held in Trust

To the extent that payments by a debtor for college tuition were made from funds held in a trust specifically for the payment of a child's education, such as a qualified 26 U.S.C. § 529 account, such payments do not originate from property of the debtor and thus are not property of the bankruptcy estate pursuant to § 541(b)(6) of the Bankruptcy Code;⁴ therefore, they cannot be avoided by a trustee.⁵ Similarly, student loan disbursements for the child of a debtor that pass through a debtor's account prior to remittance to the educational institution are also effectively funds held in a trust for the benefit of the child, and subsequent tuition payments cannot be avoided. In other words, student loans that the debtor obtains to pay for his/her children's college education do not constitute property in which a debtor has any interest because these funds could not lawfully have been used to pay the debtor's creditors.⁶

Payments for Minor Children's Private School Tuition

There are state laws requiring that parents provide education for their minor children. In actions to avoid private-school tuition payments made by debtor parents on behalf of their minor children, courts have found that debtors received reasonably equivalent value in...