Out of Reach: Protecting Parental Contributions to Higher Education from Clawback in Bankruptcy
| Publication year | 2017 |
Out of Reach: Protecting Parental Contributions to Higher Education from Clawback in Bankruptcy
Jenna C. MacDonald
Parental contributions to higher education have become commonplace. However, courts are divided on how contributions by parents towards the college education of their children should be treated when those parents file for bankruptcy. The Bankruptcy Code grants trustees avoidance powers under § 548 to recover transfers made by a debtor up to two years before the petition date if those transfers are actually or constructively fraudulent. Trustees are attempting to use these avoidance powers to "clawback" payments made to colleges and universities by debtors for the education of their children. Factors including societal expectations, financial aid calculations, emotional benefits, and economics have created varying opinions on whether these contributions constitute constructive fraud under § 548.
This disagreement has not gone unnoticed. In 2015, a bill was introduced in the House of Representatives that seeks to create an exception to trustee avoidance power for all parental tuition payments: the Protecting All College Tuition (PACT) Act. However, the PACT will not effectively protect educational expenditures from trustee avoidance powers because it fails to explicitly preempt state bankruptcy laws.
Parental contributions to higher education are similar to charitable donations, a category of transfers that has been protected from trustee avoidance powers since the passage of the Religious Liberty and Charitable Donation Protection Act (RLCDPA) of 1998. Using the RLCDPA as a guide, this Comment will propose amendments to the Code to protect payments to institutions of higher education by parent debtors on behalf of their children. With simple additions to § 544 and § 548, federal lawmakers can advance the public's interest in higher education, protect creditors, and limit the need for litigation around the subject.
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As the cost of college continues to rise, parents are contributing more financially to the higher education of their children.1 When a parent files for bankruptcy, these contributions become subject to review.2 In recent years, some bankruptcy trustees have tried to recover ("clawback") payments made to colleges and universities by parent debtors on behalf of their adult children.3 The trustees argue that, where a child is eighteen or older, these funds should be used to satisfy the parent debtor's own growing debts.4 As of 2015, at least twenty-five colleges had been asked to return money as fraudulent transfers and over a dozen had complied.5 According to consumer bankruptcy experts, this trend is expected to rise.6
Trustees are responsible for examining the financial history of a debtor in bankruptcy and, where possible, recovering funds the debtor transferred prior to filing for redistribution to creditors.7 Where a trustee finds that a debtor did not receive "reasonably equivalent value" in exchange for a transfer of the debtor's assets, the trustee can sue to recover that property as a constructively fraudulent transfer.8 Most commonly, trustees look for property or cash the debtor gave to family members or friends.9 But when a parent pays tuition to a college or university for his or her child, some trustees have argued that it is not the parent who receives value in return, but the child.10 It is under this argument that trustees look to recover those funds.11
The Bankruptcy Code (the Code) does not define reasonably equivalent value, but courts and commentators agree that debtors must receive some sort of economic benefit in exchange for a transfer of their assets before reasonably
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equivalent value can be found.12 Even still, some courts have effectively ignored the requirement of reasonably equivalent value in their analysis and instead based their decisions to protect tuition payments from clawback on public policy grounds.13
The courts are not the only ones that think trustees should not be able to clawback tuition from universities.14 In 2015, federal lawmakers introduced the Protecting All College Tuition (PACT) Act to protect tuition payments from trustees.15 The PACT Act addresses the treatment of tuition payments by parent debtors in bankruptcy and seeks to protect such payments from clawback under § 548 of the Code.16 However, the bill stalled after it was introduced in the House of Representatives.17 This lack of activity coupled with several drafting issues suggest that the PACT Act, as it is written, is not the solution to the disagreement on how educational expenditures should be treated in bankruptcy.18 That does not mean the goal of that legislation is unfounded, though. Protecting tuition payments from clawback is important for three policy reasons: (1) parental income impacts student financial aid, (2) schools receive payments from parents in good faith, and (3) society expects parents to help their children pay for college.
This Comment will argue that § 544 and § 548 of the Code should be amended to protect parental payments to colleges and universities. It will suggest protection for such payments that equate to fifteen percent or less of the parent debtor's income and those that exceed fifteen percent where a consistent practice can be shown. This fifteen percent threshold is similar to the protection the Religious Liberty and Charitable Donation Protection Act (RLCDPA) created for charitable donations.19 RLCDPA, enacted in 1998, will serve as a helpful starting point.20 But this Comment will show that effective legislation must go a few steps further and address some of the questions left
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unanswered by RLCDPA.21 By amending § 544 and 548 to protect payments to colleges and universities where specific criteria are met, Congress can protect both the ability of parents to contribute to their children's higher education and the interest of creditors in preventing debtor fraud.
When an individual files for chapter 7 bankruptcy, the individual seeks to liquidate his nonexempt22 property in exchange for a discharge of his debts.23 After a debtor files a petition with the bankruptcy court, a chapter 7 trustee is appointed to administer the debtor's estate and facilitate the liquidation of the debtor's nonexempt assets.24 The trustee seeks to maximize the amount received by the debtor's unsecured creditors, utilizing the powers granted by the Code.25
One of these powers is avoidance power, or the power to clawback transfers of property made by a debtor in the two years preceding the bankruptcy filing if the transfers are fraudulent.26 Fraudulent transfers include both those that are actually fraudulent and those that are constructively fraudulent.27 Deciding if a debtor received reasonably equivalent value for a transfer is an important step in identifying constructively fraudulent transfers.28 Unfortunately, the Code does not define reasonably equivalent value, so the job of interpreting the concept has fallen to the courts.29 This task has proven to be particularly challenging where the value, if any, a debtor receives in exchange for a transfer of his property is indirect or intangible.30 A scenario in which this challenge commonly arises is when a debtor has contributed financially to his children's higher education in the two years preceding the
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bankruptcy filing.31 So far, courts disagree about whether such payments constitute constructive fraud.32 This Section will further explain § 548 and trustee avoidance powers. Then it will seek to better understand the meaning of reasonably equivalent value. Finally, it will introduce four key cases that demonstrate the variety of approaches courts have taken in analyzing parental contributions to higher education under § 548.
A. Section 548 - Fraudulent Transfers
Section 548 of the Code grants the bankruptcy trustees avoidance powers.33 In other words, § 548 grants trustees the ability to clawback transfers made prior to bankruptcy if such transfers are found to be fraudulent.34 The section serves to ensure a debtor's assets are distributed in a way that is in the best interest of all creditors.35
Provisions like this have a deep history in bankruptcy law. The history of this section dates back to the Statute of 13 Elizabeth which was passed by the English parliament in 1571.36 The Statute sought to address a practice by debtors of transferring their assets to friends or family to obstruct attempts by creditors to collect on their claims.37 Debtors waited until their creditors gave up on recovering their claims and then retook ownership of the property they had transferred.38 These actions by the debtor were fraudulent because they depleted the debtor's estate without receiving anything of similar value in exchange that could be used to satisfy the claims of his creditors.39
Today, trustees can avoid transfers made by the debtor up to two years before the filing date of the bankruptcy petition.40 Section 548(a)(1) provides:
The trustee may avoid any transfer . . . of an interest of the debtor in property, or any obligation . . . incurred by the debtor, that was made
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or incurred on or within 2 years before the date of the filing of the petition, if the debtor voluntarily or involuntarily—
(A) made such transfer or incurred such obligation with actual intent to hinder, delay, or defraud any entity to which the debtor was or became, on or after the date that such transfer was made or such obligation was incurred, indebted; or
(B)
(i) received less than a reasonably equivalent value in exchange for such transfer or obligation; and
(ii)(I) 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; . . . .41
This section allows trustees to...
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