Bankruptcy trustees are “clawing back” tuition paid for debtors’ kids

According to an article in the Wall Street Journal, Bankruptcy Trustees are using a legal argument called “fraudulent transfer” to take back tuition payments clients have made 7027599019_ffc018d450_mto their children’s colleges. This can be a shock to people, but trustees do things like this all the time.

Here’s how it works:

Under bankruptcy law, all the property you have at the time of your bankruptcy filing is part of the bankruptcy estate. If you have property above certain exemption amounts, the trustee can demand turnover of that property. This would seem to incentivize people to get rid of assets before filing bankruptcy. You can understand the temptation for someone to sell their boat to their brother for $1.00.

Bankruptcy law has a way of dealing with this problem, called fraudulent transfer law. A fraudulent transfer in Minnesota can occur when someone gives away property for less than “equivalent value.” This allows the trustee to “claw back” the property and distribute it equitably to all the creditors.

But is college tuition a fraudulent transfer? The trustee’s theory is that if you were paying for college tuition for yourself, it wouldn’t be a fraudulent transfer because you received equivalent value for the transfer. But when you pay tuition for your adult children, (which you’re not legally obligated to do) you don’t receive anything in return (other than children who are less likely to need your support in the future). In that way, it’s like a gift, and can be pursued as a fraudulent transfer.

So if the trustee claws back the tuition, kids have a problem. The school will want its tuition, and may hold back transcripts or diplomas, or prevent registration for the next semester, until they’re paid up. So this is a scenario bankruptcy filers really want to avoid.

There might be some defenses. For example, if the property would have been exempt anyway, it might not be a fraudulent transfer. But this issue hasn’t been directly addressed by binding caselaw in Minnesota, and so it’s no sure thing. To brainstorm other solutions to this problem, get in touch.