Don't Bet the Business

Bankruptcy trustees are charged with pursuing the recovery of improper asset transfers so that this money and property can be redistributed to creditors of the debtor’s estate. However, Plus Loans taken by parents for a child’s education are beyond a trustee’s reach, according to a recent bankruptcy case.

Before we get to the ruling, it’s important to note that among the avoidance actions bankruptcy trustees have focused upon of late are the recovery of tuition payments made by parents for a child’s college and graduate school education. 

The bankruptcy courts have ruled that, unlike tuition for high school, parents have no legal obligation to pay for college or graduate school. While some bankruptcy courts have protected debtors against the claw back of tuition payments based upon a perceived societal benefit, other courts, while recognizing this possible moral obligation or societal benefit, have found that college and graduate school tuition payments are recoverable as constructive fraudulent transfers. 

One common method of financing a child’s college education is for the parent to take out a “Plus Loan” from the Department of Education (DOE). The parent signs a Master Promissory Note for the loan which is then used to fund their child’s education. The Plus Loan proceeds paid to the school are not, however, funds coming directly from the parent. Rather, the funds are transfers from the DOE directly to the child’s school. Moreover, the funds may only be used for certain authorized expenditures such as tuition, room and board, books, a computer and the like; Plus Loan proceeds cannot be used for general living expenses such as food or clothing. 

Again, the DOE transfers loan proceeds directly to the school which are then applied to the child’s student account. The student’s parent receives no money from the DOE, nor does the parent transfer cash to the school. However, once the DOE completes its transfer, the parent has the repayment obligation to the DOE.

In the context of a personal bankruptcy, the issue becomes whether DOE transfer of loan proceeds is recoverable by a trustee as a constructive fraudulent transfer. In a recent case, Shapiro v. Gideon, 16-04939 (U.S. Bankr., E.D. Mich., 2017), the bankruptcy court rejected the trustee’s fraudulent transfer claim and dismissed the trustee’s action to recover such DOE transfers. The bankruptcy court held that the transfers came from the DOE and were paid to the university; the funds were not paid by the debtor parent. Thus, the court concluded that the DOE’s transfers could not be deemed fraudulent transfers of the debtor’s assets for the purpose of frustrating the debtor’s general creditors. 

Put another way, while the debtor parent incurred a repayment obligation in the form of the loan, the trustee was not seeking to avoid that obligation. Rather, the trustee’s actions amounted to an attempt to claw back the DOE’s transfer of loan proceeds. But, since the debtor did not transfer his money to the school, the court ruled there was nothing to claw back into the debtor’s estate. Simply, the funds paid to the child’s school were never the debtor’s “property” so the trustee’s avoidance action was dismissed.  

The trustee had also sued the student. However, the bankruptcy court dismissed that action as well, finding that the child possessed no recoverable transfers of funds from the debtor parent.

As trustees try to claw back tuition payments, it is important to differentiate between transfers by a parent and “Plus Loans,” which are transfers from the government. While claw back actions against parents who have parted with their own money might be recoverable, Plus Loan proceeds appear to be, and should be, off limits.