It might be farcical, but sometimes bankruptcy trustees will file lawsuits against universities in consumer bankruptcy cases. If parents pay for their children’s college tuition with money that could go to creditors, then the trustees might have a case. To combat this possibility, New York’s own Representative Chris Collins offered a bill in Congress that would ban such trustee actions.
At issue here is not what the Bankruptcy Code considers a “preferential payment” but a “fraudulent transfer.” The difference is subtle but relevant. A preferential payment (“preference” for short) is a payment made usually within 90 days of a bankruptcy petition to a particular creditor while the debtor is insolvent. The trustee can sue the creditor to “avoid”—that is, disallow—the transfer in an adversary proceeding. The main purpose is to ensure equitable distribution of the debtor’s assets among the creditors and to motivate them to cooperate with debtors rather than race to the courthouse to liquidate them. Preferences are covered by Section 547 of the Bankruptcy Code.
A fraudulent transfer, by contrast, is when the debtor intentionally transfers money to another party to evade creditors’ rights. For example, a debtor who sells a house to a friend for a few dollars but still lives in it would not be a preference because the debtor doesn’t owe the friend any preexisting debt. The trustee can avoid these transfers too, but one can take further actions, like moving the bankruptcy court to dismiss the debtor’s case. The “look-back” period for avoiding a fraudulent transfer is usually longer than for a preference.
You can read more about the difference here.
Because a child’s college tuition creates a debt between a college and the child, parents who pay for the child’s tuition might be engaging in a fraudulent transfer to evade the creditors, not a preference payment. The harsher consequences for fraudulent transfers and the norms favoring parents paying their kids’ college costs are what are causing Rep. Collins’ concerns.
As it happens, according to a May 12 article in The Wall Street Journal that reported on Rep. Collins’ bill, in an unspecified number of recent years trustees have sued only 25 universities to recover tuition dollars, and more than half did so. The article also cites anonymous consumer bankruptcy experts who predict that the trend will rise in the coming years, even though it was nonexistent until recently.
The bill is only in its infancy, but when it comes to paying for children’s higher education, there is one big step parents can take to prevent trustee actions against universities: Putting the money aside early. In particular, parents can invest some of their income in 529 college savings plans, which are excluded from the bankruptcy estate because Congress wanted to protect the student-beneficiaries. Because job security for parents is uncertain, setting the money aside early is a wise choice.
On the other side, for creditors who have been served with preference or fraudulent transfer claims by trustees, my practice has experience defending against such actions.
For answers to more questions about bankruptcy, the automatic stay, effective strategies for dealing with foreclosure, and protecting your assets in bankruptcy please feel free to contact experienced bankruptcy trustee actions Bruce Weiner for a free initial consultation.
