December 3, 2019, Connecticut– Between 2012 and 2014, Steven Palladino and Lori Palladino, (together, the “Palladinos” or “debtor parents”) paid approximately $64,000 in college tuition fees to Sacred Heart University, Inc. (the “Defendant”) for their 18-year-old daughter. Subsequently, the parents were convicted for fraud in operating a Ponzi scheme and were also subjected to a $9.7-million civil judgment obtained by the Securities and Exchange Commission. After the Ponzi scheme blew up, the debtor parents filed for bankruptcy.
Mark G. Degiacomo, Chapter 7 Trustee for the estate of the debtor parents’ brought a lawsuit against the college to avoid and recover the tuition payments under federal and state fraudulent transfer law. The most significant issue at appeal was the Trustee’s constructive fraud claim under Code §548, i.e., transfer by an insolvent debtor for less than “reasonably equivalent value.” The Trustee argued that the college provided no value to the Palladinos or their bankruptcy estate as against the alleged transfer.
The bankruptcy court ruled against the Trustee, holding that having “a financially self-sufficient daughter” leads to future self-sufficiency and non-reliance on the parents and thus constitutes “reasonably equivalent value” under Code §548(a)(1)(B)(i).
On appeal, the First Circuit reversed the bankruptcy court’s decision. The Court rejected the lower court’s reasoning “that a financially self-sufficient daughter offered [the debtor parents] an economic benefit.” The Court held that the tuition payments were fraudulent transfers, and the Trustee is entitled to avoid the tuition payments. The Court found that nothing of direct value flowed to the parents (or their unpaid creditors) due to the daughter’s ability to go to college. The First Circuit took a textual approach, noting that Congress has expressly excluded certain transfers from the fraudulent conveyance regime – and none of those exclusions have anything to do with a child’s college tuition. The Court added that supporting a family member may be worthy and laudable. Still, the Court concluded that such payment couldn’t be rendered immune in the face of unpaid creditors, and a clear fraudulent conveyance statute.
Citing Tavenner v. Smoot,257 F.3d 401, 408-09 (4th Cir. 2001), the Court highlighted that although the term “reasonably equivalent value” is not defined in the statute, it does not include intangible, emotional and non-economic benefits. The Court found that no value was conferred on the debtor parents as a result of the alleged transfer. Thus, the alleged tuition payments depleted the estate and furnished nothing of direct value to the creditors who were the central concern of the Code provisions. Further, the Court opined that the debtor parent debtors were “under no legal obligation to pay college tuition for their adult children. Thus, the college had to return the alleged tuition payments to the Trustee for the benefit of the debtor parents’ bankruptcy estate.