Connecticut Tuition Claw-Back Legislation

June 14, 2017 Advisory

The Connecticut General Assembly recently took a significant step to protect colleges and universities from bankruptcy trustees who have recently tried to force schools to return pre-bankruptcy tuition payments that parents made on behalf of their children. Public Act 17-50, An Act Revising the Uniform Fraudulent Transfer Act, will take effect October 1, 2017.

Background. The issue arises when parents pay their child's tuition, but then file for bankruptcy protection. In every bankruptcy case, the bankruptcy trustee's job is to recover as many assets as possible to pay the parents' creditors. The Bankruptcy Code gives the trustee an array of tools to do this, including the power to "claw back" so-called fraudulent transfers. In recent years, trustees have used this power to seek to recover tuition payments from colleges and universities, arguing that parents' payments of their child's tuition are fraudulent transfers.

The theory behind these claims is that parents have no legal obligation to pay undergraduate tuition for their adult children, and that parents do not receive "reasonably equivalent value" for these payments because they solely benefit a third party (the child). There is conflicting case law on the question whether parents get reasonably equivalent value when they pay for a child's college or university tuition, and that issue continues to be litigated today. Bankruptcy trustees have made these tuition claw-back claims against colleges and universities around the country.

Tuition Claw-Back Claims under Federal and State Law. The Bankruptcy Code gives the trustee two tools to claw back parents' tuition payments from a college or university. First, under 11 U.S.C. 548(a)(1)(B), a trustee can recover any tuition payment made two years before the parent filed bankruptcy if (i) the parent was insolvent at the time of the payment and (ii) in exchange, the parent received less than "reasonably equivalent" value.

Second, under the so-called "strong arm provision" of the Bankruptcy Code, 11 U.S.C. § 544, the trustee can claw back any payment that is voidable under the law of the state where the parent filed for bankruptcy. The reach-back period under state fraudulent transfer statutes is typically longer than the two years provided under Section 548. For example, under Connecticut's Uniform Fraudulent Transfer Act, Conn. Gen. Stat. 52-552e, f, the reach-back period for alleged fraudulent transfer claims is four years.

The Change in Connecticut Law. The Connecticut legislature recently passed legislation that would curtail the use of this "strong arm provision." Public Act 17-50 amends Connecticut's Uniform Fraudulent Transfer Act to eliminate tuition claw-back claims. The Act expressly states that a payment is not voidable against a college or university if it "was made . . . by a parent or guardian on behalf of a minor or adult child in furtherance of the child's undergraduate education." So a bankruptcy trustee in a Connecticut bankruptcy proceeding cannot recover tuition payments under Connecticut law that were made by Connecticut parents for the undergraduate education of their children.

The Limits of the New Connecticut Law. The change in Connecticut law only reduces, but does not eliminate, the exposure of Connecticut colleges and universities to tuition claw-back claims.

First, parents who file for bankruptcy in states other than Connecticut would not be subject to Connecticut law, and the fraudulent transfer statutes in other states may still apply to tuition payments. Therefore, colleges and universities may be subject to tuition claw-back claims by trustees in bankruptcies filed in other states.

Second, the new Connecticut statute does not affect a trustee's ability to recover tuition payments directly under Section 548 of the Bankruptcy Code. However, a trustee will be limited to the two-year reach back period under federal law – reducing the scope of exposure of colleges and universities. (In 2015, legislation was introduced in Congress to amend Section 548 to preclude recovery of tuition payments made by a parent to a college or university for the education of a child (H.R. 2267, the Protecting All College Tuition Act of 2015), but the bill died in committee and has not been reintroduced in this Congress.)

What Else Can Colleges and Universities Do to Protect Themselves? There are a few steps colleges and universities can take to avoid tuition claw-back claims. First, try to get tuition payments directly from the student when that is possible. Second, to the extent possible, look for warning signs of potential insolvency of parents (or others) before accepting tuition payments from anyone other than the student. Third, encourage payments from 529 of Coverdell Plans, which are partially protected from tuition claw-back claims. Fourth, when faced with a tuition claw-back claim, gather accurate evidence of the source of all of the tuition payments at issue to make sure those payments were made at a time when the parent was solvent, and to establish any defenses (such as a check coming from a parent's account that was originally a gift from a grandparent, or a local scholarship).