Carlos J. Cuevas

An interesting bankruptcy law issue that has been litigated in the U.S. Bankruptcy Court for the Eastern District of New York is whether a pre-petition private school tuition payment by a Chapter 7 debtor for a dependent child is avoidable as a constructive fraudulent conveyance under either federal or New York law. Chief Judge Carla Craig and Judge Elizabeth Stong have held that a pre-petition private school tuition payment by a Chapter 7 debtor for a dependent child is not avoidable as a constructive fraudulent conveyance. Geltzer v. Xaverian High School (In re Akanmu), 502 B.R. 124 (Bankr. E.D.N.Y. 2013) (C.J. Craig); Geltzer v. Lawrence Woodmere Academy (In re Michel), 2017 WL 4158831 (Bankr. E.D.N.Y. 2017) (J. Stong).

In Geltzer, trustee Robert Geltzer (the trustee) commenced two adversary proceedings to avoid pre-petition tuition payments made by the debtors for their minor children. The defendants, two parochial schools, made motions to dismiss. The court summarized the trustee’s argument as follows:

The trustee’s claims are based upon the theory that because the parents were not “direct beneficiaries” of the tuition payments, and because private schooling of their children was, in the trustee’s judgment, “not reasonably necessary,” the debtors did not receive reasonably equivalent value or fair consideration for the tuition payments under §548(a)(1)(B) of the Bankruptcy Code or §273 of the New York Debtor & Creditor Law.

Id. at 127.

The court granted the motions to dismiss. The court began its analysis by examining the language and policy of the applicable federal and state constructive fraudulent conveyance provisions. The goal of Bankruptcy Code §548, the federal fraudulent conveyance statute, is to prevent a debtor from depleting the estate through gratuitous transfers of a debtor’s property.

In order to establish that a constructive fraudulent conveyance occurred, a plaintiff must establish under federal law that the estate did not receive reasonably equivalent value, and that the conveyance also violated one of the three subsections of Bankruptcy Code §548(a)(1)(B)(ii). 11 U.S.C. §548(a)(1)(B). In order to state a cause of action under New York Debtor Creditor Law §273, it must be alleged that the debtor made a conveyance that rendered a debtor insolvent and that the conveyance was made without fair consideration. N.Y. Debtor-Cred. Law §273.

An important component of the court’s decision was its analysis of what constituted reasonably equivalent value and fair consideration. The Bankruptcy Code does not define reasonably equivalent value. The issue of reasonably equivalent value is determined by the value of the consideration exchanged between the parties at the time of the conveyance or the time the debt is incurred. In reaching a determination a court should consider both the direct and indirect benefits received by the debtor as a result of the conveyance.

The court made the following comments concerning the term fair consideration:

“Fair consideration” for purposes of DCL §273 can be established by showing that the transfer was in exchange for “fair equivalent” value and that the transferee acted in good faith. DCL §272(a). “Fair consideration” under the DCL and “reasonably equivalent value” under §548(a)(1)(B)(i) have substantially the same meaning.

Id. at 130-31.

The court ruled that there was reasonably equivalent value and fair consideration because under New York law a parent has a legal duty to provide for a child’s necessities such as food and education. Moreover, New York law requires that a parent ensures that his or her child attend school. A parent’s failure to abide by the minimum parental requirements could result in the loss of custody of the child or criminal sanctions. The court held that the debtors, by paying tuition to the defendants, had satisfied their legal duty under New York law to educate their children.

The court rejected the trustee’s argument that under New York law the debtors were not required to send their children to either parochial or private school. The court stated:

The fact that the Debtors chose to educate their children in parochial school rather than public school, arguably exceeding the “minimum standard of care,” does not change the fact that, by doing so, they satisfied their legal obligation to educate their children, thereby receiving reasonably equivalent value and fair consideration. It is irrelevant to this determination whether the Debtors could have spent less on the children’s education, or, for that matter, on their clothing, food, or shelter. To hold otherwise would permit a trustee to scrutinize debtors’ expenditures for their children’s benefit, and seek to recover from the vendor if, in the trustee’s judgment, the expenditure was not reasonably necessary, or if the good or service could have been obtained at a lower price, or at no cost, elsewhere.

Id. at 132.

The court declared that a Chapter 7 trustee is not granted an unlimited veto power over a debtor’s pre-petition personal decisions. Regardless of the prudence of a debtor’s pre-petition expenditures, that by itself does not warrant the use of the constructive fraudulent conveyance laws to avoid these expenditures.

The court also rejected the trustee’s attempt to use the Chapter 13 disposable income test and transplant it into Chapter 7. The court stated:

The “reasonably necessary” analysis is entirely inapplicable in a chapter 7 case. A chapter 7 debtor does not propose a plan to repay creditors, and his post-petition income is not included in the chapter 7 estate or in the distributions received by creditors. In a chapter 7 case, the trustee collects and liquidates the debtor’s pre-petition, non-exempt assets. 11 U.S.C. §704. The proceeds are then divided amongst creditors in order of priority. 11 U.S.C. §726. Unless the chapter 7 case would be an abuse of the Bankruptcy Code, i.e., if the debtor has the financial ability to repay creditors under a chapter 11 or chapter 13 plan, there is no review of a chapter 7 debtor’s post-petition income and expenses. See 11 U.S.C. §707(b). (footnote omitted).

Id. at 134.

The court thought that the trustee’s reliance on cases applying the constructive fraudulent laws to the pre-petition payment of college tuition was distinguishable. The cases cited by the trustee involved adult children in which the debtors did not have a legal obligation to support their children. The court stated:

Here, however, the result is crystal clear. The Debtors are legally obligated under New York Law to provide their minor children with an education. N.Y. Fam. Ct. Act §1012(f). The fact that they chose to do so by sending their children to private or parochial school, rather than public school, does not render the payments subject to scrutiny by the Trustee for avoidance, any more than the Trustee would be entitled to second-guess other choices made by debtors pre-petition in providing clothing, food, shelter, or other goods or services, to their minor children.

Id. at 136.

The Bankruptcy Court concluded that the debtors had received reasonably equivalent value, and the debtors and their children had to be treated as a single economic unit. Chief Judge Craig wrote:

The Debtors received reasonably equivalent value and fair consideration for the Tuition Payments for their children’s education, not only because the Debtors satisfied their legal obligation to educate their children, but also because the Debtors and their minor children must be viewed as a single economic unit for these purposes. In other words, goods and services purchased by parents for their minor children should generally be treated, for purposes of constructive fraudulent conveyance analysis, as though they had been purchased by the parents for themselves.

This conclusion follows from the fact that the affairs of parents and their minor children are generally so entangled as to effectively create a single economic unit.

Id. at 136-37.

Chief Judge Craig reached the correct conclusion. The debtors were under a legal duty to support their children. Absent an intentional fraudulent conveyance, bankruptcy law was not intended to supersede family or domestic relations law. For example, Bankruptcy Code §507(a)(1) grants a first administrative priority claim for a domestic support obligation that is owed to or recoverable by a spouse, former spouse, or child of the debtor. 11 U.S.C. §507(a)(1). Chief Judge Craig was correct in employing public policy considerations to reach her conclusion.

Chief Judge Craig’s decision is also buttressed by the Supreme Court’s decision by BFP v. Resolution Trust Co., 511 U.S. 531 (1994). In BFP, the Supreme Court stated that fair market value is to be determined by the reference to the market place. The marketplace reflected that other parents were willing to pay the same or similar tuition for their children to attend the schools in question. Under these circumstances, the debtors did receive reasonably equivalent value for their tuition payments, and the transactions were not constructive fraudulent conveyances.

Carlos J. Cuevas is a solo practitioner in Yonkers and a research associate with the University of Houston School of Law.