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Is paying your child's school tuition a fraudulent transfer?

In bankruptcy law, there is what is known as an adversary proceeding. This is typically brought by the trustee to recover assets of the debtor, which may have been unfairly transferred to one creditor in preference to another. These payments are sometimes called preference payments or fraudulent conveyances and the Bankruptcy Code gives the trustee the power to "avoid" those transfers.

This is because the Bankruptcy Code is focused on fairness among creditors. If there is only $100 in nonexempt assets available for a debtor's 10 creditors, the trustee's job is to ensure that all of them receive proportional share of the proceeds, and not that one creditor takes $90, while the other nine each receive $1.

Adversary proceedings are not very common in most personal bankruptcies, because often there are few nonexempt assets for the trustee to distribute. Recently, however, more proceedings have been initiated against educational institutions as trustees go after the often substantial tuition payments made by parents for their children.

The trustee can recover payments where the debtor did not receive "reasonably equivalent value." Because the payment was made for their child, they did not technically receive anything of value. Some bankruptcy judges have allowed these payments to be recovered.

With tuition at private colleges averaging more than $31,000 a year, a parent could drive themselves into bankruptcy with such payments, especially if they have suffered a loss of income or other financial calamity.

Court are divided on the practice, with some suggesting a "moral obligation" to pay these bills, while others state that there is no legal obligation that requires parents pay college tuition of their children and have required the payments returned from the university.

Wsj.com, "Bankruptcy Trustees Claw Back College Tuition Paid for Filers' Kids," Katy Stech, May 5, 2015

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