What’s Behind Bankruptcy Lawsuits Over College Tuition?

Bankruptcy trustees are suing universities—and sometimes, college students themselves—to take back tuition that had been paid years before as part of an aggressive and growing legal tactic. Parents who file for bankruptcy after paying for the skyrocketing cost of college tuition can face scrutiny from court-appointed trustees who argue that the money should have been spent on their own growing debts, as reported in The Wall Street Journal Tuesday. The University of Maryland, College Park is fighting to keep $61,595.33 in tuition payments that Connecticut couple that began making for their son starting in 2010. In court papers, the school’s lawyer said the trend, if left unchecked, will “drive a wedge between parent and child.”
Students walk through the Ann Arbor campus of the University of Michigan on Tuesday, April 22, 2014, in Ann Arbor.
Ryan Garza/Detroit Free Press/Associated Press
How are these lawsuits affecting families? The lawsuits present an unexpected consequence that bankruptcy can create for families. “It’d be horrible for a kid and their parent to have to go through this,” said Deborah Thorne, a professor of sociology at Ohio University who has studied the effects of financial distress on families. Many bankruptcy lawyers said students are fair game to be sued, though trustees don’t do that because it is unlikely they could afford to repay the debt. A Wall Street Journal search of public records since 2008 found a handful of cases in which the kids themselves were sued. A Boston College graduate, for example, who was sued in 2006 after his parents filed for bankruptcy and eventually agreed to pay $10,000. The college itself paid $3,230. Even unsuccessful lawsuits can still be expensive for families. When a Michigan couple’s daughter was sued in 2013 for $12,305.70 in tuition for Wayne State University, a bankruptcy judge declined the student’s request for a free lawyer. Marshal Garmo, whom she hired instead, said he discounted his fees to a fraction of the $5,000 he usually would have charged. When a college returns tuition money, some parents told The Wall Street Journal that they worried whether their child would be expelled, denied a transcript or asked to repay the school for the money it turned over. What’s driving the trend? Tuition recovery lawsuits are a new phenomenon. Historically, tuition payments were so small that a court-appointed trustee wouldn’t waste time pursuing them. But as college costs rise and more parents chip in to help their kids, bankruptcy experts predict more of these lawsuits to come. Forty-eight percent of parents with children under age 18 are saving for college this year, according to a report released last week by the country’s largest private student-loan lender SLM Corp. and market-research company Ipsos Public Affairs. On average, families that are saving have $10,040 set aside for college. Where are the lawsuits coming from? Behind the lawsuits are court-appointed trustees who have a duty to recover as much money as possible to repay creditors. They have the power to look for improper payments and transfers made four to six years before bankruptcy in most states. “They have a duty to bring [the lawsuits] unless they can make a judgment that the benefit is outweighed by the cost,” said Florida bankruptcy lawyer Charles Throckmorton. Under the U.S. bankruptcy code, trustees can sue to take back money that a bankrupt person spent several years before filing for protection if a trustee finds that the person didn’t get “reasonably equivalent value” for that expense. The law doesn’t define “reasonably equivalent value.” Trustees are paid a fee of $60 and a percentage of what they recover. In 2013, trustees collected more than $3 billion from people and businesses in chapter 7 cases, the latest year for which figures are available from the U.S. Department of Justice. What do courts say about this? Bankruptcy judges have rarely been asked to rule whether these lawsuits are fair because most of them settle. In the few cases in which they have ruled, they have disagreed. In 2010, Marquette University lawyers fought to keep $21,500 from Carmen and William Leonard’s bankruptcy estate by arguing that their son “will be afforded opportunities throughout his lifetime that he would not have been offered if it weren’t for his education.” “Surely parents would not pay for the education of their children from their own funds, approve a tax millage increase or otherwise support any educational program if there was no benefit to be derived from an education,” Marquette University’s lawyers said in court papers. But Judge Thomas Tucker of the U.S. Bankruptcy Court in Detroit wrote in a 29-page opinion on April 8, 2011, said he wasn’t convinced that the benefit to the Leonards was “concrete and quantifiable.” “Understandably, the [Leonards] may have felt a moral obligation to help their son pay for college,” Judge Tucker wrote. “While satisfying such a moral obligation and receiving such “peace of mind” may be very real benefits that are personally quite important to the [Leonards], these intangible benefits are not ‘economic’ benefits to [them].” What’s the weirdest thing about the Leonards’ case? The parents cosigned on the loan that provided the tuition money. So even though the tuition money was returned, the Leonard family still made payments on the loan, which was not discharged during the bankruptcy case. Unlike Judge Tucker, two others in Pennsylvania stopped a trustee from recovering tuition. But didn’t colleges provide an education? Colleges and universities unsurprisingly displeased with the trend. “The universities which did what they promised to do—provide an education in exchange for tuition—are now being penalized,” said Hunton & William’s Joseph Esposito, who has represented colleges and universities. Higher education isn’t the only industry that has been caught off-guard by bankruptcy law’s clawback concept. Trustees trying to recover funds for victims of Ponzi schemes in Minnesota and Florida successfully went after money the architects of the schemes had donated to charities. State lawmakers, angered by the suits, passed rules that made it harder for lawyers to take back that money by putting older donations out of reach. Robert Waldschmidt, a chapter 7 trustee near Nashville, said he hasn’t filed a lawsuit to recover tuition money but that he once sued to take back money that was donated to a cystic fibrosis charity in a $63 million Ponzi scheme case. “Sometimes you scratch your head and say, ‘This doesn’t feel right,’” he said. What about tuition for private elementary and secondary schools? Trustees are less likely to go after this money because most states have laws that require a parent to take care of their children until they become adults. A few years ago, the trustee in a Staten Island couple’s bankruptcy was not allowed to take back more than $46,000 that the couple had spent at Our Lady of Mount Carmel School in West Brighton and Xaverian High School in Brooklyn. Write to Katy Stech at [email protected]. Follow her on Twitter at @KatyStech