How A Loophole in the Bankruptcy Code is Forcing Colleges and Universities to Have Some Skin in the Game

By: Jacob Mezei

I. Introduction

Just because a college or university received a full tuition payment, that does not mean that that university will be able to keep all, or even some, of that payment. A loophole in §§ 544 and 548 of the Bankruptcy Code allows a trustee to claim “tuition payments that insolvent parents made for their children” from the university itself.[1] The possible effects of this loophole can have an enormous impact on the future of the individual student and/or the university as well. “If the student has not graduated yet, the university could suspend” her access to certain courses and prevent her from moving forward in her academic career until further payment is received.[2] However, payment would be impossible, as the debtor has already declared bankruptcy and is thus in no feasible position to make tuition payments. As a result, the student is left with one option: drop out of school.[3] The effect on the institution would simply be a loss in a tremendous sum of money, which would result in having to either cutback in administrative costs or spread the costs to incoming students.[4]

Although this loophole creates a host of problems, it brings to light the issue of student debt in America and the rising costs of tuition. Over the past thirty years, students in the United States have seen massive growth in the costs of tuition. With this rise in tuition came the expansion of “for profit” universities.[5] In short, the higher education sector has become a gold-mine industry, and business is booming. As tuition rises, and more and more students find themselves beneath mountains of debt, is it really a bad thing to force universities and colleges to have a little “skin in the game?” This Article will discuss the current Bankruptcy Code loophole and delve into the proposed solution, and finally analyze the risk sharing approach to maintaining manageable tuition rates.

II. The Bankruptcy Loophole

In July 2008, a father and mother co-signed a loan from JP Morgan Chase in the amount of $35,000 and placed the sum in an account to pay for their son’s tuition at Marquette University.[6] This loan money was used to pay Marquette a total of $21,527.00 for the 2008-2009 academic year.[7] In November 2008, both parents filed a joint Chapter 7 bankruptcy, and in February 2010, the appointed Trustee, Stuart Gold, filed a complaint and amended that complaint in June 2010 seeking to avoid “four transfers as fraudulent transfers, and recover them from the transferee, Marquette.”[8] The crux of trustee Gold’s complaint is grounded in § 548(a)(1)(B) of the Bankruptcy Code.[9]

Section 548(a)(1)(B) of the Bankruptcy Code mandates that “The Trustee may avoid any transfer . . . of an interest of the debtor in property . . . if the debtor voluntarily or involuntarily . . . received less than a reasonably equivalent value in exchange for such transfer.”[10] If the parents established a trust, then this provision would not be applicable because “if the debtor holds property in the form of a trust, and makes a pre-petition transfer of such property, the transfer is not subject to avoidance as a fraudulent transfer under Bankruptcy Code § 548.”[11] However, in In re Leonard, 454 B.R. 444, 446 (Bankr. E.D. Mich. 2011) the parents failed to establish that a trust was in existence, and on the motion for summary judgment the facts were viewed in a light most favorable to the Trustee.[12]

Thus, as the Trustee set forth in his complaint, if “each transfer was a transfer of property of the Debtors, made while the Debtors were insolvent, for which the Debtors did not receive reasonably equivalent value in exchange,” then the Trustee should be able to recover that transferred property under § 548.[13] This provision essentially allows the Trustee to re-claim the tuition payment made to the University itself.

One might think that by paying for your child to receive a college education, you are essentially receiving “reasonably equivalent value” for the money paid in the form of certain intangible benefits.  This is precisely the argument that Marquette made to the Bankruptcy Court for the Eastern District of Michigan, but it failed.[14] The Court explained that the defendant would have the burden of proving that the “indirect benefit to the debtor/transferor is ‘concrete and quantifiable’” and further would have to actually quantify that benefit in order for that benefit to be deemed reasonably equivalent.[15]  This is an extremely difficult burden to prove, especially in the case of determining indirect benefits.[16] Lastly, as the Sixth Circuit held in Lisle v. John Wiley & Sons, Inc., the benefit received by the debtor/transferor, must be an “economic benefit . . . in order to be considered value.”[17] Although sending one’s child off to college is beneficial for the future of both the parents and the child, the benefit to the parents is indirect, not quantifiable, and usually not economic. Thus, under common bankruptcy law, when parents use a loan to pay for their child’s college tuition, those parents does not receive “reasonably equivalent value” in sending their child off to college.

The only instance in which this is not the case is when the child is younger than eighteen years old.[18] In In Re Akanmu, the Eastern District of New York explained that the key difference is a “legal obligation” for parents to afford their children proper primary, intermediate, and secondary education.[19] Because providing such an education is compulsory under the law, a parent receives “reasonably equivalent value” for sending his/her child to school pre-college.[20] The Eastern District of Michigan came to the same conclusion, drawing a distinction between cases in which the Trustee attempts to avoid transfer of tuition payments from insolvent parents to universities, and cases in which the Trustee attempts to avoid transfer of tuition from insolvent parents to mandatory K-12 schools.[21] In In Re Karolak the court held that “Mrs. Karolak did receive reasonably equivalent value in exchange for the tuition payments . . . [in the form of] grammar school education that Mrs. Karolak’s children received at Liggett.”[22] The court further explained that “Mrs. Karolak received an economic benefit that was concrete and quantifiable.”[23]

As it stands now, the law allows for trustees to “claw back college tuition” payments from universities under §548(a)(1)(B).[24] In fact, the number of cases is increasing steadily, and “a search of public filings, dating back to 2008, turned up at least 25 colleges that have been asked to return money in recent years.”[25]

III. Let’s Make a PACT: the Proposed Legislation to Close the Loophole

In response to this loophole, Congressman Chris Collins proposed the Protecting All College Tuition Act, or PACT act.[26] The PACT bill attempts to eliminate the loophole by adding an additional subsection (f) to the current § 548.[27] The subsection states, “(f) A payment of tuition by a parent to an institution of higher education (as defined in either section 101 or 102 of the Higher Education Act) for the education of that parent’s child is not a transfer covered under paragraph (1)(B).” This would essentially close the loophole associated with § 548, but would not close the loophole altogether. If the Trustee can “satisfy the requirements of § 544 as plaintiff,” then “Trustees will arguably still hold the ability to sue to recover a debtor’s tuition payments under the applicable state fraudulent transfer statutes.”[28] So with or without PACT, the issue is still present, and that leads to the question of what, if anything, should be done about it.

VI. Skin-in-the-Game Approach

It is common knowledge that a college education in the United States is expensive. “A nationwide Pew study finds that 57 percent of prospective students believe a college degree no longer carries a value worth the cost. Seventy-five percent of respondents declared college simply unaffordable.”[29] With college tuition becoming so burdensome, it would make sense to try to keep college tuition down, and press students to graduate on time, without taking on unnecessary loan debt. A statistic by “National Student Clearinghouse  . . . says only 55 percent of students in federal aid programs complete a degree or certificate within six years, and that percentage is lower for low-income students.”[30] Further, these “borrowers are more likely to default on their loans and less likely to graduate.”[31] Some focus must be placed on the universities themselves, especially “for-profit” universities that are only out to make a buck with little concern for the success of their students. That is why several members of Congress are proposing that colleges share in the risk of student loan defaults.[32]

Ensuring that colleges and universities are held at least somewhat accountable for students who fail to graduate and take out large amounts of debt, would force colleges and universities to push students to graduate on time, educate students on borrowing debt to pay for tuition costs, and maintain a reasonable tuition price tag.[33] Senators Elizabeth Warren, Jack Reed, Dick Durbin, and Chris Murphy all support legislation that would essentially “make colleges pay when their former students run into loan problems.”[34]

Although this approach could potentially raise a few problems, those problems could have solutions. Holding colleges responsible for economic downturns for which they have no control seems counter-intuitive and wrong. In addition, requiring colleges to be on the hook for their students who default on their loans could push colleges to admit more wealthy students and turn away low income or minority students.[35] However, “federal policy could pay colleges a bonus for every Pell Grant student they graduated” which would help to “keep the doors open for  . . . [the] disadvantaged.”[36] In addition, the government could “adjust the penalty formula to account for economic downturns . . . and track the amount of progress  . . . and hold colleges accountable for a percentage . . . only after a ten year payment period.”[37]

There are several benefits in having accountability for high student default rates for institutions of higher education. The loophole in the Bankruptcy Code poses significant issues, but that is only because it is a loophole, and not a carefully crafted piece of legislation. If Congress takes on this issue with full force, the days of students and their parents being the only ones to bear any risk for striving for a higher education could be numbered.


[1] Katy Stech, Bankruptcy Trustees Claw Back College Tuition Paid for Filers’ Kids, The Wall Street Journal (May 5, 2015),

[2] Lynne B. Xerras (FN1), Pact: Will Congress Except College Tuition Payments from Avoidance?, Am. Bankr. Inst. J., July 2015, at 12, 12.

[3] Id.

[4] Id.

[5] Kamille Wolff Dean, Student Loans, Politics, and the Occupy Movement: Financial Aid Rebellion and Reform, 46 J. Marshall L. Rev. 105, 106 (2012).


[6] In re Leonard, 454 B.R. 444, 446 (Bankr. E.D. Mich. 2011).

[7] Id.

[8] Id. at 446-447.

[9] See id. at 448.

[10] See 11 U.S.C. § 548(a)(1)(B).

[11] See In re Leonard 454 B.R. at 450-451.

[12] Id. at 451.

[13] Id. at 448.

[14] Id. at 455.

[15] Id. at 457 (internal quotation marks omitted).

[16] Id.

[17] Id. (internal quotation marks omitted).

[18] In re Akanmu, 502 B.R. 124, 136 (Bankr. E.D.N.Y. 2013).

[19] Id.

[20] See id.

[21] In re Karolak, No. 12-61378, 2013 WL 4786861, at *3 (Bankr. E.D. Mich. Sept. 6, 2013).

[22] Id.

[23] Id.

[24] Stech, supra note 1.

[25] Id.

[26] Chris Collins, In an Effort to Protect College Education, Collins & Parenthood Introduce PACT Act, Chris Collins (May 13, 2015),

[27] See H.R. 2267, 114th Cong. (2015).

[28] Xerras, supra note 2.

[29] Tom Lindsay, Sorry But ‘College is Too Expensive’ is Not A ‘Myth’, Forbes (July 19, 2015),

[30] Kelsey Ott, Sen. Lamar Alexander Fights for Federal Support for Graduating College, WREG Memphis (Aug. 5, 2015),

[31] Id.

[32] See Alexander: If Colleges Share in the Risk of Student Loan Defaults, They Can Help Reduce Overborrowing—and the Cost of College, U.S. Senate Committee on Health, Educ., Lab., & Pensions (May 20, 2015),, (last visited April 16, 2015); See also Jordan Weissman, Elizabeth Warren Wants Colleges to Pay a Price When Students Can’t Pay Their Loans. Great Idea., Slate (June 12, 2015),

[33] See Alexander: If Colleges Share in the Risk of Student Loan Defaults, They Can Help Reduce Overborrowing—and the Cost of College, supra note 32. (As Senator Lamar Alexander remarked, “ensuring that colleges and universities have some responsibility to . . . encouraging students to borrow wisely, graduate on time, and be able to repay what they’ve been loaned . . . may not only help students make wiser decisions about borrowing, it could help reduce the cost of college — thereby reducing debt.”)

[34] Weissman, supra note 32.

[35] Id.

[36] Andrew Kelly, Giving Colleges Some Skin in the Game, Forbes (July 31, 2014),

[37] Weissman, supra note 32.