Bankruptcy Issues in Divorce Cases

Bankruptcy Issues in Divorce Cases

Published on November 26, 2012 by: Ian M. Falcone

This article is intended for family law professionals.

           One of the most common questions I get from divorce attorneys is “What happens if my client’s spouse files bankruptcy?  Are they protected?”  Not surprisingly, the answer is, it depends.

            When the Bankruptcy Code was amended in 2005 (BAPCPA) there were several changes.  The first relevant change was the addition of a defined term:  Domestic Support Obligation.  11 U.S.C. 101(14A) states that a Domestic Support Obligation is a

         “debt that accrues before, on, or after the date of the [bankruptcy filing]...., including interest that accrues on that debt as provided under applicable nonbankruptcy law notwithstanding any other provision [of the Bankruptcy Code], that is

        (A) owed to or recoverable by –

i.        A spouse, former spouse, or child of the debtor or such child’s parent, legal guardian or responsible relative; or

                   ii.      a governmental unit;

(B) in the nature of alimony, maintenance, or support (including assistance provided by a governmental unit) of such spouse, former spouse, or child of the debtor or such child's parent, without regard to whether such debt is expressly so designated,

(C) established or subject to establishment before, on, or after the [Bankruptcy filing] ..., by reason of applicable provisions of-

(i)      a separation agreement, divorce decree, or property settlement agreement

(ii)     an order of a court of record; or

(iii)    a determination made in accordance with applicable nonbankruptcy law by a governmental unit; and

(D) not assigned to a nongovernmental entity, unless that obligation is assigned voluntarily by the spouse, former spouse, child of the debtor, or such child's parent, legal guardian, or responsible relative for the purpose of collecting the debt.”

This definition encompasses the previous concept of “in the nature of alimony, maintenance or support”, but also broadens the concept to apparently protect any person caring for a child.  

What makes an obligation “in the nature of alimony, maintenance or support”?

         There are many factors that the Court will look to when determining whether the debt is a DSO.  These include, but are not limited to:

1.          The intent of the parties.

2.          Whether the obligation under consideration is subject to contingencies, such as death or remarriage.

3.          Whether the payment was fashioned in order to balance disparate incomes of the parties.

4.          Whether the obligation is payable in installments or a lump sum.

5.          Whether there are minor children involved in a marriage requiring support.

6.          The respective physical health of the spouse and the level of education.

7.          Whether, in fact, there was a need for spousal support at the time of the circumstances of the particular.

8.          The tax treatment of the obligation.

         See, e.g. In re Robinson, 193 B.R. 367 (Bankr. N.D.Ga. 1996); In re MacDonald, 194 B.R. 83 (Bankr. N.D.Ga. 1996); Ackley v. Ackley (In re Ackley), 186 B.R. 1005 (Bankr. N.D.Ga. 1995); rev'd, 187 B.R. 24 (N.D.Ga. 1995); Nix v. Nix (In re Nix), 185 B.R. 929 (Bankr. N.D.Ga. 1994); Myers v. Myers (In re Myers), 61 B.R. 891 (Bankr. N.D.Ga. 1986); and In re Edwards, 33 B.R. 944, 946 (Bankr. N.D.Ga. 1983).

         Labels can be helpful, but the Court is not bound by the labels supplied.  In short, it is the totality of the circumstances that will best guide the Court.

When are DSOs dischargeable?

Never. 11 U.S.C. 523(a)(5) states:

(a) A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title [11 USCS § 727, 1141, 1228(a), 1228(b), or 1328(b)] does not discharge an individual debtor from any debt--

(5)  for a domestic support obligation

The Code sections cited within the statute refer to discharges under Chapter 7, 11 and 13.  Thus, DSOs are never dischargeable under any chapter of bankruptcy. 

However, past due obligations can be restructured through the use of Chapter 13 and, to a lesser extent, Chapter 11.  In a Chapter 13 case, all pre-petition arrearages can be repaid over a period not to exceed 5 years.  In Chapter 11 cases, possibly because of a “quirk” in the Code, all pre-petition arrearages must be paid upon the “effective date” of the plan.  The Code does not define “effective date” and recently a local attorney attempted to define the effective date as five years after payments started.  Unfortunately, the case was dismissed for other reasons.  (See In re Hugh David Coherd  12-60285-jrs NDGA).

What about “property settlements”?

Under pre-BAPCPA law, obligations contained in divorce settlements fell into one of two categories:  “in the nature of alimony, maintenance or support” (now covered as DSOs) and “property settlements”.  Generally speaking, the rule of thumb was that a property settlement obligation could be discharged after applying a balancing test.  BAPCA changed that analysis tremendously.

Now, 11 U.S.C. 523(a)(15) reads:

(a) A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title [11 USCS § 727, 1141, 1228(a), 1228(b), or 1328(b)] does not discharge an individual debtor from any debt--

(15)  to a spouse, former spouse, or child of the debtor and not of the kind described in paragraph (5) that is incurred by the debtor in the course of a divorce or separation or in connection with a separation agreement, divorce decree or other order of a court of record, or a determination made in accordance with State or territorial law by a governmental unit;

The definition now includes virtually all obligations incurred “in connection with” a divorce or related action.[1]  Courts have held that obligations arising in subsequent modification and contempt actions, such as attorneys fees, are covered by this section. 

This expansive definition would seem to indicate that “property settlement” debt, like their DSO cousins, cannot be discharged.  Despite the statutory language, this is not the case.  Property settlement debt cannot be discharged in a Chapter 7 or Chapter 11 case.  However, Chapter 13 contains some addition language.  11 U.S.C. 1328(a)(2) states

(a)   Subject to subsection (d), as soon as practicable after completion by the debtor of all payments under the plan, and in the case of a debtor who is required by a judicial or administrative order, or by statute, to pay a domestic support obligation, after such debtor certifies that all amounts payable under such order or such statute that are due on or before the date of the certification (including amounts due before the petition was filed, but only to the extent provided for by the plan) have been paid, unless the court approves a written waiver of discharge executed by the debtor after the order for relief under this chapter [11 USCS §§ 1301 et seq.], the court shall grant the debtor a discharge of all debts provided for by the plan or disallowed under section 502 of this title [11 USCS § 502], except any debt--

(2 )  of the kind specified in section 507(a)(8)(C) [11 USCS § 507(a)(8)(C)] or in paragraph (1)(B), (1)(C), (2), (3), (4), (5), (8), or (9) of section 523(a) [11 USCS § 523(a)];

What this convoluted statute says is, that upon completion of a debtor’s Chapter 13 plan, any unpaid obligation for property settlement debts are discharged.  The amount of repayment is based on several factors, including the debtor “liquidation value” the amount available to pay into the plan, and the length of the plan.[2] 

What do you need to do as a family law attorney?

It is unlikely that you will know that your client’s spouse plans to file for bankruptcy protection in the future.  So, all you can do is try and protect your client.  Clearly, DSOs enjoy more protection than mere property settlements.  If you can, try and weigh the agreement towards this side of the spectrum.  That does not mean that you should try to call every obligation a DSO.  Remember, it’s not the label that defines the treatment, it’s the intent and totality of the circumstances. 

If alimony is warranted, be sure to include it in a separate section.  Be sure to cite financial circumstances that justify the award of alimony.  This does  not need to be particularly details.  A statement as simple as “due to the income disparity of the parties and a their relative financial positions, the following is awarded as alimony . . .”

Also, be sure to include hold harmless clauses in your agreement.  If the debt is jointly held and wife will be obligated to pay the debt, be sure the agreement states that she will hold husband harmless for any and all damages that arise from her failure to pay (or similar language).

Adversary Proceedings

One of the effects of BAPCPA has been the reduction of litigation in the bankruptcy courts over whether a divorce related debt is dischargeable.  If something is clearly a DSO, no action is required to have it declared non-dischargeable.  Unfortunately, however, a standard discharge order effectively says “those debts which are properly dischargeable are hereby discharged.”  There is no breakdown in the Court’s order stating which debts are included in the discharge and which are not.  Does that mean a client needs to take action when their ex-husband files a bankruptcy case?

Obviously, it is always best to consult with a bankruptcy lawyer to be safe.  However, unlike pre-BAPCPA times, where an adversary proceeding (litigation inside the bankruptcy court) was required to first determine whether the debt was a DSO or property settlement, and then, if found to be a dischargeable property settlement obligation, in the Chapter 7 scenario, at least, action is typically not really required. It won’t matter whether the debt is a DSO or property settlement if the case is Chapter 7 because neither is dischargeable.

In a Chapter 13 case, it may be advisable to file an adversary proceeding to determine whether the debt is a DSO or property settlement.  If the debtor treats the debt as a property settlement and no one objects, and the debtor completes the case, that obligation may be discharged.

If you are faced with a Chapter 11 filing, always seek the advice of an experienced bankruptcy attorney.  These cases are far more complicated than Chapter 7 and Chapter 13 and require far more involvement by an attorney.

Summary

The intersection of bankruptcy and family law is complicated at best, but the following 5 items will be helpful to remember:

1.              DSOs are never dischargeable under any bankruptcy chapter.

2.              BAPCPA expanded the definition of “property settlement” to include almost any obligation contained in connection with a divorce.

3.              “Property settlements” can be discharged in a completed Chapter 13 case.

4.              The difference between a DSO and Property Settlement is not a label

5.              Adversary proceedings are not always required but should be discussed.

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[1] Although most attorneys still refer to these obligations as “property settlement” debts, they might better be referred to as “non DSO obligations” or “other” debts. so as to include the expanded obligations. 

[2] It is possible to confirm  plan that does not pay any of the property settlement debt.  Such a plan would have to otherwise comply with all requirements of the Bankruptcy Code.  Such a circumstance is uncommon and the explanation for how it would arise is beyond the scope of this article.