Bankruptcy and Divorce: A basic outline for the family law professional.

Bankruptcy and Divorce:  A basic outline for the family law professional.

Published on August 10, 2013 by: Ian M. Falcone

The following outline was prepared to assist judges, attorneys and other non-bankruptcy professionals with common issues that frequently arise in family law cases.  It is not intended to address any one issue in detail, but rather to provide a basic outline and starting point when faced with a bankruptcy situation.  Please feel free to contact me if you have any questions.

THE AUTOMATIC STAY

A.        When does it apply?    

1.      The stay is automatic upon the filing of a bankruptcy petition.  Notice is not necessary (11 USCS § 362 automatic stay is in force from time petition in bankruptcy is filed and fact that creditor had not received notice of filing is irrelevant. In re Garcia (1982, ND Ill) 23 BR 266, 9 BCD 905.  Because automatic stay becomes effective upon filing of Chapter 13 bankruptcy petition under 11 USCS § 362(a), no formal notice is required. Richard v Chicago (1987, ND Ill) 80 BR 451 (criticized in In re Shah (2001, BC ED Pa) 46 CBC2d 101). Automatic stay is effective upon filing of Chapter 13 debtor's petition and no formal notice is required. In re Davis (1987, BC ND Ohio) 74 BR 406, 16 BCD 40.)

2.      Sanctions are not imposed unless the violation was willful (11 USC 362(k) (1) Except as provided in paragraph (2), an individual injured by any willful violation of a stay provided by this section shall recover actual damages, including costs and attorneys' fees, and, in appropriate circumstances, may recover punitive damages.  (2) If such violation is based on an action taken by an entity in the good faith belief that subsection (h) applies to the debtor, the recovery under paragraph (1) of this subsection against such entity shall be limited to actual damages) 

3.      There are a few exceptions to the stay being automatic.  If there has been a previous case filed within one year of the current filing, the stay is only good for thirty (30) days (11 U.S.C. 362(c)(3)), unless the Court extends the stay for cause (which is liberally granted).  If two or more cases have been filed within the prior year, there is no stay created upon filing.  The debtor must actually file a motion to impose the stay.  Be aware, however, that our local judges have taken the position that although the stay may dissolve after 30 days (or not have been created in the first place), a creditor cannot take action against an estate asset.  (In re Ajaka  370 B.R. 426 (NDGA, 2007 Judge Murphy) In the instant case, it appears that all the property for which Debtor seeks protection from the automatic stay is property of the estate. As §362(c)(3) does not apply to terminate the stay as to property of the estate, relief under that Bankruptcy Code section is unnecessary. (emphasis added))

B.         What does it prevent?  

1.      In its most general application, the automatic stay prevents “the commencement or continuation, including the issuance or employment of process, of a judicial, administrative, or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case under this title, or to recover a claim against the debtor that arose before the commencement of the case.  11 U.S.C 362 (a)(1).  However, the stay actually protects against much more.

2.      The stay also protects against “the enforcement against the debtor or the debtor’s property of a judgment obtained before the commencement of the case” (11 USC 362(a)(2)), “any act to obtain possession of property of or from the debtor’s bankruptcy estate, or to exercise control over property of the estate” (11 USC 362(a)(3)), and “any act to create, perfect, or enforce any lien against the property of the debtor’s bankruptcy estate” (11 USC 362(a)(4)).

3.          As you may have noticed, many of the protections focus on actions against the “estate.”  It is important to understand that the definition of the “estate” changes from bankruptcy chapter to bankruptcy chapter. 

a.       11 U.S.C. 541 provides the basic definition of the estate for Chapter 7 cases.  (The commencement of a case under section 301, 302, or 303 of this title creates an estate. Such estate is comprised of all the following property, wherever located and by whomever held: (1) Except as provided in subsections (b) and (c)(2) of this section, all legal or equitable interests of the debtor in property as of the commencement of the case.  (3) Any interest in property that the trustee recovers under section 329(b), 363(n), 543, 550, 553, or 723 of this title. (5) Any interest in property that would have been property of the estate if such interest had been an interest of the debtor on the date of the filing of the petition, and that the debtor acquires or becomes entitled to acquire within 180 days after such date—(A) by bequest, devise, or inheritance;(B) as a result of a property settlement agreement with the debtor's spouse, or of an interlocutory or final divorce decree; or (C) as a beneficiary of a life insurance policy or of a death benefit plan. 11 USC 541 (selectively edited).

b.      11 U.S.C. 1306 expands that definition for the purpose of Chapter 13.  ((a) Property of the estate includes, in addition to the property specified in section 541 of this title—(1) all property of the kind specified in such section that the debtor acquires after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7, 11, or 12 of this title, whichever occurs first; and (2) earnings from services performed by the debtor after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7, 11, or 12 of this title, whichever occurs first.)  A similar provision can be found at 11 U.S.C. 1115 for Chapter 11 cases.  ((a) In a case in which the debtor is an individual, property of the estate includes, in addition to the property specified in section 541—(1) all property of the kind specified in section 541 that the debtor acquires after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7, 12, or 13, whichever occurs first; and (2) earnings from services performed by the debtor after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7, 12, or 13, whichever occurs first.)

c.       The easiest way to think of the definition is that Chapter 7 is a snapshot and Chapter 13 and 11 are motion pictures.  On the date of filing imagine taking a photograph of all of the debtor’s assets.  In a Chapter 7 case, the assets are fixed at the time of filing.  The asset either existed or did not exist at the time of filing.  Post-petition income was not in the photograph at the time of filing and therefore is not part of the estate in a Chapter 7 case.  However, Chapter 13 and Chapter 11 are more like movies.  The camera follows the action during the case.  As a result, post-petition income and other assets that are acquired after filing become part of the estate.

C.     Exceptions to the stay:       

1.      The following actions are NOT prohibited by the automatic stay.

a.       sales or transfers of property initiated by the debtor (See In re Schwartz, 954 F. 2d 569).  This would indicate that a debtor can transfer property that is not property of the estate without relief from the stay.  However, because it is often difficult to determine whether an asset is part of the estate, it is always best to seek and obtain relief from the stay before completing an asset transfer.

b.      the collection of a domestic support obligation from property that is not property of the estate (11 USC 362(b)(2)(B)).  If a contempt action is filed against a debtor in a Chapter 7 case, in theory, without lifting the stay, the Movant could proceed to collect solely from post-petition income since it is not part of the estate (this would not be true in a Chapter 11 or Chapter 13 case since post-petition earnings would be considered part of the estate).  Another interesting theory would be to proceed solely against ERISA qualified assets since they are not included in the definition of estate in any chapter (See 11 U.S.C. 541(b)(7)).  The safest course of action, of course, is to require the Movant to file Motion for Relief from the Automatic Stay (timeline is approximately 30-60 days)

c.       with respect to the withholding of income that is property of the estate or property of the debtor for payment of a domestic support obligation under a judicial or administrative order or statute (11 USC 362(b)(2)(C).  This section was added by BAPCPA to allow for the entry of income deduction orders for DSOs.  (See In re Powers 2010 WL 942166 (Bankr. S.D. Ind. 2010)).

d.      The commencement or continuation of a criminal action or proceeding against the debtor  (11 USC 362(b)(1)). 

                                                            i.      It is not always clear whether an action is “criminal” in nature.  Collection of a “bad check” would seem to be a criminal proceeding.  Nonetheless, our local bankruptcy judges have often looked at the intent of the action to determine whether the action is truly a criminal proceeding or a collection action in disguise.

                                                          ii.      The difference between criminal and civil contempt can be crucial.  If a party is truly being held for criminal contempt, then that action should not be prevented by the automatic stay.  (Criminal matters, including criminal contempt proceedings, are not subject to the automatic stay of 11 U.S.C. §362.  In re: Michael Hughes, NDGA Judge Murphy  04-98206-MHM)

e.       the establishment of paternity (11 USC 362(b)(2)(A)(i))

f.        the establishment or modification of an order for domestic support obligations (11 USC 362(b)(2)(A)(ii)).  There can be some very strange results as a result of what is and is not stayed.  For example:  Ex-Wife files a contempt action against Ex-Husband for failure to pay child support.  Ex-Husband files a motion to modify his child support obligation.  The night before the hearings, Ex-Husband files bankruptcy.  The contempt action is stayed (11 U.S.C. 362(a)(1) and (2)), but the modification action is not (11 U.S.C. 362(b)(2)(A)(ii)).

g.       concerning child custody or visitation (11 USC 362(b)(2)(A)(iii))

h.       for the dissolution of a marriage, except to the extent that such proceeding seeks to determine the division of property that is property of the estate (11 USC 362(b)(2)(A)(iv)).  Again, an asset that is clearly not part of the estate can be divided, but determining whether an asset is within that definition can be problematic.  It is best to have the parties seek relief from the Bankruptcy Court. 

i.         regarding domestic violence (11 USC 362(b)(2)(A)(v))

2.      The safest answer in every case, of course, is to require the parties to file a Motion for Relief from the Stay.  The process typically takes 30-60 days, but under limited circumstances, can be heard on an emergency basis.  The parties can also file a motion and submit a consent order, which is typically entered within a few days.

DISCHARGABILITY

1.      Domestic Support Obligations.  Prior to October 15, 2007, the Bankruptcy Code differentiated between debts that were “in the nature of alimony, maintenance, or support” and those that were merely “property settlements.”   As a general rule, support-type debts were non-dischargeable, property settlements were subject to a balancing test.  As a result, there was a fairly steady stream of litigation attempting to determine the character, and therefore, the dischargeability of these debts.  When the Bankruptcy Code was revised, several substantial changes were made.

a.     The term Domestic Support Obligation was defined as “a debt that accrues before, on, or after the date of the order for relief in a case under this title, including interest that accrues on that debt as provided under applicable non-bankruptcy law notwithstanding any other provision of this title, 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 date of the order for relief in a case under this  title, 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 non-bankruptcy 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.” 11 U.S.C. 101(14A)

                                                                         i.      Spouse or Former Spouse Requirement.  Prior to the 2007 amendment, the vast majority of courts [held] that there is no requirement that alimony, maintenance of support be owed directly to a spouse or dependent in order to be non-dischargeable under the Bankruptcy Code.”  In re MacDonald, 69 B.R. 259 (Bankr D. N.J. 1986).  While the 2007 revisions might be read to contradict that interpretation, that has not been the case.  “[T[he fact that the attorney’s fee award is payable directly to [the claimant’s attorney] has no bearing on whether the debt is a DSO. In re Marshall, 489 B.R. 630 (Bankr. S.D.GA. 2013)

b.      DSO’s are never dischargeable.   A discharge under Chapter 7 (11 USC 727), Chapter 11 (11 USC 1141), or Chapter 13 (11 USC 1328(b) does not discharge an individual debtor from any debt for a domestic support obligation.  (11 USC 523(a)(5)).  In other words, DSOs are not discharged even when there is a bankruptcy discharge entered.

c.       Labels Don’t Matter/Factors to Consider.  Despite the fact that there is no such thing as “Federal Divorce Law”, it is actually federal law that determines whether a debt is a DSO.  Of course, State law plays a pivotal role in guiding the decision.  “A domestic obligation can be deemed actually in the nature of support . . .even if it is not considered ‘support’ under state law.”  In re Strickland, 90 F. 3d 444 (11^th Cir. 1996).  My favorite summary of this area of law is “If you take a can of peas and slap a corn label on it, does that make it a can of corn?  The answer, or course, is no.  “Whether a given debt is in the nature of support is an issue of federal law. Although federal law controls, state law does provide guidance in determining whether the obligation should be considered 'support' under § 523(a)(5). To make this determination a bankruptcy court should undertake a simple inquiry as to whether the obligation can legitimately be characterized as support, that is, whether it is in the nature of support. In conducting this inquiry, a court cannot rely solely on the label used by the parties. As other courts have recognized, it is likely that neither the parties nor the divorce court contemplated the effect of a subsequent bankruptcy when the obligation arose. The court must therefore look beyond the label to examine whether the debt actually is in the nature of support or alimony. A debt is in the nature of support or alimony if at the time of its creation the parties intended the obligation to function as support or alimony. Thus, the party seeking to hold the debt nondischargeable has the burden of proving by a preponderance of the evidence that the parties intended the obligation as support.”  Cummings v. Cummings, 244 F.3d 1263, 1265 (11th Cir. 2001)).  Having said that, the Courts  (See In re Mac Donald, 194 B.R. 283 (N.D. Ga., 1996) typically look at any number of factors, including, but not limited to:

                                                                           i.      The intent of the parties.

                                                                         ii.      Is the obligation subject to contingencies, such as death or remarriage?

                                                                        iii.      Is the obligation intended to balance disparate incomes of the parties?

                                                                       iv.      Is the debt payable in installments or a lump sum?

                                                                         v.      Is the obligation enforceable by contempt?

                                                                       vi.      What was the length of the marriage?

                                                                      vii.      Was there a clear need for support?

                                                                    viii.      What was the tax treatment of the obligation?

d.      Concurrent Jurisdiction.  The State and Federal Courts have concurrent jurisdiction to make determinations of dischargeability under 11 U.S.C. 523(a)(5).  (See 11 USC 523(c) omitting 523(a)(5) from those debts that require an adversary proceeding to be filed to prevent discharge)

e.       Examples:

                                                                           i.      Education Expenses. Generally speaking, education expenses for a minor child are considered a form of support.  This is true, even for post-majority education expenses (“the nature of debtor's promise to pay educational expenses and child support is not determined by the legal age of majority under state law. The bankruptcy court characterized the agreement to pay educational expenses as in the nature of support, and the only ground on which debtor has challenged that characterization on appeal relates to the state law legal duty as determined by the age of majority.”  In re Harrell, 754 F. 2d  902 (11^th Cir. 1985))

                                                                         ii.      Medical and health insurance.  Courts typically examine the relative financial circumstances of the parties to determine whether an obligation to pay health insurance is a support obligation.  (“In addition to the Final Decree's assessment of $400.00 per child as monthly child support, the Interlocutory Orders of the court ordered the Debtor to pay any and all existing debts related to the medical care of the four children. Like the creation of the Debtor's direct support obligation, the assessment of responsibility for these debts formed part and parcel of an unmistakably clear program by the state court to insure the present and future well-being of the children. As such, to the extent that these debts still remain outstanding, the Debtor may not discharge responsibility for them in bankruptcy.”  Matter of Robinson 193 B.R. 367 (Bankr. N.D. Ga. 1996)

                                                                        iii.      Life Insurance.  Courts have found that, to the extent a life insurance obligation is intended to protect a support obligation, that debt is, itself, a support obligation and is non-dischargeable.  In re Merrill 252 B.R. 497 (B.A.P. 10^th Cir. 2000), aff’d, 15 Fed. Appx. 766 (10th Cir. 2001)

                                                                       iv.      Effect of Assignment.  Prior to the 2005 Amendments, an assignment could effectively terminate a support obligation in bankruptcy.  The new Bankruptcy Code expressly allows for assignment so long as it is “voluntary” and “for the purpose of collecting the debt.”  (See 11 U.S.C. 101 (14A)(D) including within the definition of “domestic support obligation” debts “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.”)

                                                                         v.      Attorneys Fees.  Attorneys fees awarded in connection with a support award are typically considered “in the nature of” support as well and are therefore non-dischargeable.  The determination generally turns on the relative financial circumstances of the parties.  (“§ 523(a)(5) requires nothing more than "a simple inquiry as to whether the obligation can legitimately be characterized as support." In re Harrell, 754 F.2d at 906 (11^th Cir. 1985)).

1.      Awards Payable to Opposing Counsel.  This has been an area of concern for some time.  An award owed solely to opposing counsel is clearly not “owed to, or recoverable by a spouse”.  However, despite concerns, most Courts seem to find that the award is still a form of support.  “it is clear that pre-BAPCPA precedent overwhelmingly concludes that an
award of attorney’s fees does not lose its DSO character by being payable directly to the attorney. Matter of Holt, 40 B.R. 1009 (S.D. Ga. 1984); Stevens, 2006 Bankr. LEXIS 5096, 2006 WL 6885815; see also In re Bedingfield, 42 B.R. 641 (S.D. Ga. 1983) (support obligations may be DSOs even if not payable directly to wife or children). Post-BAPCPA cases have reached similar decisions. See, e.g., In re Andrews, 434 B.R. 541 (Bankr. W.D. Ark. 2010) (finding under current law that attorney’s fee award arising from a divorce decree was a ‘domestic support obligation′’ even though the payee was former wife’s attorney); Rogowski, 462 B.R. 435 (surveying cases and holding that matrimonial attorney’s fees payable directly to the attorney satisfied the definition of DSO).”  In re Marshall, 489 B.R. 630 (Bankr. N.D. Ga. 2013).

2.      Attorney’s fees to a party’s own attorney.  These fees are not a domestic support obligation and are dischargeable on the same basis as any other unsecured general debt.  “Every court that has published a decision on this issue has held that a debt due from a debtor for his or her own attorney fees incurred in connection with matrimonial and related proceedings are dischargeable.”  (In re Dean, 231 B.R. 19 (Bankr. W.D. N.Y. 1999).  Attorneys are free to secure their debts, which would change their treatment.  This, of course, is not common practice, but does happen on occasion.

                                                                       vi.      Guardian Ad Litem Fees.  Guardian Ad Litem fees are typically considered support obligations and are non-dischargeable.  However, since the payee is not a “spouse or former spouse” similar concerns exist as those above.  Again, despite the plain language of 11 U.S.C. 101(14A), most Courts have ignored the payee and examined the nature of the debt itself to determine whether the debt is dischargeable.    “It is nearly universally recognized that when a state domestic relations court appoints a guardian ad litem to protect the interests of a child, the services provided by the guardian ad litem have the effect of providing support. The parents or other parties who created the dispute requiring the appointment of the guardian ad litem must bear the cost of that support. Accordingly, equity requires—and the clear weight of caselaw authority holds—that fees incurred by a guardian ad litem be classified as a support obligation that may not be discharged by the parent or other party responsible for the fees. Cf. Reissig v. Gruber (In re Gruber), 436 B.R. 39, 43 (Bankr.N.D.Ohio 2010) (‘[T]he attorney fees were awarded in a proceeding concerning the health and welfare of the Parties' children. As such, it is impractical to sever the award of attorney fees from the needs of the children.’)”  In re Kassicieh, 467 B.R. 445 (Bankr. S.D.Ohio, 2012).

                                                                      vii.                  Mediation Fees.  I have not seen a case on this issue, but if a party is ordered to pay mediation fees for which the other party is responsible, presumably the debt would either be non-dischargeable as a support obligation (523(a)(5)) or as an “other debt” in “connection with a separation agreement, divorce decree or other court of record” (523(a)(15)).  Remember that if the obligation is construed as an “other debt” it would be discharged in a completed Chapter 13 case. 

f.        Hindsight is 20/20.  Orders and agreements are not always drafted with bankruptcy concerns in mind.  The following are examples of language that could be used to require the payment of alimony.

                                                                           i.      “Husband shall pay Wife the sum of $25,000 in monthly installments of $1000.”  This example certainly could be alimony, but it begs more questions:  Was it labeled alimony?  Was there other property division?  How long were the parties married?

                                                                         ii.      “Due to the income disparity of the parties and their relative financial positions, the following is awarded as alimony:  Husband shall pay Wife $25,000 in monthly installments of $1000.”  While this language is far from perfect, it certainly lends itself to a clearer determination that this was, in fact, intended as alimony.

                                                                        iii.      Hedging.  I get a fair number of questions asking whether this language or that language will prevent discharge if the obligee files for bankruptcy.  My favorite is the “hedged bet.” The proposed language might as well read as follows:  “We mean for this to be property settlement so no one has to pay any taxes, but if you file bankruptcy, well then, of course, we meant for it to be alimony and it can’t be discharged in bankruptcy.”  There simply are no “magic words.”  The obligation either was intended as a property settlement or as alimony at the time it was created; it doesn’t change because one party filed for bankruptcy protection.

2.      Property Settlement/Other.  Although lawyers still use the term “property settlement” to refer to the debts included under 11 U.S.C. 523(a)(15), the better term would probably be “other debts”.  In 2005, Section 523(a)(15) of the Bankruptcy Code was amended to read, “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.”  Clearly, this definition expands coverage of debts beyond traditional “property settlement” obligations.

a.       Differences among the Chapters.  The treatment of these types of debts varies tremendously between Chapter 7 and Chapter 13.

                                                                           i.      Chapter 7.  The old “balancing test” is gone.  If a debtor files Chapter 7, not only are the DSO’s not discharged, but any debt that could be included within the 523(a)(15) definition is not discharged either.  The creditor need not take any action to protect his or her rights.  The language “separation agreement, divorce decree or other order of a court of record” (emphasis added) has virtually eliminated the discharge of any debt that is related to a divorce or other domestic action. (“the Award granted to Respondent in connection with defending her rights under the divorce decree falls within the meaning of 523(a)(15).”  In re Howerton, N.D.Ga. 12-01055.  See also In re Koscielski 2011 WL 338634 (Bankr. N.D. Ill, January 31, 2011) concluding that attorneys fees incurred in connection with enforcement of a divorce decree were non-dischargeable pursuant to 11 USC 523(a)(15), In re Cavagnetto, 2012 WL 6585560 (Bankr N.D. Ill 2012) holding that attorneys fees as a sanction against the debtor for filing a baseless complaint in connection with divorce proceedings were not dischargeable under 11 U.S.C. 523 (a)(15), Zimmerman v. Hying, 477 B.R. 731 (Bankr. E.D. Wis. 2012) attorneys fees ordered pursuant to post-divorce contempt proceedings non-dischargeable under both 523(a)(5) and 523(a)(15))

                                                                         ii.      Chapter 13.   Upon successful completion of a Chapter 13 plan, any unpaid debt for “property settlement” (or “other debt”) is discharged. 11 U.S.C. 1328(a)(2) (The omission of a reference to 523(a)(15) allows a “property settlement” (“other debt”) to be discharged.) As a result, a former spouse should take care to examine the treatment and classification of their debt prior to confirmation of the Chapter 13 Plan.  They should also be sure to file a proof of claim within the applicable timelines.

b.      Adversary Proceeding Requirement.  The 2005 amendments to the Bankruptcy Code eliminated the need for a creditor to file an adversary proceeding (Complaint to Determine Dischargeability) for any debts other than those under 523(a)(2), (4) and (6).  DSOs and property settlements are not part of those sections.  Therefore, while it is not imperative that a creditor files an action during the bankruptcy case, it is certainly advisable.  In theory, a case can be reopened to file to adversary proceeding to determine dischargeability at a later date.

3.      Concurrent Jurisdiction.  Both the Bankruptcy Court and Superior Court have the right to determine dischargeability under 523(a)(5) and (15)  (“although the bankruptcy court has exclusive jurisdiction to determine the dischargeability of certain debts resulting from false financial statements, fraud, embezzlement, larceny or willful and malicious injury by a debtor, 11 U.S.C. §523(c), state courts have concurrent jurisdiction to determine the dischargeability of other potentially nondischargeable debts, including debts arising in domestic law proceedings that may be nondischargeable under §523(a)(5) or (15).” Cummings v. Cummings, 244 F.3d 1263 (11th Cir. 2001); Eden v. Robert A Chapski, Ltd., 405 F.3d 582 (7th Cir. 2005)).