Tuesday, July 19, 2016

Chapters Matter!: The different impacts of Chapter 7 and Chapter 13 on divorce obligations.

Chapters Matter!:  The different impacts of Chapter 7 and Chapter 13 on divorce obligations.

Published on by: Ian M. Falcone
This article is intended for bankruptcy and family law professionals.

Not all bankruptcy chapters are created equally!  It is important to understand how the different chapters function and how that impacts the debtor.

The Automatic Stay:
The filing of any bankruptcy case invokes an “automatic stay.” (See 11 USC 362)  The “stay” is an order that “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.”  While many family court judges take the cautious position that the automatic stay prevents a divorce case from proceeding, this is not accurate.

For example, the automatic stay does not prevent the commencement or continuation of a proceeding for the establishment of paternity, for the establishment or modification of an order for domestic support obligations, for the establishment or modification of child custody or visitation, 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 and issues regarding domestic violence (11 U.S.C. 362(b)(2)(A))

One key issue to remember is that the automatic stay only applies to “property of the estate.”  In a Chapter 7 case (liquidation), the estate can be loosely defined as all of the debtor’s assets at the time of filing (11 U.S.C. 541).  In a Chapter 13 (reorganization) case, the estate includes all of the debtor’s assets at the time of filing, plus any income earned during the pendency of the case (11 U.S.C. 1306(a)(2)) 

Thus, if a contempt action is pending against the Debtor when a Chapter 7 case is filed, the Family Court may be able to proceed and force the debtor to repay the debt from post-petition earnings (it is always best to obtain stay relief to be safe).   In a Chapter 13 case, the contempt case could not proceed.  However, in a Chapter 13 case any arrearage would be paid through the Chapter 13 Plan as a priority debt.  Unfortunately, the bankruptcy court may be far more lenient than the Family Court judge would have been to the debtor.  

Sec 523 of the Bankruptcy Code provides the exceptions to discharge.  The most important sections, as regards divorce related obligations, are 523(a)(5) and 523(a)(15).  Traditionally, these sections, although somewhat inaccurate, are referred to as "domestic support obligations" (523(a)(5)) and "property settlement" (523(a)(15)).

If a debt qualifies as a "domestic support obligation," it cannot be discharged under any chapter. Unfortunately, determining whether a debt is, in fact, a DSO can be a challenge.   (See my blog article published August 10, 2013 (Bankruptcy and Divorce: A basic outline for the f...) for a detailed explanation.)  However, "property settlements" are treated very differently under Chapter 7 and Chapter 13.  Debts included in Sec 523(a)(15) are not discharged in a Chapter 7 case, but are discharged in a  completed Chapter 13 case.  (See 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.)
 Section 523(a)(15) includes debts "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."  This definition is far more expansive than most attorneys realize.  The term "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" has been interpreted to include almost any obligation that arises in the context of a divorce, custody or support modification, contempt action, and any other related actions.  (“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)).

Adversary Proceeding and Other Options
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.  State family law courts have concurrent jurisdiction to determine whether a debt is dischargeable under 523(a)(5) and (a)(15).  Cummings v. Cummings, 244 F.3d 1263 (11th Cir. 2001)Eden v. Robert A Chapski, Ltd., 405 F.3d 582 (7th Cir. 2005)).  Thus, in the context of a Chapter 7 filing, it may be advisable to wait until the Chapter 7 case is completed and proceed with a contempt action in front of the family law judge whose order has been violated.

In the context of a Chapter 13 case, it is crucial to determine whether a debt is a DSO or property settlement very early in the case.   A DSO debt will be paid in its entirety as a priority, while a property settlement obligation will typically be treated as a general unsecured debt and paid a percentage of the amount owed.  While an adversary can be filed, it may be easier to file an objection to the treatment of the claim in the Chapter 13 plan.

Before advising any client, it is imperative to understand their situation completely.  You should review their underlying documents to determine whether an obligation is likely a DSO or merely a property settlement.   Only then, can you make appropriate recommendations about the impact of their bankruptcy filing.