Bust and Burst
Bankruptcy Considerations in Divorces
Prepared for the Houston Bar Association
Family Law Section
October 7, 1998
Warren Cole
Piro & Lilly, L.L.P.
1400 Post Oak Blvd, Ste 600
Houston, TX 77056
Tel: 713-966-4444
Fax: 713-966-4466 |
Fred W. Stumpf
Stumpf, Falgout, Craddock & Massey
1400 Post Oak Blvd, Ste 400
Houston, TX 77056
Tel: 713-871-0919
Fax: 713-871-0408
|
CHAPTER 7, 11, 13 -- BRIEF DESCRIPTION OF DIFFERENCES
(Debtors - co-debtors - effects)
- Chapter 7
: Liquidation case - individual unable to pay debts files and discharges, with some exceptions, all unsecured debts. Any assets exceeding Debtor's exemptions turned over to trustee to liquidate and resulting funds pay debts to extent possible.
- Chapter 13
: Allows individuals with regular income an opportunity to pay debts to extent possible; free from all collection activity; can reduce claims secured by property to value of security; can adjust interest rates; pay off unsecured debts by paying only percentage; certain debts non-dischargeable in Chapter 7 are dischargeable in Chapter 13; creditor having non-dischargeable claim in Chapter 13 may, in Chapter 13, have claim reduced to small percentage and balance discharged. Support obligations are non-dischargeable in all bankruptcy chapters under §523(a)(5). If a Debtor files Chapter 13 and completes plan payments, the property settlements debts will be discharged.
- Chapter 11
: Typically used by business to reorganize (also individuals e.g. professionals, doctors, executives); advantages - granting of immediate discharge upon confirmation; longer period for debt repayment (Chapter 13 limited to 5 years); treatment of higher debt amount than available in Chapter 13 with $250,000 unsecured and $750,000 secured debt limits.
PRE-DIVORCE FILING: No special considerations in general. But, if they couldn't pay their debts before the split, how will they pay now? A fresh start may be advisable, but watch out for your fees or retainer. Preferences, Schedules and Inventories should match to avoid credibility problems.
FILING DURING DIVORCE: Claims arising from support of former spouse or dependent are non-dischargeable in Chapter 7, 11 or 13 (§523(a)(5)); e.g. past due child support. For instance, an ex-wife may want to get money from her former spouse, but also to continue to receive it if she remarries. Even if remarriage is not a concern, the ex-wife may not want to pay taxes on it, as would be required if it were traditional alimony. This can result in the money that is paid to the former wife not being protected from §523(a)(5) discharge. Obligations may be non-dischargeable as money owed for support, even if it is not paid to the spouse, but rather to someone else who assisted the spouse; most common example is the lawyer who represented ex-wife claiming the award of fees as non-dischargeable because ex-wife (typically) required representation to get support needs (creates issue of parties' respective earning potentials). However, the courts tend to rule that such attorneys' fees are non-dischargeable.
Many decrees provide lump sums of money, or payments over time called maintenance when they are actually not. Some state court judges have attempted to resolve the issue by stating in their decrees that the sums are non-dischargeable; the parties likewise will sometimes put such terms in the decrees. The determination of such issues, however, is solely within the power of the federal bankruptcy judge.
Issue of whether debt may or may not be for support creates hidden problem. If the debt is truly for support, no adversary complaint to object to discharge needs to be filed. But if such analysis is wrong and an attempt to collect post-filing on the debt is made, liability exists for a violation of the automatic stay, or if already discharged, the discharge order; also can be a violation of the Fair Debt Collection Practices Act.
POST DIVORCE FILING: Upon the filing of a proceeding in bankruptcy court, all prior financial deals are off. All contracts and promises are subject to review, either entirely or in part, and compliance with what seemed like a firm arrangement may not be necessary. When handling negotiations for divorce, counsel should always keep in the back of his or her mind the question what will happen if this party files a bankruptcy petition. (See also Filing During Divorce and discussion below).
BRIEF OVERVIEW OF RECENT CHANGES TO CODE RELEVANT TO SPOUSAL BANKRUPTCY (i.e. necessity of lift of stay: limitations).
Operation of Stay in Family Court Proceedings
- Support Obligations Bankruptcy Reform Act of 1994 excepts from stay actions to establish/enforce support orders in favor or Debtor's dependents if such actions do not seek payment from estate property (§ 362(b)(2)).
- Not Stayed:
- Determination of alimony, maintenance, child support.
- actions regarding marital status, paternity, parental rights/responsibilities
- collection of alimony, maintenance of child support from non-estate property.
Example: Spouse/former spouse may proceed to collect support obligations from post-petition income of Chapter 7 Debtor, but not Chapter 13 Debtor whose post-petition income is property of estate.
- collection of alimony, maintenance, child support from exempt property. In re Cole, 202 BR 356, 358 (Bankr. S.D.N.Y. 1996).
- Stayed Action to collect alimony, maintenance, child support from estate property.
- See relief from stay in Chapter 13.
- protect support obligee by priority status for support obligation - 11 U.S.C. (§ 507(a)) - Chapter 31 plan must provide for full payment of support obligation to spouse, former spouse, Debtor's dependent prior to distribution to lessor-priority creditors, e.g. taxing authorities. In re Cole, 202 BR 356, 358-9 (Bankr. S.D.N.Y. 1996)(support obligee may seek collection from Chapter 11 Debtor's exempt property even though §362(b)(2)(B) does not explicitly so provide.)
Non-Support Obligations
- Stay absolutely precludes spouse, former spouse, from pursuit of non-support obligation against bankrupt debtor in state court.
- debt collection barred; and
- initiation or continuance of any legal proceeding involving estate property barred.
Example: One party to divorce action files bankruptcy prior to entry of divorce decree-distribution of marital property (and marital debt) at issue-stay applies.
- Non-debtor spouse must seek relief from stay in Chapter 7, 11, and 13, or "wait out" stay (which remains in place until bankruptcy is dismissed, closed or discharge order entered).
- "non-asset" case: relief granted as matter of course.
- "asset cases": "Marital estate" vs. "bankruptcy estate" -e.g. in re Cole non-debtor spouse's interest in obtaining distributive award from state court warrants modification of stay, but state court cannot determine issues regarding title to Debtor's property or estate property.
- Spouse files bankruptcy after entry of final divorce decree.
- non-support debts from divorce or separation (e.g. property settlement obligations and hold harmless agreements on joint debt) are dischargeable unless non-debtor spouse brings adversary objecting to discharge under 11 U.S.C. §523(a)(15).
Example: In re Ladak, 205 BR 709 (Bankr. D.Vt. 1997) (non-debtor spouse, who sought to modify pre-petition divorce decree, violated stay; the Court noted "dischargeability of debts is our primary jurisdiction and is not shared with the state family court, but bankruptcy and sate courts have concurrent jurisdiction to determine whether marital obligation is, or is not, support obligation.")
- In re Ladak: Bankruptcy discharge not yet entered and stay in place; "if discharge entered, then Motion to Modify Decree would have violated §524 permanent injunction rather than stay. Absent determination in adversary that property settlement debt to non-debtor spouse was non-dischargeable, non-debtor spouse forever barred from enforcing property settlement provision. Court noted that holding should not be read to preclude modification of decree regarding spousal maintenance or child support inferring that modification of support award may be precipitated by material change in circumstances caused by obligor's bankruptcy; here, no ongoing maintenance obligation from debtor to non-debtor spouse).
Matrimonial Debt (Support/Non-Support)
- Concurrent jurisdiction by bankruptcy and state courts to determine whether marital obligation is support or non-support.
- Neither stay nor permanent injunction bars state court action for decree clarification.
Example: Divorce order requires one spouse make marital home mortgage payments and other spouse is granted possession; even if possession is labeled support by state court, non-debtor spouse may want to seek stay relief prior to any collection activity to (1) avoid sanctions for stay violation, and (2) avoid legal fees if Debtor raises stay violation as a defense. (Ladak at p. 711).
- Alternatively, Debtor or obligee may bring §523(a)(5) adversary in bankruptcy court to determine whether debt is "in nature of support".
- if obligee initiates, then must pay $150 filing fees.
- whether state court or bankruptcy court defines debt, what constitutes alimony, maintenance, support under §523(a)(5) must be determined under federal, not state law. In re Brabham, 184 B.R. 476 (Bankr. D.S.C. 1995).
PSEUDO-ALIMONY (i.e. judgment in lieu of assets and obligor spouse files bankruptcy to discharge obligation to former spouse See C. Matrimonial Debt.
BANKRUPTCY FOR SAKE OF FRUSTRATING DIVORCE COURT. Don't do it. It's expensive and probably innefective.
WHAT DIVORCE COURT CAN AND CAN'T DO WHEN BANKRUPTCY IS PENDING
RELEVANT CODE PROVISIONS
Section 523(a)(15) of Bankruptcy Code:
-- provides discharge exception for debts, other than alimony and support, relating to separation agreement and divorce decree, e.g. debts ordered to be assumed and "hold harmless" agreements.
-- bankruptcy courts have exclusive jurisdiction of §523(a)(15)
- Liability on indemnification order under §523(a)(15) will be discharged unless timely discharge objection filed by adversary complaint:
-- filing deadline is 60 days from first date set for §341 creditors meeting.
-- alert client that §341 notice will be sent to them and they must immediately notify you.
- Practice Tip: When drafting the documents, evaluating decrees-merely ordering party to pay marital debt is insufficient (courts have ruled such order does not create any new obligation for Debtor, hence does not give rise to §513(a)(15) debt); decree should order person to pay it and hold the spouse harmless.
- Burden of Proof: shifts to Debtor after adversary complaint filed to prove one or both of the following reasons for discharge of debt: (1) Debtor does not have ability to pay debt from income not reasonably necessary to be expended for maintenance, support of Debtor, Debtor's dependent; and (2) discharging debt would result in benefit to Debtor that outweighs the deferment to spouse, former spouse, Debtor's child.
- Practice Tip: Client must be made aware that merely winning an adversary holding that indemnification order is non-dischargeable debt does not get them money.
-- creditors still have right to pursue and collect from non-filing spouse, but will not be able to collect from Debtor spouse.
-- non-filing spouse is left with paying off the debts and collecting from filing former spouse.
-- Debtor spouse could file a new case under Chapter 13 to stop collection by former spouse even though previously filed a Chapter 7.
-- structure settlement to avoid problems: (1) attempt to obtain adequate security for promise-mortgage or deed of trust on real estate, second lien on "prized" possession, take greater percentage of pension money, higher child support, have potential Debtor ordered to get note co-signed by relative as co-obligor.
Section 523(a)(15) issues apply in Chapter 7 proceeding, but not to Chapter 13 case due to discharge provisions of §1328 for Debtors completing plan payments, thereby discharging property settlement debts.
Example: Debtor can file Chapter 13, repay debts to best of ability (usually small percentage of total) and discharge remaining balance to include money owed under decree that might be non-dischargeable in Chapter 7 due to §523(a)(15).
ADVERSARY PROCEEDINGS - Where to litigate. Unlike determinations of alimony and child support, the bankruptcy court has exclusive jurisdiction to determine the issue of the dischargeability of obligations arising under § 523(a)(15). In re Chinnery, 181 B.R. 954, 965 (Bankr. W.D. Mo. 1995). While determinations of dischargeability of alimony and child support can be filed at any time pursuant to Bankruptcy Rule 4007(b), determinations of dischargeability under § 523(a)(15) require a complaint to be filed within 60 days of the first date set for the meeting of creditors. 11 U.S.C. § 523(c) and Fed. R. Bankr. P. 4007(c).