Bar News - July 13, 2012
Federal Practice & Bankruptcy: Will a Bankruptcy Undo Your Family Court Stipulation?
By: Cheryl Deshaies
You represent a stay-at-home spouse involved in an acrimonious divorce after a long-term marriage. They have substantial credit card debt. After what seems like months of negotiations you and your client feel victorious. Through your artful negotiations you managed to secure a stipulation for divorce in which your client will receive the equity from the marital home and the working spouse will be responsible for all of the credit card debt.
Fast forward. The working spouse has sold the house, spent the proceeds, and filed chapter 7 bankruptcy intending to discharge the credit card debt and the obligation to turnover the equity. Is your client out of luck?
The Chapter 7 Discharge
Although the Bankruptcy Code favors a debtor’s right to a fresh start, Congress has decided, for certain reasons of public policy, that not all debts should be treated equal. Thus, the chapter 7 discharge is not all encompassing. There is a list in Section 523(a) of the Code of the specific types of debts not included in (e.g. "excepted" from) the discharge provided by chapter 7. Only debts that are not included in the Section 523 list of exceptions will be discharged by the chapter 7 bankruptcy. There are nineteen exceptions to discharge enumerated in Section 523(a). Each exception is narrowly construed and is read with an eye toward granting a discharge when possible. If a creditor’s claim comes squarely within an exception to discharge contained in Section 523(a) the debt is excepted from the chapter 7 discharge. Palmacci v. Umpierrez, 121 F3d 781, 786 (1st Cir. 1997) quoting Century 21 Balfour Real Estate v. Menna (In re Menna), 16 F3d 7, 9 (1st Cir. 1994).
Domestic support obligations and obligations to a spouse, former spouse, or child of the debtor 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 are enumerated at Sections 523(a)(5) and (a)(15) of the list of debts that are not discharged in a chapter 7 bankruptcy. They are automatically excepted from the discharge granted in a chapter 7 bankruptcy proceeding. The fact that such a claim is excepted from the chapter 7 discharge means that the bankruptcy has no effect on the claim and it remains enforceable despite the issuance of the chapter 7 "discharge of debtor". Since the Bankruptcy Abuse Prevention and Consumer Protection Act ("BAPCPA") became effective in 2005 there is no balancing test applied to weigh the fresh start policy against the need to have a debt excepted from discharge. Simply, if the debt is a type described in Section 523(a)(5) or (a)(15) the debt is not discharged.
As to obligations arising from a divorce decree, the analysis regarding whether a debt is excepted from discharge may be undertaken during the bankruptcy by the bankruptcy court or subsequently by a state court. This is because state courts and bankruptcy court have concurrent jurisdiction to determine the dischargeability of Section 523(a)(5) and (a)(15) debts. This is a change from the law prior to BAPCPA which required that a determination regarding whether a debt was non-dischargeable under Section 523(a)(15) (essentially a "property distribution") be brought by the domestic creditor during the bankruptcy proceeding within 60 days of the meeting of creditors. If the creditor failed to bring the adversary proceeding within that timeframe the action would be barred. The result was that many domestic creditors were not savvy enough to know what to do and when to do it and/or they did not have the resources to quickly hire bankruptcy counsel in order to preserve their rights. This was a landmine for domestic practitioners and their clients.
BAPCPA remedied this problem by eliminating the deadline for Section 523(a)(15) dischargeability claims and expanding jurisdiction to include the state courts. State courts now have concurrent jurisdiction to determine both Section 523(a)(5) and 523(a)(15) claims so that a domestic creditor who did not participate in his or her ex-spouse’s bankruptcy may nonetheless ask the state to court to rule on the dischargeability and ultimately enforce the domestic obligation. When the state court is asked to do so, the process is simple. It need only determine if the debt is a domestic support obligation as referenced in Section 523(a)(5) and defined in Section 101(14A) or any other obligation arising from a divorce decree as described in Section 523(a)(15). If it is, it survives the chapter 7 discharge automatically. No action is necessary during the bankruptcy.
There you have it. A chapter 7 bankruptcy proceeding cannot undo a Family Court stipulation whether the obligation is in the nature of support or an allocation of debt or a property distribution. Chapter 7 bankruptcy no longer provides any out for the obligor spouse; all debts arising from a decree in divorce are nondischargeable.
What about Spouses Who File/Convert to Chapter 13?
Chapter 13 of the Code is referred to as an individual’s reorganization. Under chapter 13 the debtor commits to a plan of repayment which lasts usually for 36 or 60 months. During the term of the plan the debtor commits all of his or her disposable income to making payments to the chapter 13 trustee. By making payments under the plan the debtor enables the chapter 13 Trustee to make payments to the debtor’s creditors. Certain debts must be paid in full while others typically receive only cents on the dollar.
One of the benefits of filing bankruptcy under chapter 13 instead of chapter 7 is that the discharge issued under chapter 13 is broader including some types of debts that are not discharged in a chapter 7. One such debt is a domestic obligation enumerated at Section 523(a)(15) – that is any obligation arising from a domestic proceeding other than one in the "nature of support." Thus, by filing a chapter 13 bankruptcy instead of one under chapter 7 a debtor may be able to discharge an obligation to pay over the proceeds from the sale of the home or to pay all of the marital credit card debt. So long as the obligation is not one in the "nature of support" it is dischargeable. The determination of whether the obligation is in the nature of support can be made by the bankruptcy court during the bankruptcy or by state court later. The bankruptcy court and state court have concurrent jurisdiction to make this determination.
The end result is that many types of obligations under a divorce stipulation can be substantially undone when a spouse files chapter 13 bankruptcy after the divorce decree is issued if they are not in the nature of support. The problem doesn’t just arise with the allocation of joint debts. Lots of other common obligations don’t fall neatly into the property category or the support category. These include requirements to pay the other spouse a sum of money, to pay his or her attorney’s fees, to keep a life insurance policy in force, to sign over the tax refund, or to deed over the marital home.
Practitioners should be wary of the potential that one spouse will file a chapter 13 bankruptcy after the divorce is final and as a matter of strategy try to draft the stipulation in a way that provides a reviewing court with some guidance. For example it might be wise to include more information in the decree or stipulation regarding each obligation explaining why the benefit and the burden of the obligation lay with each party and whether it is necessary for a individual’s support or just an allocation of property. Including such information hopefully will make it easier for the reviewing court to determine whether a particular obligation is in the nature of support within the meaning of Section 523 and should result in a better or at least more predictable determination. Another strategy might me to discuss the debt situation with the spouses prior to finalizing the divorce. If the reality of the situation is that neither spouse can even hope to afford the debt now that they will be living separately, perhaps it might make sense to file a joint bankruptcy petition before the divorce is finalized.
Debt, divorce, and bankruptcy very often come hand in hand. Divorcing parties with substantial debt that neither party is in a good position to handle would be wise to seek the advice of financial advisors and perhaps bankruptcy counsel at the outset of the divorce. Advice at the outset can help the parties fashion a divorce and financial plan that makes the best sense for their future and their fresh start.
Cheryl C. Deshaies focuses her practice of law in the area of consumer bankruptcy including debtor and creditor issues from her office at 24 Front Street, Exeter, New Hampshire. She is licensed to practice law in New Hampshire and Massachusetts and may be reached at (603) 580-1416 or email@example.com.