Bankruptcy & Litigation Series: #2 My Ex is filing Bankruptcy!

While we have previously posted about the many issues that can arise when a bankruptcy happens at the same times as a divorce, what happens if a bankruptcy is filed after the divorce is final?

If a Bankruptcy action is filed immediately after the divorce becomes final it is possible for the Bankruptcy Court to undo the Agreement or Judgment of the Divorce Court if it appears the parties were attempting to defraud creditors (for instance if all of the assets were transferred to the non-debtor spouse rather than split equitably).  If the division is equitable, though, then it is unlikely that the Bankruptcy Court would want to revisit the divorce division.

However, the debtor might be bound to make payments in the divorce case which could affect eligibility for bankruptcy, and might have made promises to divide property that is now an issue. Domestic Relations Orders are non-dischargeable in most cases and therefore the decisions made in a divorce settlement, will have significant impact on what can and can't be discharged in the bankruptcy. There are three main areas where a bankruptcy can affect or be affected by a divorce judgment:  property division issues, support issues, and joint debts.

Property Division Issues in a Post-Divorce Bankruptcy:

If a divorce judgement requires that certain property be transferred from the debtor to their ex-spouse then the bankruptcy could affect that transfer.  If the transfer is made within 1 year prior to the bankruptcy then this could be considered a transfer to an insider and if it is not for fair value (for instance if the property division was not equitable), then the bankruptcy court can, upon motion of the trustee, require that the property be returned to the debtor's estate.

If the transfer hasn't been made yet, then that property is included in the debtor spouse's bankruptcy estate and the ex-spouse becomes another creditor of the estate.  Whether they take priority or not will depend on the nature of the property to be divided, and whether their claim is a non-dischargable domestic relations order or not.  Domestic relations orders are treated slightly differently for Chapter 7 and Chapter 13 bankruptcies, so the type of bankruptcy that is filed may also affect whether the property transfer is required or not.

Usually a failure to transfer property required by a Divorce Judgment would subject the debtor spouse to a Complaint for Contempt in the Probate & Family Court.  However, the Bankruptcy Court takes precedence and the Automatic Stay prevents creditors (even ex-spouses) from proceeding in other courts without first getting the permission of the Bankruptcy Court.

Support Issues in a Post-Divorce Bankruptcy:

Alimony and Child Support are considered Domestic Support Obligations, which are non-dischargable and must be paid by the debtor in a bankruptcy.  Any child support or alimony arrears are non-discharable in a bankruptcy and take priority over other debts.  In addition, if the family court awards the costs and attorneys fees of collecting alimony and child support in a Contempt action, those debts are non-dischargable as well.  In a Chapter 13, arrears may be paid overtime as part of the plan, but in a Chapter 7 they remain due immediately.

Practically speaking, going through a bankruptcy, might gain a debtor spouse some leeway from the Probate & Family Court in obtaining a payment plan for payback of the arrears, but they will still need to be paid.  If the ongoing support order itself is incorrect or onerous, this cannot be changed in the Bankruptcy Court, but can still be revisited by the Probate & Family Court by the filing of a Complaint for Modification.

If the debtor spouse is receiving child support or alimony this counts towards their income for bankruptcy means test purposes.  If it is owed but is not being paid then it does not need to be included, though the arrears may be an asset that should be listed.

Joint Debt Issues in a Post-Divorce Bankruptcy:

Post-Divorce there may be debts for which both parties are liable to the creditor but one or the other party has agreed (or been ordered) as part of the divorce to pay these debts.  Some typical examples of joint debts are home mortgages, joint credit cards, joint tax debt, and co-signed car loans.  If a joint debt is not paid off in the divorce, then from the creditor's perspective it is still owed by both parties.  If the divorce judgment requires one spouse to pay the debt and they do not make payment, it will affect both spouse's credit and the creditor can come after either or both of them to collect.  The spouse who was supposed to be protected in the divorce can likely file a Complaint for Contempt against the other spouse but this won't undo any credit damage and doesn't stop the collection action by the creditor.

In a Bankruptcy, the debtor is required to list co-debtors and the Bankruptcy Court can discharge debts to the third party creditor.  Whether or not the obligation of a debtor spouse to their ex-spouse is also discharged will depend on whether or not it is considered a domestic support obligation or non-dischargable domestic relations order.  It is likely important for the ex-spouse to participate in the bankruptcy and file a Proof of Claim if they believe there is an obligation to them as well as the creditor.  However, it is also important to note that even if a debt is non-dischargable, as a practical matter it may still be difficult to collect.  A debtor with no assets, found in Contempt in the Probate & Family Court, may not be able to pay the joint debt and the creditor will still pursue the non-bankrupt spouse.  It is therefore important to anticipate potential issues such as this at the time of the divorce, especially if it is obvious that one spouse's budget will not allow them to pay the bills they are agreeing to pay.

Bankruptcy & Litigation Series: #1 Divorce

When a bankruptcy is filed, the automatic stay precludes creditors from proceeding in lawsuits against the debtor. If a bankruptcy is filed during a divorce case, the automatic stay applies to the divorce case as well.

The divorce Judge may proceed on issues of child support, alimony and custody of children, but may not make any decisions relating to the division of assets and debts without the permission of the bankruptcy court, and any decisions made by the divorce Judge are reviewable by the bankruptcy Judge.

Therefore, it is very important to consider the right timing of a bankruptcy and a divorce when a client will likely have to go through both process.

Filing Divorce First: Finishing the divorce action before beginning the bankruptcy filing allows the divorce action to proceed to its natural conclusion without interruption by the bankruptcy court. It is still possible, though, for the Bankruptcy Court to undo the Agreement or Judgment of the Divorce Court if it appears the parties were attempting to defraud creditors (for instance if all of the assets were transferred to the non-debtor spouse rather split equitably). Despite this risk, it is unlikely if the division is equitable that there would be any issue, and both cases would like proceed more smoothly one after the other, rather than simultaneously.

However, the debtor might be bound to make payments in the divorce case which could affect eligibility for bankruptcy, and might have made promises to divide property that is now an issue.  Domestic Relations Orders are non-dischargeable in most cases and therefore the decisions made in a divorce settlement, will have significant impact on what can and can't be discharged in the bankruptcy.  This is even further complicated by joint debts.  It's therefore important to have bankruptcy counsel review a potential divorce settlement prior even if the intention is to complete the divorce case first.

Filing Bankruptcy First: Likewise, there are certain circumstances where it might make more sense to file for bankruptcy prior to filing the divorce. For instance in a case where both spouses had significant debt, they can file as joint debtors so long as they are still married. Even if only one of the parties intended to file, there is a case which suggests that some of the protections for the debtor extend to the non-debtor spouse (protections that might not apply if the parties are already divorced).

The facts of each case will control whether it makes sense to file the bankruptcy or divorce first.  If you are assisting a client with a divorce case but don't have expertise in bankruptcy we recommend reviewing your strategy with an attorney trained in bankruptcy.  The terms of the proposed property settlement or transfers of property under the agreement may be hurtful to your bankruptcy case if your client plans on filing for bankruptcy shortly after the conclusion of the divorce matter. These issues are even more complicated when a Chapter 13 plan is in place, because a divorce can cause problems with making plan payments.  Having an attorney that can explain the bankruptcy consequences of the decisions made during the divorce will be critical in helping your client get a fresh start.

What to do when you receive a Notice of Bankruptcy? Step 4: What is your liability?

In our previous posts in this series you should have already identified why you received the Bankruptcy Notice and what the deadlines are that might apply to you.  In order to determine whether you should take any action related to this Notice, you now need to determine what you may have to lose.

If you are a creditor and you take no action, the debt owed to you may be discharged.  In most cases, there is nothing a creditor can do to prevent the discharge, especially in a no-asset case.  The right of the debtor to file for bankruptcy trumps your right to be paid by the debtor.  However, there are some examples where taking action can result in payment (or at least non-discharge of your debt).  Some examples where you may be able to prevent discharge of your debt, or all debts, is when the debtor committed fraud, when the debtor is trying to exempt property that should not be exempted, or when the debt is secured or otherwise protected from discharge (these are just some examples and is not intended to be an exhaustive list).

In any case where a creditor can prevent discharge, they are usually required to take some action to notify the court of their dispute and enforce their rights.  For example, in the case of fraud, the creditor must file an adversary proceeding challenging the discharge of that debt based on fraud.  In each individual case, you will have to determine if the value of preventing discharge of the debt is greater than the cost of enforcing that right.  In many such cases the creditor may reach settlement with the trustee regarding payment.

There are also situations where a bankruptcy may affect your liability, but there is nothing you can do about it.  For example, many codebtors will be affected by the bankruptcy of the debtor but have little rights to challenge the bankruptcy, because their liability is due to their own agreement with the creditor and they have no separately existing rights against the debtor.  This is often the case when one spouse, or ex-spouse files for bankruptcy.  Bankruptcy can have a major affect on debts owed by both spouses, and therefore property division, but if the divorce agreement doesn't appropriately address this possibility, the non-debtor spouse may have few or no options.  For more information about cosignors or the interplay of divorce and bankruptcy you may want to review these other posts:

I am the primary borrower on a loan and my cosigner has filed for bankruptcy. What should I do to protect myself?

I co-signed a loan and the primary borrower has filed for bankruptcy. What should I do to protect myself?

4 Facts Your Divorce Attorney Should know about Bankruptcy? Fact #4: Jurisdiction over Your Assets

4 Facts Your Divorce Attorney Should know about Bankruptcy? Fact #3: Jurisdiction over Your Debts

4 Facts Your Divorce Attorney Should know about Bankruptcy? Fact #2: Domestic Support Obligations

4 Facts Your Divorce Attorney Should know about Bankruptcy? Fact #1: The Automatic Stay

Once you've identified your exposure in a bankruptcy, the last step is to determine if you need help in limiting that exposure.  Should you hire a bankruptcy attorney to help you evaluate your claims? 

My Ex Owes Support and is Filing for Bankruptcy: What Now?

We previously wrote an article regarding the dischargeability of domestic support obligations, such as child support and alimony. But just knowing that the arrears are not dischargeable may not be enough. How do you collect them without violating bankruptcy law?

If you are owed child support, alimony, separate support or money or property pursuant to a divorce separation agreement, and the other party files for bankruptcy, it is important that you first know your rights regarding the dischargability (or non-dischargability) of those obligations. Each of the above are handled differently depending on the type of obligation (support versus a property settlement) and the type of bankruptcy (Chapter 7 or Chapter 13).

CHAPTER 7 CASES

In Chapter 7 Cases, the answer is simple: domestic support obligations and divorce property settlements are non-dischargeable. According to the bankruptcy code at 11 U.S.C. § 523(a):

“[a] discharge [in a Chapter 7 Case] does not discharge an individual debtor from any debt… (5) for a domestic support obligation; [or] (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."

So, if a payor owes you back child support, alimony or or property division payments pursuant to a divorce agreement you should file an objection to the discharge of those debts, and then pursue your rights in the Probate and Family Court to obtain payment.

CHAPTER 13 CASES

Debtors may use the bankruptcy protections of Chapter 13 to pay back child support arrears according to the chapter 13 plan and avoid a potential contempt in Probate and Family Court. Therefore, most issues regarding unpaid child support or alimony (and payment of support arrears) arise in Chapter 13 Bankruptcy Cases. However, while bankruptcy can provide some protection to the debtor to pay back support over the course of the plan, the debtor must meet all requirements of the Massachusetts Local Bankruptcy Rules and the U.S. Bankruptcy Code in order to ensure they receive their discharge upon the completion of their plan.

A discharge in a Chapter 13 Case does not discharge an individual debtor from any debt for a domestic support obligation, but may discharge other debts, including debts arising out of a divorce or separation agreement that are not dischargeable in a Chapter 7 case. See 11 U.S.C. § 1328(a).

In order to receive a discharge of other debts (but not domestic support obligations) in a Chapter 13 case, the debtor must successfully complete the repayment plan, and must file a Motion for Discharge, and certify that all obligations for child support, spousal maintenance and alimony due that were due on or before the date of the motion, including all payments due under the plan for amounts due before the petition was filed and any domestic support obligations that arose after the filing of the petition have been paid. The debtor must serve a copy of the motion and certification on the beneficiary of the domestic support obligation.

At that point, the beneficiary may object to the entry of the debtor’s discharge if there are outstanding obligations and a discharge will not be granted unless all obligations have been paid. See 11 U.S.C. § 1328(a). See also Massachusetts Local Bankruptcy Rule 13-22 and Official Local Form 12.

However, there is one exception: domestic support obligations that are assigned to a governmental unit (i.e., collected by the Department of Revenue and distributed to the beneficiary) may be paid less than 100% through the plan, but only if disposable income is dedicated to the plan for a full five years. In this case, the debtor would continue to owe any child support not paid at the completion of the plan and DOR would continue to be involved at the end of the bankruptcy case.

Finally, bankruptcy will not change the current support obligations following bankruptcy. At the conclusion of either a chapter 7 or chapter 13 bankruptcy, the debtor’s obligations to pay child support remain unchanged, and must pay any obligations unless and until amended by an order of the Probate & Family Court. If you want to know more about amending support orders in the Probate & Family Court in Massachusetts view our information on Modifications.

4 Facts Your Divorce Attorney Should know about Bankruptcy? Fact #1: The Automatic Stay

Immediately after a Bankruptcy Petition is filed, the court enters an Automatic Stay Order prohibiting the creditors from taking or continuing any collection or legal action against the debtor. The automatic stay is a useful tool in temporarily stopping foreclosure proceedings brought by mortgage holder(s), as well as collection efforts, collection calls and lawsuits filed by creditors.

The Automatic Stay also puts an immediate stop to some portions of a pending divorce, modification, or contempt proceedings. Specifically any actions relating to debts or the division of assets cannot be ruled on by the Divorce Court while the bankruptcy is pending, unless the Bankruptcy Court is first asked for permission by filing a Motion for Relief from the Automatic Stay. Even issues relating to the collection of child support or alimony may be stayed or considered under the jurisdiction of the Bankruptcy Court while a petition is pending.

The penalties for violating the Automatic Stay can be significant, including fines and attorneys fees and it is therefore very important to seek Relief from the Automatic Stay before attempting to move forward with any issues that may be in the jurisdiction of the bankruptcy court. In order to avoid costly mistakes for divorce clients, we encourage divorce practitioners to consult with bankruptcy counsel when there is the potential that one party in the divorce will file for bankruptcy.

Of course, issues relating to custody are not affected by the Automatic Stay and can continue, though this may require a bifurcation of the probate matter.

Click here to read the other 3 Facts:
Fact #4: Jurisdiction over your Assets
Fact #3: Jurisdiction over your Debts
Fact #2: Domestic Support Obligations.

4 Facts Your Divorce Attorney Should know about Bankruptcy? Fact #2: Domestic Support Obligations

U.S. Bankruptcy Code Title 11 Section 101 14(A) defines a "domestic support obligation" 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 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.”

Domestic Support Obligations are generally non-dischargeable debts (except in some cases in a Chapter 13 after partial payment). This means that even if a spouse or former spouse files for bankruptcy, the Divorce Court can still order them to pay alimony or child support, and can still make orders relating to the collection of alimony and child support. This information is very important because it often means that an ex-spouse filing for bankruptcy can actually be helpful when alimony or child support is owed. Since the debtors other debts are now stayed and likely dischargeable, the alimony and child support will be easier to pay.

In addition, our previous post highlighted one of the ways that the category of "domestic support obligation" can be used to avoid problems such as the discharge of joint debts by categorizing certain payments as alimony.

Understanding what is and what is not a "domestic support obligation" can be very important in drafting and enforcing Divorce Agreements. In order to avoid costly mistakes for divorce clients, we encourage divorce practitioners to consult with bankruptcy counsel when there is the potential that one party in the divorce will file for bankruptcy.

Click here to read Fact #1: The Automatic Stay.

4 Facts Your Divorce Attorney Should know about Bankruptcy? Fact #3: Jurisdiction over Your Debts

The Divorce Court has the power to divide not just assets, but also debts. Just as the Court can assign the property titled to one spouse to the other spouse if the equities require, the Court can also order one spouse to pay the debts of the other spouse. But the Bankruptcy Court has the power to discharge debts. So what happens if the Divorce Court orders a spouse to pay a joint credit card debt, but the Bankruptcy Court gives that same spouse a discharge of that debt.

For purposes of this example, let's assume that the Husband and Wife were each ordered to pay half of a joint credit card debt. The Wife then files for bankruptcy and the credit card debt is discharged. Both the Husband and Wife were liable for the whole debt to the credit card company, but now only the Husband is liable to the credit card company. If the payment ordered by the divorce court is not categorized as a domestic support obligation (discussed in our next post) then the Wife no longer owes the debt to the credit card company or the Husband, and the Husband is left having to pay the entire debt.

It is possible for Separation Agreements or Divorce Judgments to avoid this problem by using assets to pay (or offset) debts, instead of trying to reassign debts. If enough assets are not available to do this then payments such as alimony, which are domestic support obligations, can be used instead to accomplish this same goal and avoid the discharge problem.

This issue can be further complicated when the debt that is at issue is a mortgage or secured debt. In order to avoid costly mistakes for divorce clients, we encourage divorce practitioners to consult with bankruptcy counsel when there is the potential that one party in the divorce will file for bankruptcy.

Click here to read Fact #2: Domestic Support Obligations.

4 Facts Your Divorce Attorney Should know about Bankruptcy? Fact #4: Jurisdiction over Your Assets

Many attorneys specialize their practice in order to better serve their clients. While concentrating on a particular practice area can help attorneys focus on making themselves the best in their field, sometimes it causes them to lose sight of the bigger picture. Divorce cases do not occur in a vacuum. When divorcing spouses face financial troubles it is important to consider the possibility of a bankruptcy and how this could affect the different aspects of a divorce.

We have put together this list of four important facts that divorce attorneys should be aware of, to help them better assist their clients who may also be facing a bankruptcy (or have a spouse who may be forced to file for bankruptcy).

Fact #4: Jurisdiction over Your Assets

When a Debtor files for Bankruptcy, they submit their assets to the jurisdiction of the Bankruptcy Court. This means that when a Debtor files for bankruptcy during a divorce case, the assets that would normally be divided in a divorce case are first subject to the jurisdiction of the Bankruptcy Court. While some assets may be joint, the spouse is merely considered another creditor with rights to the joint property that may be subject to the rights of other creditors as well.

A Bankruptcy Judge may allow the Divorce Court to make decisions relating to the division of property, but this is at their discretion, and the Bankruptcy Judge also has the right to make these decisions directly. This power applies even if the divorce has already become final. The bankruptcy laws allow the trustee to take back any items which were transfered up to two years prior to the bankruptcy filing if the transfer was not for fair value (11 U.S.C. § 548(a)(1)) or up to one year prior to the bankruptcy filing if the transfer was to an insider (11 U.S.C. § 547(b)(4)(B)). This means that the Bankruptcy Court can undo a Separation Agreement or Judgment of Divorce in favor of transferring assets from the ex-spouse to other creditors.

Finally, it is important to understand that filing for bankruptcy means that a debtor gives up their rights to decide what happens to their non-exempt assets. The bankruptcy trustee stands in the shoes of the debtor. This means that they can settle a divorce case giving up any rights the debtor may have in their spouse's property. The duty of the trustee is to the creditors not to the debtor.

These are all important consequences of filing for bankruptcy that should be considered when a bankruptcy is filed during or after a divorce case. If you are in a divorce or were recently divorced make sure you discuss this with your bankruptcy attorney. If you are getting divorced and considering bankruptcy, make sure your divorce attorney understands the consequences of filing bankruptcy or consults with a bankruptcy attorney.

Click here to read Fact #3: Jurisdiction over Your Debts.

Bankruptcy or Divorce, which should come first?

If I am facing both divorce and bankruptcy, should I file for bankruptcy before, during, or after filing for divorce?

Answer: When a bankruptcy is filed, all lawsuits against the debtor are immediately stayed. If a bankruptcy is filed during a divorce case, the automatic stay applies to the divorce case as well. The divorce Judge may proceed on issues of child support, alimony and custody of children, but may not make any decisions relating to the division of assets and debts without the permission of the bankruptcy court, and any decisions made by the divorce Judge are reviewable by the bankruptcy Judge.
Finishing the divorce action before beginning the bankruptcy filing allows the divorce action to proceed to its natural conclusion without interruption by the bankruptcy court. It is still possible, though, for the Bankruptcy Court to undo the Agreement or Judgment of the Divorce Court if it appears the parties were attempting to defraud creditors (for instance if all of the assets were transferred to the non-debtor spouse rather split equitably). Despite this risk, it is unlikely if the division is equitable that there would be any issue, and both cases would like proceed more smoothly one after the other, rather than simultaneously.

Likewise, there are certain circumstances where it might make more sense to file for bankrutpcy prior to filing the divorce. For instance in a case where both spouses had significant debt, they can file as joint debtors so long as they are still married.

Even if only one of the parties intended to file, there is a recent case which suggests that some of the protections for the debtor extend to the non-debtor spouse (protections that might not apply if the parties are already divorced). For an excellent explanation of this case visit the Bankruptcy Law Network post titled: Actions Taken Against Non-Debtor Spouse Violate Discharge Injunction.

You should consult with an attorney that is familiar with both bankruptcy and divorce law to determine the best course of action in your specific case. The facts of your case, such as the terms of the proposed property settlement or transfers of property under the agreement may be hurtful to your bankruptcy case if you plan on filing for bankruptcy shortly after the conclusion of your divorce matter. Having an attorney that can explain the bankruptcy consequences of your decisions during your divorce will be critical in helping you get your fresh start.

For more information about divorce and family law, check out our family law website and Scaling the Summit: A Family Law Blog.