by Joshua Menard
Published Feb. 18, 2005 in New Hampshire Bar News
Although bankruptcy is a tool used primarily by parties in financial
distress, it is increasingly used by warring spouses as a weapon in
divorce cases. Given present trends in divorce practice, divorce
practitioners can benefit by staying abreast of developments in bankruptcy
law. Recent developments in the law and the requirements of Rule 1.1(a) of
the New Hampshire Rules of Professional Conduct emphasize the point that divorce
attorneys must evaluate what would happen if one or both of the warring spouses
files a bankruptcy petition.
Revising the ‘deal.’ Deals cut in family court are not cast in
stone. A debtor through a bankruptcy may reclassify vague support
obligations or discharge property settlements. A debtor may also, through
a Chapter 13 filing, seek to obtain time to repay arrearages on nondischargeable
support obligations over as much as 60 months. Since the Bankruptcy Code
treats various types of divorce obligations differently, divorce attorneys
should understand these differences in treatment prior to negotiating and
drafting a settlement agreement or trying a divorce case, particularly when
there is a likelihood of a bankruptcy filing.
Obtaining a Cease
Fire. The initial objective of a bankruptcy petition is usually to
remove the pressure from overzealous creditors, including former spouses,
seeking to collect debts. This is achieved through the automatic stay,
which is effective immediately upon a debtor’s filing of a bankruptcy
petition. Creditors, including former spouses, may no longer contact the
debtor, attach the debtor’s property, or pursue the collection of any debts once
the bankruptcy petition has been filed. Any violation of the automatic
stay may result in sanctions from the bankruptcy court.
Of course
every rule has its exceptions and to the dismay of many divorce law
practitioners the exceptions are often uncertain. Some divorce related
actions are not automatically stayed. Exceptions exist to collect support
from non-estate property, to establish paternity, or to establish or modify a
support award. See 11 U.S.C. 362(b)(2). Understanding these
exceptions is critical as there is the possibility of severe penalties if a
divorce-related proceeding is mistakenly
pursued.
Discharge = Freedom? The ultimate goal of a bankruptcy case is
the discharge of debts, or more accurately a debtor’s personal reasonability to
pay such debts. This is an important distinction because it is often
erroneously assumed that the debt or obligation simply vanishes at the
conclusion of a bankruptcy case. Instead, a bankruptcy discharge releases
a debtor (and only a debtor, not any cosigners) from the personal liability for
paying the debt or obligation at issue. Furthermore, the bankruptcy
discharge does not automatically release liens on a debtor’s property that must
be done by filing a separate motion. If a debtor cannot avoid a creditor’s
lien, the property stays encumbered by the lien and the creditor may seek the
liquidation or repossession of its collateral. The bankruptcy does render
any deficiency uncollectible, since the debtor is released from personal
liability following a bankruptcy discharge.
Debts owed to a spouse, former spouse, or children that were incurred for
alimony or maintenance of the spouse, former spouse or child, however, are not
dischargeable if incurred as the result of a separation agreement or under the
divorce laws of the state. 11 U.S.C. § 523(a)(5) and (a)(15). The
Section 523(a)(5) exception works automatically, without the necessity of the
creditor filing a complaint. 11 U.S.C. § 523(c)(1). However, if any
party in interest questions whether the obligation is for support or is in fact
a property division disguised in “support” clothing, a complaint to determine
the dischargeability of those obligations may be filed at any time.
Unfortunately for divorce practitioners, creative drafting of the divorce
decree and property settlement will not suffice to reduce the bankruptcy
risk. Labels used by the parties and/or the state court simply are
not controlling once the case makes its way to the bankruptcy court
system. In two recent decisions in the First Circuit, Cowell v. Hale
(In re Hale), 289 B.R. 788 (B.A.P. 1st Cir. 2003) and Werthen
v. Werthen (In re Werthen), 282 B.R. 553 (B.A.P. 1st Cir. 2002),
the rule has been clearly established that the bankruptcy court has the
authority to go beyond the labels employed in a divorce settlement agreement
even when the divorce court expressly uses terms such as “property division” in
reaching its order.
Another bankruptcy complication is found in section 523(a)(15), which excepts
certain debts incurred in the course of a divorce or in connection with a
divorce agreement that are not already covered under section 523(a)(5).
Debts of this type are often referred to as “property settlement” debts.
Unlike support debts, which are always excepted from discharge,
property settlement debts may be discharged in bankruptcy.
To make a property settlement debt dischargeable a debtor must prove that he or
she (1) does not have the ability to pay the debt or that (2) allowing him/her
to receive a discharge of the debt will result in a benefit to that is greater
than the detrimental consequences that will befall the former spouse if the
debtor is discharged from the debt. See Garrity v. Hadley,
239 B.R. 433 (Bankr. D.N.H. 1999).
Is it over? The intersection of bankruptcy and divorce law may
occur at the time of the divorce, and even years afterwards. Financial
problems are a common symptom of couples facing divorce. The same pattern
of job loss, uninsured illness, and excessive credit card use familiar in
Chapter 7 and 13 is common in divorce situations. For such couples, both a
bankruptcy and a divorce may be needed to get a “fresh start.” In these
cases, timing is key and in some cases a joint bankruptcy before the divorce
might be appropriate.
Simply because one former spouse files for
bankruptcy protection does not mean that the outcome is pre-ordained against the
other former spouse. There is hope and knowledgeable advocacy is the
key. A series of determinations need to be made about the nature of
claims, their dischargeability, the relative financial position of the parties,
and the strength and admissibility of the evidence the client can present.
For divorce practitioners, having access to bankruptcy law expertise is now a
matter of necessity. The first step to taming the monstrous confusion
created by the intersection of these two legal disciplines is to recognize that
the bankruptcy issues are out there and will influence the efficacy of every
divorce settlement reached by former
spouses.
