Bankruptcy Reform Act protects most marital property settlements from discharge

BANKRUPTCY REFORM ACT PROTECTS MOST MARITAL PROPERTY SETTLEMENTS FROM DISCHARGE

by Mary Ellen Tully
Rabinowitz Trenk Lubekin & Tully, PC

Support and maintenance obligations to children and a former spouse have always been immune from discharge in a bankruptcy proceeding. However, prior to the 1994 Amendment to the Bankruptcy Act, the Bankruptcy Code permitted a debtor to discharge that portion of a financial separation agreement that was in the nature of a property division obligation. Throughout the years there has been extensive litigation in bankruptcy courts to determine whether an award designated as a “property settlement” actually provided a support function and, if so, was therefore non-dischargeable. If the bankruptcy court determined that the award was a property settlement, the former spouse had no greater right to payment than any other unsecured creditor of the debtor and the amount owed was discharged. Despite the tests used by the various circuits to determine whether an award was property or support, the distinctions were frequently unclear because the components of each settlement agreement were and are often interrelated and mutually dependent.

The 1994 Bankruptcy Reform Act addressed the support/property dilemma by broadening the protection for the entire settlement agreement. New Section 523(a)(15) enables the creditor spouse to prevent the discharge of the property component of the settlement by filing an adversary action in the bankruptcy court. The creditor spouse must prove by a preponderance of the evidence that the detriment to her/him if the debtor did not pay the obligation would be greater than the benefit to the debtor.

Section 523(a)(15) grants a discharge of the property settlement to a debtor who cannot support himself or his dependents or a debtor who would lose his business by paying the property obligation. Pursuant to this new provision, the court balances the benefits and the burdens to the parties, considering factors such as the amount of the debtor’s exempt property, the income of both parties and the number of dependents of each. Another significant factor courts consider is whether the non-debtor spouse will be liable to creditors if the debtor spouse fails to pay debts assumed under a hold harmless agreement, thereby increasing the non-debtor spouse’s burden.

In a 1996 Georgia case, Cleveland v. Cleveland, the court considered the totality of the divorced parties’ circumstances and projected income. The court concluded that the debtor’s income combined with that of his live-in companion left him with discretionary income sufficient to make payments towards the hold harmless settlement obligation owed to his former spouse. The court stated that the detriment to the former wife clearly outweighed the benefit of $700 of discretionary income to the husband because the wife would be forced into bankruptcy if she had to assume the new debt. However, the court will discharge a hold harmless settlement obligation to third parties if paying the debt would reduce the debtor’s income below the amount necessary for the support of the debtor and the debtor’s dependents.

BRINGING A NON-DISCHARGEABILTY ACTION

The procedure for challenging the discharge of a property settlement agreement is stringent. The former spouse must bring an adversary proceeding in bankruptcy court within sixty days of the first meeting of creditors. If the former spouse does not file a motion within the time limit, the property settlement debt is automatically discharged. Although Section 523(a)(15) does not require that the challenge to dischargeability must be limited to the child or spouse of the debtor, it appears unlikely that Congress intended to permit third party creditors to bring an action against discharge pursuant to this section. The Hon. Margaret Dee McGarity, Bankruptcy Judge for the District of Wisconsin, in a recent article noted that the legislative history indicates that section 523(a)(15) should be interpreted as an extension of 573(a)(5) which protects from discharge debts to children and spouses but not to third parties.

PART OF PROPERTY SETTLEMENT DISCHARGED

Recently a few bankruptcy courts have interpreted Section 523(a)(15) to permit discharge of a portion of the property settlement if it is determined that the debtor has the RESOURCE to pay part, but not all. In a 1995 California case, In re Comisky, the issue was whether a debtor who had received the marital home pursuant to the property settlement and who was paying support in good faith was obligated to pay his former wife an amount which represented her interest in the marital home. The debtor, who was unable to make mortgage payments on the house, lost it to foreclosure, owing his former wife $18,000.

The court noted that neither party was legally or equitably at fault and that the detriment to the wife if she were not paid was equal to the benefit to the debtor if he did not have to pay. The court determined that dischargeability of the debt in this circumstance depended solely on the debtor’s current and future ability to pay. The court analogized the situation to the repayment of government student loans where courts have held that if the debtor would suffer undue hardship if forced to pay ad of a student loan, but could pay part of it, the court had discretion to declare only part of the debt non-dischargeable. The Comisky court concluded that section 523(a)(15)(A) did not mandate an all or nothing remedy. The court determined that the debtor could pay part of the $25,000 owed to his former wife over a reasonable period of time, as well as the alimony payments of S772 a month,. because the debtor had the potential to earn additional income through part-time teaching. Thus the court flash toned an equitable remedy and granted a discharge from S15,000 of the property obligation.

SPOUSE’S INCOME A FACTOR

In a 1996 Connecticut case, In re Celani, the remarried wife, a debtor, owed her former husband $65,000 pursuant to the property settlement. Her husband claimed that the court should weigh the debtor’s new husband’s income in determining whether the benefit to her of discharging the property settlement outweighed the detriment to him. The wife argued that, because the court could not consider her new husband’s income in determining whether she could pay the debt, it also should not consider his income in balancing the benefit and detriment. The court stated that the balancing test pursuant to Section 523(a)(15)(B) did not limit the inquiry to the debtor’s income alone, but required an expansive review of the totality of the circumstances including the financial circumstances of new spouses. Thus, the court concluded that, although under 523(a)(15)(A) a new spouse’s income cannot be considered in determining whether the debtor has the ability to pay, pursuant to 523(a)(15)(B) the extent to which a new spouse’s contributions or expenses impact on the debtor should be relevant in balancing the equities. (See also Cleveland v. Cleveland).

IMMEDIATE STEPS TO PROTECT YOUR CLIENT’S PROPERTY AWARD

1.As soon as you learn that your client’s former spouse has filed for bankruptcy, obtain a copy of the debtor’s bankruptcy schedules to determine whether the debt to your client is listed.

2.File a Notice of Appearance with the bankruptcy court clerk. This notice will guarantee that the clerk will inform you of all developments in the debtor’s case.

3.File a Notice of Intervention of Child Support Creditor.

4.File a Proof of Claim with the bankruptcy court clerk and serve the debtor, debtors counsel and the bankruptcy trustee with this Proof of Claim. Filing the Proof of Claim permits your client to appear in bankruptcy court and to object to any chapter 11 or 13 plan that may not treat him or her fairly.

5.Within 59 days of the date set for the debtor’s creditor meeting, file a non-dischargeability adversary action in bankruptcy court pursuant to Section 523(a).