Is a wife’s claim for equitable distribution in divorce a debt discharged in bankruptcy or an interest in property (part 1 of 2)?

Is a wife’s claim for equitable distribution in divorce a debt discharged in bankruptcy or an interest in property (part 1 of 2)?

There appears to be a split of authority across the U.S. on the treatment of a spouse’s claim for equitable distribution in a bankruptcy case.  Pennsylvania, like Virginia, is a marital property state that provides for equitable distribution in divorce cases.  Although the amendments to the Bankruptcy Code in October 2005 with the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) has altered the treatment of family law debts in bankruptcy by defining Domestic Support Obligations in Section 101(14A), and revising two categories of exceptions to discharge of divorce debts in 523(a)(5) and (15), understanding these two approaches may prove useful to litigating divorce matters in the Virginia county circuit courts or the U.S. bankruptcy courts in Virginia.  The Third Circuit Court of Appeals declined to decide this split of opinion in the unpublished case of Fox v. Fox, Case No: 06-4075 (3rd Cir. 2007).  The two leading bankruptcy cases cited in that federal circuit illustrating the two different approaches are In re: Schorr, 299 B.R. 97 (Bankr. W.D. Pa., 2003), and In re: Scholl, 234 B.R. 636 (Bankr. E.D. Pa., 1999).

In the Scholl case, the wife filed for divorce in state court, asking for equitable distribution, pendente lite spousal support, attorney’s fees and costs.  The property subject to equitable distribution included the marital residence, husband’s pension and husband’s Individual Retirement Account (IRA).  The husband filed a chapter 7 case in the federal bankruptcy court in the Eastern District in state.  The husband listed wife as an unsecured creditor in his bankruptcy case with a possible debt from marriage not to include alimony or spousal support.  Pensions and retirement accounts are usually exempt from creditor process, and thereby protected in bankruptcy from administration by the chapter 7 trustee.   The wife filed an adversary proceeding in the husband’s bankruptcy case for a judicial determination that her right to equitable distribution was not dischargeable in husband’s chapter 7 case.  The wife also sought, and was granted, relief from the automatic stay to continue the divorce case in state court.  In her adversary proceeding, the wife contended that she had vested property rights in the state court equitable distribution procedure that were not discharged by the husband’s bankruptcy.  In defense, the husband contended that the wife had a contingent, unliquidated, disputed claim comparable to a tort claim that could be discharged in bankruptcy.  The bankruptcy court judge recognized that marital property subject to equitable distribution is placed under the divorce court’s jurisdiction, held in custodia legis  (“in the custody of the law”) until the conclusion of the state divorce case.  While the definition of a claim in bankruptcy is broad under Section 101 (5)(A), it does not encompass rights that do not include enforceable obligations.  The filing of a divorce action itself does not give rise to a right to payment, so there is no claim to discharge in the subsequent bankruptcy filing.  In resolving the matter, the bankruptcy court judge looked to state law to determine whether the wife had a right to payment or “claim” at the time the bankruptcy case was filed.  In this case, there was no equitable distribution order or separation agreement supporting a right to payment under state law.  Consequently, the judge held that the wife would take her interests in the marital property free of the creditors of husband’s bankruptcy estate, and husband’s interests in the marital property were property of the bankruptcy estate subject to administration unless exempted.

In a supporting footnote, the judge in the Scholl case cited the case of In re: Roberge, 188 B.R. 366 (Bankr. E.D. Va., 1995), an appeal from the U.S.  Bankruptcy Court for the Eastern District of Virginia, Richmond Division.  In the Roberge case, the bankruptcy judge denied the wife’s motion for relief from the automatic stay in her husband’s chapter 7 case in order to allow her to prosecute an equitable distribution in a Florida.  The husband had left the marital residence to move to Virginia, where he obtained an ex parte divorce from the wife, then filed a chapter 7 bankruptcy two months later.  As the Virginia court never had personal jurisdiction over the wife and could not therefore affect her property rights, the wife was able to file an equitable distribution suit in Florida.  The chapter 7 bankruptcy trustee opposed wife’s motion in the bankruptcy court for relief from the stay to pursue her Florida equitable distribution case.  On appeal, the U.S. District Court for the Eastern District of Virginia first recognized that the Florida case was stayed by the husband’s bankruptcy filing.  The court then recognized that the stay may be lifted for cause under 11 U.S.C. 362, and that the grant of jurisdiction over bankruptcy matters to the district court allowed the district court to abstain from deciding state law matters in the interest of justice or in the interest of comity or respect for state law under 28 U.S.C. 1334(c)(1).

The wife argued in Roberge that domestic relations law is essentially state law best left to the state courts to decide.  The bankruptcy trustee argued that the wife’s equitable distribution rights, an unsecured claim in bankruptcy, were cut off by husband’s bankruptcy filing, based on the trustee’s superior avoidance powers as a hypothetical judgment lien creditor under 11 U.S.C. 544.  The trustee’s argument depended upon state law that recognized equitable distribution rights as being subject to a prior perfected lien.

The judge disagreed with the trustee’s argument in Roberge, holding that the mere filing of a bankruptcy petition does not divest otherwise vested equitable distribution rights.  The judge recognized that property rights are created and defined by state law and that bankruptcy law generally does not act as substantive law.  While bankruptcy should not be used as a weapon in divorce proceeding, the court was mindful of the possibility of collusion by the spouses to cut off creditors’ rights, so relief from the automatic stay is properly a matter of the discretion of the bankruptcy court judge.  The court noted that the bankruptcy court’s decision would contradict the state’s public policy of fostering marriage, by allowing a spouse to abandon his spouse by obtaining an ex parte divorce and cutting off her equitable distribution rights.  Relief from the stay should have been granted in this case, according to the three part test of the Fourth Circuit Court of Appeals in In re: Robbins, 964 F.2d 342 (4th Cir., 1992), because domestic law matters are best left to the states to decide, modifying the stay promotes judicial economy, and the creditors would not be prejudiced by allowing equitable distribution to proceed.  The bankruptcy court judge’s decision was reversed on appeal and the case was remanded back to bankruptcy court.

You should consult with your Virginia bankruptcy or divorce lawyer concerning whether your equitable distribution rights can be discharged in bankruptcy.  The answer to this question is completed in Part 2, where a contrary result in the Schorr case is discussed.

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