To what extent may a bankruptcy trustee avoid a transfer of real property from one spouse to another incident to a divorce settlement?

To what extent may a bankruptcy trustee avoid a transfer of real property from one spouse to another incident to a divorce settlement?

A trustee may avoid a transfer and obtain a money judgment against a non-debtor ex-spouse to the extent that the Debtor spouse did not receive reasonably equivalent value in return for the transfer of real property, as shown by In re Neal, No. 11-8081 (2012), a 6th Circuit Bankuptcy Appellate Panel case.

Before signing the separation agreement, the wife in the Neal case paid off in full the second mortgage/home equity line of credit on the former marital residence in the amount of $28,000 by a loan from her parents.  The wife conveyed her half interest in the former marital residence to the husband by a Quit Claim Deed (a deed containing no warranties).  The real property was shown to be worth approximately $77,000 with a $50,000 first mortgage, so there was effectively no equity when the Wife paid off the home equity line of credit, and only $27,000 when she conveyed her half interest to her husband.  In the separation agreement, the Husband and Wife agreed that the Wife had waived, or given up, any interest in the former marital residence.  The Husband assumed sole responsibility for payment of the mortgage on the real property.

The property settlement agreement provided that the Husband would keep a vehicle and two motorcycles while the Wife would keep an older vehicle and her pension.  The Wife and Husband also agreed that Husband had sole ownership of his separate property, which included two lots and several more vehicles.

As is the customary legal practice in Virginia, the Ohio divorce court approved and incorporated the separation agreement between the parties into the final decree of divorce.  Six months later, the Debtor wife filed a chapter 7 bankruptcy case in the U.S. Bankruptcy Court for the Northern District of Ohio, Eastern Division.  Fifteen months later, after the Debtor wife received her discharge in bankruptcy, the chapter 7 bankruptcy trustee filed an adversary proceeding against her ex-husband to avoid and recover the value of the constructively fraudulent transfer of real property to him, relying on the trustee’s avoidance powers contained in Bankruptcy Code Sections 548(a) (11 U.S.C. §548(a)), 544 (11 U.S.C. §544),  and 550 (11 U.S.C. §550),  and Ohio state fraudulent conveyance statutes.

In response to the trustee’s allegation that the Debtor wife did not receive reasonably equivalent value for the transfer of real estate, the ex-husband alleged that he would have likely received spousal support, continued health insurance, and half the Debtor’s pension had the case been tried in divorce court.  He also contended that the Debtor’s credit card debt and debt to her parents for the loan to pay off the home equity line of credit (which she discharged in bankruptcy) would not have been considered marital debt for which he might have been held liable.

At trial in the bankruptcy court, the evidence demonstrated that the Debtor was the primary breadwinner and the spouse who managed the household finances.  Most of the debts during the marriage had been incurred in the Wife’s name alone, but had been used for family or marital purposes.  The bankruptcy court held that the Debtor had made a prepetition transfer of an interest in property, that the transfer had been made within 2 years of filing bankruptcy, and that the Debtor was insolvent at the time the transfer was made due to the amount of debt the Debtor had assumed and the short period of time between the entry of the divorce decree and the filing of the chapter 7 bankruptcy case.

In deciding whether the Debtor had received reasonably equivalent value for the transfer of real property to her husband, the court analyzed state law rather than bankruptcy law.  The court noted that Ohio’s equitable distribution law presumes an equal apportionment of property and debt between the husband and wife, unless such a division would be inequitable.  Since both parties were capable of supporting themselves, there would not likely have been an award of spousal support and there was no evidence of a waiver of any rights to further health insurance in the separation agreement or the divorce decree.  The bankruptcy judge found that although the ex-husband would likely have been entitled to half the wife’s pension, worth about $9,000, he would have been responsible for half the substantial credit card debt and loan to her parents in the sum of approximately $90,000.

The bankruptcy court judge further held, sua sponte, that the analysis of reasonably equivalent value underlying the trustee’s avoidance action was not precluded by collateral estoppel due to a provision in the separation agreement which characterized the exchange of value as “fair and equitable”, because the bankruptcy proceeding and the divorce had different policy goals, citing In re Fordu,  201 F.3d 693 (6th Cir., 1999), where the 6th Circuit noted that the standards for determining fair and equitable in context of the domestic relations arena are different from determining reasonably equivalent value in the context of a bankruptcy avoidance action.

On appeal, the Bankruptcy Appellate Panel (BAP) first decided that the “fair and equitable” provision in the state divorce decree would not be given any preclusive effect in this bankruptcy avoidance action.  The court further held that the purpose of the trustee’s avoidance powers under 11 U.S.C. §550 against a transferee like the ex-husband was to restore the bankruptcy estate to the position it would have been in if the transfer had not been made. The BAP recognized that the only issue in dispute on appeal was that of reasonably equivalent value.

The Bankruptcy Appellate Panel concluded that the bankruptcy court had erred in its analysis of reasonably equivalent value by considering the amount of unsecured debt assumed by the Debtor wife, since it appeared the husband would not have been liable for the credit card debts in the wife’s name, and there was no evidence that the husband was liable to her parents for the loan to pay off the home equity line of credit.  Consequently, by assuming these debts in the divorce case, the Debtor wife had not conferred a benefit upon her ex-husband.  In addition, the liability of the ex-husband to the trustee was limited to the difference between the value transferred and reasonably equivalent value.  In this case, the Wife traded her interest in half the equity in the former marital residence worth $13,750 in exchange for the Husband’s release of his half interest in her pension worth $9,217.02.  Thus the ex-husband’s liability to the trustee was limited to the difference in the amount of $4,532.98.  Finally, the BAP determined that the bankruptcy court was not required in an avoidance action to determine the likely outcome of a contested divorce case when analyzing reasonably equivalent value, it was only required to compare the value transferred to the value received in the marriage dissolution.

You should consult with your Virginia divorce and bankruptcy law lawyer or Richmond Divorce and Bankruptcy Law Lawyer James H. Wilson, Jr., to discuss your actual or potential liability to a bankruptcy trustee for transfers to or from your spouse in connection with a Virginia divorce case.

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