Is a divorce award of the former marital residence to wife enforceable against husband’s chapter 7 bankruptcy trustee?

Is a divorce award of the former marital residence to wife enforceable against husband’s chapter 7 bankruptcy trustee?

Yes, in the case of  In re: Timothy H. Thorpe, Reinbold, Trustee, v. Thorpe, No: 17-1766 (7th Cir. Ct. App., 2018), where the Seventh Circuit Court of Appeals affirmed the decision of the judge of the U.S. District Court for the Central District of Illinois ruling that the estate’s interest was subject to wife’s contingent interest under state law.

The parties were married for nearly 26 years before wife filed for divorce in Illinois. The spouses owned real property as joint tenants (what would be considered a tenancy in common under Virginia law) where each owned a half interest and either could convey his or her interest without the other spouse joining in on the transfer. Under Illinois law, both spouses acquire contingent rights in marital property upon the filing of a divorce case.    Eight months after wife’s divorce filing, husband filed a chapter 7 bankruptcy case.

Under 11 U.S.C. §541, when the husband filed chapter 7 bankruptcy, the bankruptcy estate acquired husband’s interest in the marital residence.    Two years later, the automatic stay under 11 U.S.C. §362 was modified to permit entry of a final order in the divorce case awarding husband’s interest in the real property to wife.  Husband’s chapter 7 trustee filed an adversary proceeding against wife to undo the divorce court judge’s ruling in order to sell husband’s interest in the real property.

The wife prevailed in the bankruptcy court and at the U.S. District Court level.  Husband’s chapter 7 trustee appealed to the Circuit Court of Appeals for the Seventh Circuit.  The appellate court first recognized that property rights in bankruptcy are determined according to state law, citing Butner v. U.S., 440 U.S. 48 (1979).  The court then recognized that Illinois occupied a middle ground in marital property rights law: independent ownership interests were not created upon acquisition of the property, as in a community property state, or only upon entry of a final decree of divorce.  Instead, in Illinois, the spouses acquire independent contingent interests upon the filing of a divorce which “blossom” into full interests upon entry of a Final Decree.

(In contrast, under Virginia Code § 20-107.3(B), spouses have rights and interests in marital property, but such interests and rights do not attach to legal title and are only used to determine a monetary award (equalizing payment) under Virginia Code § 20-107.3(E).  It appears a bankruptcy trustee’s rights in Virginia property would not be subject to a spouse’s interest until entry of a final decree of divorce.)

The appellate court reasoned that the bankruptcy estate acquired the husband’s contingent rights in the former marital residence, which disappeared when the final decree of divorce was entered awarding the entire property to wife.  In response to the trustee’s argument that the court’s holding would deprive trustees of the right to challenge state court divorce decrees, the court noted that federal powers were preserved by the fraudulent conveyances statutes and the trustee’s strong-arm powers under 11 U.S.C. §544.  Finally, the court reaffirmed the philosophy that bankruptcy is not intended to expand the debtor’s rights beyond what existed at the commencement of the case, citing Moody v. Amoco Oil, 734 F.2d 1200 (7th Cir, 1984).

You should discuss your marital rights and interests in property upon divorce with your lawyer or Glen Allen bankruptcy and divorce lawyer James H. Wilson, Jr.

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