Month: February 2018

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 (7^th 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 (7^th 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.

Is husband’s divorce agreement to make wife’s mortgage payments nondischargeable in a chapter 13 bankruptcy?

Yes, in the case of  In re Thomas, 511 BR 89 (6^th Cir. BAP, 2014), a  Bankruptcy Appellate Panel decision from the 6^th District, on appeal from the U.S. Bankruptcy Court for the Western District of Kentucky.

In Thomas, the husband and wife married, divorce, re-married and divorced again.  In the course of each divorce proceeding, the husband and wife reached a final comprehensive separation agreement followed by an agreed divorce.  In the final separation agreement, the husband gave up his interests in the former marital residence and the wife agreed to make the mortgage payments on the first mortgage and to split the mortgage payments on the second mortgage with the husband.   As part of her assumption of the first mortgage payments, the wife agreed to hold husband harmless thereon.  A hold harmless agreement is “…a part in a contract when parties agree not to hold the other party responsible for loss, liability, or damage.’  Black’s Law Dictionary, Free Online Legal Dictionary, 2d Ed. Husband quitclaimed his interest in the former marital residence to the wife.  The parties agreed to divide any deficiency arising from the sale of the property, but with all the net proceeds going to the wife in the event of a surplus from a sale.  The parties did not address a judgment lien for more than $8,000 that attached to husband’s interest in the property before they entered into the separation agreement; the wife claimed she was unaware of the judgment lien at that time.

There was no spousal support owed to either party under the separation agreement.  The wife was given primary custody of the children and husband agreed to pay child support to the wife.

After the parties were divorced from each other for the second time, the wife sold the former marital residence.  As the proceeds of sale were not sufficient to satisfy all liens against the property, the wife paid money at settlement to close the sale.

Four months later, the state court divorce decree was modified to provide that the husband owed the wife $7,500 for his half of the second mortgage and an additional $5,000 for the negotiated settlement payoff of the judgment lien against the property.

The husband subsequently filed chapter 13 bankruptcy.  He listed the wife as a priority creditor for one month’s child support and a general, nonpriority, unsecured creditor for $15,000.  The wife filed a proof of claim for a $12,500 priority claim for the second mortgage debt and judgment lien debt, with priority as a “Domestic Support Obligation”, a term defined in Bankruptcy Code Section 101(14A) and nondischargeable in any kind of bankruptcy under 11 U.S.C. §523(a)5.  Priority debts are defined in Section 507 of the Bankruptcy Code and must be paid in full under the chapter 13 plan by virtue of 11 U.S.C. §1322(a)(2), unless the holder of the claim agrees to different treatment.

The husband objected to wife’s claim as a domestic support obligation on the grounds that it was not in the nature of alimony, maintenance, or support, but was for liens that had already been paid off.  Husband’s argument relied on the fact that a non-DSO debt arising from divorce or separation, a debt that fits within 11 U.S.C. §523(a)(15) is dischargeable in a chapter 13 bankruptcy case (but not in a chapter 7 bankruptcy case) and is not a priority debt which must be paid in full.

The bankruptcy court judge found the wife’s claim was in the nature of alimony, maintenance or support and overruled husband’s objection to her proof of claim.  The husband appealed the decision to the Bankruptcy Appellate Court, and neither party requested that the appeal be heard by the U.S. District Court, as permitted by 28 U.S.C. §§158(a), (b) (6) and (c)(1).

The appellate court first recognized that the dischargeability of domestic support obligation is a mixed question of fact and law with two different review standards on appeal, a “clearly erroneous” review standard for fact findings and a de novo review standard for the rulings based on interpretations of 11 U.S.C. §523.  The court then recognized the public policy reasons behind the nondischargeable domestic support obligations, and the different treatment afforded post-divorce obligations under 11 U.S.C. §523(a)(15) only in chapter 13 bankruptcy cases.  The court then restated the four-part analysis in the 6^th Circuit for determining whether an obligation is in the nature of support or maintenance, citing Long v. Calhoun (In re Calhoun), 715 F.2d 1103, 1109-10 (6th Cir. 1983), and Fitzgerald v. Fitzgerald (In re Fitzgerald), 9 F.3d 517, 520 (6th Cir. 1993) :

“First, the obligation constitutes support only if the state court or parties intended to create a support obligation. Second, the obligation must have the actual effect of providing necessary support. Third, if the first two conditions are satisfied, the court must determine if the obligation is so excessive as to be unreasonable under traditional concepts of support. Fourth, if the amount is unreasonable, the obligation is dischargeable to the extent necessary to serve the purposes of federal bankruptcy law.”

The burden of demonstrating that the obligation is in the nature of support is on the nondebtor.  Fitzgerald v. Fitzgerald (In re Fitzgerald), 9 F.3d 517, 520 (6th Cir. 1993) .

In Thomas, the dispute centered only on the first factor: whether the parties intended to create an  obligation in the nature of support.  The bankruptcy court had found the parties intended the second mortgage debt as support for five reasons: 1. it protected the children’s home; 2. the previous divorce decree included an upward deviation from the child support obligations to allow the wife to pay the mortgage, which the second decree lacked; 3. the decree’s provision to split any deficiency from the sale; 4. the hold harmless in the previous divorce decree does not relieve the husband from an obligation to pay the disputed claim; and 5. the agreements do not show the husband was entitled to support.

The appeals court affirmed the bankruptcy court’s view that the later separation agreement and second divorce superseded the terms of the previous separation agreement and divorce, although a comparison of the two could help the court determine the parties’ intent.  The appeals court disagreed with the husband’s argument – that child support was lowered in the second divorce because he was unemployed and not because his new support obligation included the second mortgage payment – as a fact that was not mutually exclusive with the bankruptcy court’s inference that his unemployment created the need for the second mortgage payment to be considered support while his regular child support payment was decreased.  In support of this, the appellate court cited  In re Palmieri, No. 11-51224, 2011 WL 6812336, at *5 (Bankr. E.D. Mich. Nov. 21, 2011) for the majority rule (and a list of supporting cases) that mortgage payments are in the nature of support because they provide a basic necessity: allowing the family members to remain in the marital residence.  Further, the wife testified at the bankruptcy court hearing that her income was insufficient to pay the first and second mortgage payments.

The appellate court dismissed the husband’s argument that the obligation was really property settlement and not support, as the parties had waived spousal support in the separation agreement by recognizing that the bankruptcy court is free to find an obligation is in the nature of support even though the state court labeled it otherwise.  In fact, the mortgage payment obligation had not been labeled by the parties as either support or property settlement in the separation agreement.  The husband’s argument that the obligation to make second mortgage payments could not be in the nature of support because the parties contemplated the sale of the marital residence was dismissed by the appellate court, which supported the bankruptcy court’s reading of an ambiguity in the splitting of a deficiency and award of a surplus to wife as an intent to provide the children with a residence – a possible down payment on a future home.

The appellate court affirmed the bankruptcy court’s ruling based on the totality of the circumstances, which ruling was not clearly erroneous, that the second mortgage payments were in the nature of support.  As the judgment lien was entirely the husband’s responsibility, was not addressed in the separation agreement, and prevented the wife from realizing any surplus from the sale of the former marital residence intended to be support, it too must be a domestic support obligation.  The court disagreed with the husband’s argument that it could not be in the nature of support as it was owed to a third party, not his spouse or former spouse, as not supported by the case law, citing Holliday v. Kline (In re Kline), 65 F.3d 749 (8th Cir.1995) and Rugiero v. DiNardo, 502 F. App’x 436, 439 (6th Cir. 2012).  As further support for the bankruptcy court’s ruling allowing the claim as a nondischargeable, priority Domestic Support Obligation, the court noted that the state court had treated the second mortgage debt as part of an order arising out of a support contempt hearing in 2009.

You should consult with your Virginia bankruptcy and divorce attorney or Richmond divorce lawyer James H. Wilson, Jr., to discuss whether any particular obligation arising out of separation or divorce might be considered to be in the nature of support.

Is a husband’s agreement to pay his wife half the monthly payment amount for her parent’s loan to them during the marriage nondischargeable in husband’s chapter 7 bankruptcy after a divorce?

Yes, the court ruled in Shaver v. Shaver, Adversary Proceeding Number 14-5005, from the U.S. Bankruptcy Court for the Western District of Virginia, Harrisonburg Division.

In Shaver, the wife’s parents lent $30,000 to the couple during the marriage.  The wife’s parents drew the money from a home equity line of credit on their home.  There were no written documents evidencing the loan between the parents and their daughter and son-in-law.  The husband and wife orally agreed to repay the wife’s parents with monthly payments of $280 directly to the parents’ lender until the loan was paid in full.

The husband and wife subsequently entered into two written separation agreements, both prepared by the husband, when they decided to divorce.  In the first agreement, the husband agreed to pay half the monthly loan payment directly to the wife.  The next day, the parties signed a second agreement in which they divided up responsibility for paying the marital debts, without specifically mentioning the debt to the wife’s parents.  The husband and wife were later divorced.

The husband remarried and subsequently filed a joint chapter 7 bankruptcy case with his new wife, listing his now ex-wife as one of his creditors.  The ex-wife filed an adversary proceeding, a separate case associated with a bankruptcy case, to determine the dischargeability of the debt evidenced by the first agreement.  The ex-wife claimed the debt was nondischargeable in a chapter 7 case under 11 U.S.C. §523(a)(15), which makes nonsupport debts owed to a spouse or former spouse, incident to a divorce or separation , nondischargeable.  [The ex-wife did not claim the debt was as a “domestic support obligation” under 11 U.S.C. §101(14A), as being in the nature of support or maintenance, which would have made the debt nondischargeable under 11 U.S.C. §523(a)(5) in any kind of bankruptcy, not just chapter 7.]

The main issue in Shaver is whether the debt is owed to a spouse or former spouse, such that it is nondischargeable.  The husband claimed the debt was owed to the ex-wife’s parents, not to the ex-wife, and the first agreement merely altered the payment terms, but did not create a new debt to the ex-wife.

The court first determined that the first and second agreements were to be read together as a single document, citing the Fourth Circuit Court of Appeals case of Lansdowne on the Potomac Homeowners Ass’n, Inc. v. OpenBand at Lansdowne, LLC, 713 F.3d 187, 205 (4th Cir. 2013).  The court then held that the new obligation to pay $140 directly to the wife was a new debt, part of the parties’ overall division of marital debts evidenced by the first and second agreements, creating the ex-wife’s right to receive a payment directly from the husband.  As the new debt was owed to a former spouse, the debt met all the elements of 11 U.S.C. §523(a)(15) and was nondischargeable in the husband’s chapter 7 bankruptcy case.  Further, the bankruptcy court ordered the husband to pay the ex-wife’s attorneys fees and costs as allowed by the second agreement.

The husband could have avoided the outcome in Shaver by not preparing the first agreement, or by specifying the effect of the second agreement upon the first, or by filing a chapter 13 bankruptcy case instead of a chapter 7 bankruptcy case.  Divorce counsel would typically address the effect that a comprehensive separation agreement would have on any prior agreements between the parties, typically by providing that the later, comprehensive agreement supersedes those agreements and renders them void and a nullity, if that is what the parties had intended.  While it is not rare for spouses to sign their own brief written agreement before consulting counsel for a comprehensive separation agreement, it is unusual for divorcing spouses to have more than one controlling separation agreement.

While a debt under 11 U.S.C. §523(a)(15) is nondischargeable in a chapter 7 case, it would be dischargeable in a chapter 13 case under 11 U.S.C. §1328(a) .  Perhaps the husband and the new wife should have filed a joint chapter 13 case to discharge the debt to the ex-wife, or the new wife could have filed a chapter 7 case, and the husband could have filed a chapter 13 case on his own at a different time.

You should consult with your Virginia bankruptcy and divorce attorney or Richmond Divorce Lawyer James H. Wilson, Jr., to discuss how to best address debts owed to or from former spouses in bankruptcy.

Does wife have a claim in husband’s chapter 7 bankruptcy case for an equitable share of the marital property before entry of the final decree of divorce?

Yes, in the case of In re Ruitenberg, 745 F.3d 647 (3d Cir., 2014), where the U.S. Court of Appeals for the Third Circuit affirmed the decision of the U.S. Bankruptcy Court for the District of N.J. in In re Ruitenberg, 469 B.R. 203 (D.N.J., 2012), overruling the chapter 7 trustee’s objection to wife’s claim to an equitable interest in marital property in husband’s bankruptcy case during the pendency of the parties’ divorce case in state court.

In Ruitenberg, the husband filed a chapter 7 bankruptcy case while a divorce case was pending in state court.  No final decree of divorce had been entered in the state court divorce case in N.J., an equitable distribution state like Virginia.  The wife filed a proof of claim in the husband’s chapter 7 case for $577,935, representing her estimated interest in marital property subject to equitable distribution in the divorce case.  The chapter 7 trustee in the husband’s bankruptcy case objected to the claim as a claim that did arise prepetition and should be disallowed.  Almost a year after the husband filed bankruptcy, the wife filed her own chapter 7 bankruptcy case, thus allowing the chapter 7 trustee in her case to pursue her claim in the husband’s bankruptcy case.  The chapter 7 trustee in the wife’s bankruptcy case argued that wife’s claim should be allowed.

In deciding the matter in the lower court, the bankruptcy court judge first recognized that the court had jurisdiction over the validity of the case under 28 U.S.C. § 1334(a) and (b), 28 U.S.C. § 157(a), and a local order of the U.S. District Court referring Title 11 cases to the bankruptcy court, and had jurisdiction over the validity of the claim as a core matter under 11 U.S.C. § 157(b)(2)(B).  The bankruptcy court judge then analyzed whether the wife’s right to equitable distribution constituted a “claim”, as defined in 11 U.S.C. §101(5), analyzing the different approaches of the courts to a pre-divorce claim for equitable distribution, or an equitable interest in marital property.  The court noting that some court allowed such a contingent claim as a prepetition debt and general unsecured claim subject to discharge, citing In re Schorr, 299 B.R. 97 (W.D. Pa., 1993), et al., while others courts have not allowed such a claim as not ripe and not subject to discharge, citing In re Scholl 234 B.R. 636 (E.D. Pa., 1999) , et al.  As the equitable claim in marital property can give rise to a monetary award under state law, the nondebtor spouse has been recognized by some courts as having a claim under 11 U.S.C. §101(5) against the debtor spouse’s property in bankruptcy.  In re Lawrence, 237 B.R. 61 (D. N.J., 1999).

The Ruitenberg bankruptcy court judge recognized that he had ruled otherwise in the case of In re Howell, 311 B.R. 173 (D. N.J., 2004), where the court followed In re Berlingeri, 246 B.R. 196 (D. N.J. 2000), in holding that a spouse did not need relief from the automatic stay to pursue equitable distribution because it concerned a post-petition interest of the non-debtor spouse [This issue should been made moot everywhere with the 2005 revisions to 11 U.S.C. §362(b)(2) .].  As the Third Circuit Court of Appeals had recently expanded the definition of “claim”, In re Grossman, 607 F.3d 114 (3d Cir., 2010) (claim arises when conduct giving rise to injury occurs) and In re Kane, 628 F.3d 631 (3d Cir., 2010) (spouse must list inchoate interest in equitable distribution as asset of the bankruptcy estate), the bankruptcy court judge was required to revisit the issue.  The reasons in favor of considering the nonfiling spouse’s interest in equitable distribution a claim included (1) the fairness of a parallel broad treatment of both property in 11 U.S.C. §541 and “claim” in 11 U.S.C. §101(5), (2) the precedent in a distinction drawn in Kane between interests in property (asset) and present rights to property (claim) should be limited to considering only what is property of the estate under 541, (3) the accrual of claims should be treated alike, whether they are product liability injuries or equitable distribution rights, and (4) the concerns about the dischargeability of pre-petition equitable distribution claims against spouses has been remedied by revisions to 11 U.S.C. §523(a)(5) and (15).

The bankruptcy court then reversed its previous reliance on Belingeri, as overruled by Grossman, and held the equitable distribution claim of the wife’s chapter 7 bankruptcy trustee should be allowed in the husband’s chapter 7 bankruptcy case.  The husband’s chapter 7 trustee appealed the bankruptcy court’s decision, and the U.S. District Court certified the case for direct appeal to the Circuit Court of Appeals.

On appeal, the Third Circuit Court of Appeals clarified the wife’s actual interest in equitable distribution to be a partnership interest held in the husband’s name alone, presumed to be marital property subject to equitable distribution in New Jersey, N.J. Stat. Ann. § 2A:34-23.1.  The court noted that if the claim were held to be a prepetition claim, wife could share in the distribution in the husband’s bankruptcy case, while wife would be left to merely the remains if the claim were a postpetition claim. [Although a Virginia divorce judge might still equitably divide marital property in light of such a consequence].  The court noted that the wife’s claim, even though unliquidated, contingent, and perhaps unmatured, was still literally a claim under 11 U.S.C. §101(5), as “…a right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured..”.  The court recognized in its decision in Grossman that Congress and the Supreme Court had indicated that the defined term “claim” should be given the broadest application.  The appellate court rejected the trustee’s argument that Grossman should be limited to tort cases, and instead, held that the broader definition of claim was applicable to all types of cases.  Recognizing that the wife had a prepetition claim to equitable distribution also made sense in light of the court’s previous decision in Kane, that such an interest must be disclosed as an asset in a bankruptcy case.  The recognition of a prepetition claim in equitable distribution after a divorce case has been filed respects state property law, as N.J. recognizes the marital estate was in the custody of the law at that point.  Carr v. Carr, 576 A.2d 336 (1990) .  Consequently, the appellate court affirmed the bankruptcy court’s allowance of the prepetition claim for equitable distribution.

You should consult with your Virginia bankruptcy and divorce attorney, or Richmond divorce lawyer James H. Wilson, Jr., as to your rights in a spouse’s bankruptcy case pending a divorce.