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

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 (6th Cir. BAP, 2014), a  Bankruptcy Appellate Panel decision from the 6th 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)5Priority 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 6th 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.

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