Bankruptcy and Divorce

It is a given that bankruptcy law and family law intersect more often than not; therefore, it is vitally important that family law practitioners have some basic idea about what bankruptcy can and cannot do for their clients. This guide is meant to serve as a brief desk reference to family lawyers when a basic question about bankruptcy comes up. I’ve also written the guide for consumers who want a thorough introduction to bankruptcy law.

Overview of Bankruptcy Chapters

Chapter 7

Chapter 7 bankruptcy is often referred to as a “complete liquidation” or “straight” bankruptcy, so not surprisingly, many people, lawyers included, hold the false belief that filing Chapter 7 will result in losing everything you own. But nothing could be further from the truth.  When a bankruptcy case is filed, something called the bankruptcy “estate” is created. This estate encompasses all rights, title, and property the debtor is entitled to as of the petition date. In simpler terms, this means that whatever property the debtor owns on the date of filing now belongs to the Chapter 7 Trustee.  The trustee is the government appointed individual tasked with administering the bankruptcy estate.  Administering the estate refers to liquidating – or selling – the debtor’s non-exempt assets to distribute to his unsecured creditors.  The trustee takes a percentage of the sales proceeds as payment, so the trustee has an incentive (in addition to a fiduciary duty) to sell whatever property is available.

But only non-exempt assets are capable of being sold by the trustee. The term “non-exempt” refers to the set of Georgia laws that protect certain property from being seized by the trustee in a bankruptcy.  For instance, under Georgia law (O.C.G.A. §44-13-100), debtors can now exempt up to $21,500 in their residence ($43,000 if married) from the trustee.  This means that if a debtor and his significant other owe $200,000 on a house that the trustee can sell for $250,000, $43,000 of those sales proceeds will be distributed to the debtor and spouse, $200,000 will be turned over to the mortgage holder, and the trustee takes the remainder to distribute to the debtor’s unsecured creditors (minus the trustee’s fee, of course).

In the example given above, real estate brokers’ and attorneys’ fees would all but eliminate the $7,000 of equity available to the trustee. In such a case, the trustee would most likely “abandon” the property back to the debtor, meaning that the trustee has no interest in selling it.  Debtors can also exempt $5,000 in household goods and $5,000 in a motor vehicle.  Debtors often believe they have more than $5,000 in household goods because they paid so much more, but used furniture and electronics is rarely worth anything close to the original purchase price, so there is really nothing to worry about for the average debtor.

The trustee is typically only interested in real property with equity, luxury cars, cash, stocks, and other highly liquid assets. Most people filing for Chapter 7 relief have a house and car that are both underwater and no valuable possessions, a case referred to as a “no-asset” case by the trustee that will be pushed through without issue.

Chapter 13

Chapter 13 is often referred to as the “wage-earners” repayment plan.  Chapter 13 enables debtors to repay debts (although not necessarily in full) over a 3 to 5 year period, depending on the debtor’s disposable income.  A Chapter 13 bankruptcy is most beneficial in the following situations:

  1.  You want to keep your house and car and have the ability to catch up your delinquent payments through the Chapter 13 p
  1.  You want to retain assets that would normally be taken by the Chapter 7 Trustee.
  1.  You want to repay certain debts that cannot be discharged in a Chapter 7 bankruptcy case, such as recent tax deb Most pertinently, Chapter 13, unlike Chapter 7, allows debtors to discharge property settlements owed to ex-spouses.

Chapter 11

Chapter 11 is the most complex bankruptcy to file and is typically used to reorganize a business, which may be, among other things, a corporation, sole proprietorship, limited liability company, or partnership. Chapter 11 can also be used to reorganize the debts of high-income individuals. This is something that most bankruptcy practitioners are not familiar with, and it definitely takes someone with prior experience in this area to confirm a plan of reorganization on behalf of an individual.  While a Chapter 11 is more expensive, it is also more flexible in that the debtor is not subject to the oversight of a Chapter 13 trustee. Note that property settlements are ONLY dischargeable in a Chapter 13.

The Discharge

The bankruptcy discharge is the ultimate goal for all debtors.  The discharge wipes out all the debtor’s pre-petition (debts that arise prior to bankruptcy) debts.  Notably, the discharge only affects debts that existed as of the date of the filing of the petition. The discussion of what debts are dischargeable will be covered in more detail below, but rest assured  that  child  support  and  alimony  are  never  dischargeable  in  bankruptcy, though property settlements are dischargeable in a Chapter 13.   Also, if only one spouse files bankruptcy, the other spouse will still be liable to any debts in which both spouses are obligated.

Certain debts are held non-dischargeable by the bankruptcy court. A non-exhaustive list is provided below:

  1. debts incurred by fraudulent, willful, and malicious conduct;
  1. defalcation and breach of fiduciary duty (this refers to a trustee’s fiduciary duty under a trust);
  1. Income taxes in which the return was due less than 3 years ago;
  1. Payroll (employee side trust taxes) and sales taxes;
  1. DUI convictions;
  1. Domestic support obligations;
  1. Property settlements (except in Chapter 13).

A  debtor’s  discharge  may  be  denied  all  together  under  section  727  of  the bankruptcy code.   If the debtor performs certain acts prior to or during his bankruptcy case, this code section will allow the trustee, U.S. Trustee, or creditors to object to the debtor’s discharge in its entirety. Acts which will prevent a debtor from receiving a discharge include perjury, concealing or destroying property of the debtor within one year of filing bankruptcy with the intent to defraud, hinder, or delay creditors, and failure to disclose assets.

These are just a few of the examples that can result in the denial of a debtor’s discharge. This  is  also  where  a  disgruntled  ex-spouse  with  insider knowledge  of  your client’s finances can do a lot of damage if your client is not completely honest with you about his financial situation.   An ex-spouse could contact the U.S. Trustee’s Office (the bankruptcy “police”) and let them know of assets the debtor failed to list on his bankruptcy petition. Such an act could be detrimental to a debtor’s case, which is why I preach to my clients to always be honest throughout the entire bankruptcy process.

Debts discharged in bankruptcy (and some exceptions)

A debt discharged (or wiped out) in bankruptcy enjoins creditors from attempting to collect the debt pursuant to 11 U.S.C. §524. Debt that is not wiped out remains enforceable against the debtor under applicable state laws. Unless the creditor seeks relief from the automatic stay, creditors cannot commence collection efforts until the bankruptcy case is closed.

Some divorce attorneys draft property settlement agreements stating that a person cannot file bankruptcy to discharge the settlement. The agreements fail to state any legal authority for this assertion and are in contradiction to the bankruptcy code. Further, it can be argued that attorneys who ask the domestic court to reinstate discharged debt (or substitute the discharged debt for other obligations) may be violating the discharge injunction of 11 U.S.C. §524. These violations could be grounds for sanctions.

11 U.S.C. §523 of the bankruptcy code lists certain debts that are not discharged on the completion of the bankruptcy case. These non-dischargeable debts remain enforceable against the debtor. 11 U.S.C. §523 (a)(5) states that a domestic support obligation cannot be discharged by the debtor and therefore the debtor remains completely liable on the debt for support payments.

11 U.S.C. §523(a)(15) makes a property settlement non-dischargeable in a Chapter 7. In Chapter 13, a property settlement can be paid and discharged as an unsecured claim, which means that the settlement amount will be paid a pro rata share along with all other general unsecured clai Any amount of the property settlement not paid through the plan will be discharged.

The Automatic Stay

The automatic stay in 11 U.S.C. §362 arises automatically upon the filing of the bankruptcy petition. The purpose of the stay is to stop all collection activities to give the debtor some breathing room to come up with a Chapter 13 plan or to obtain a discharge under a Chapter 7. In general, all civil court actions against the debtor must be stayed until the bankruptcy court grants relief from stay allowing the action to continue. Criminal charges against the debtor are not subject to the automatic stay.

Even though an individual can be thrown in jail for contempt of a court order for failing to pay child support, bankruptcy courts often view contempt actions to collect on child support as a “collection action”. As a result, any action against a debtor for contempt that is, in reality, an action to collect on past-due child support or alimony will be stayed.

An exception to the automatic stay provisions is found in 11 U.S.C. §362(b)(2) which allows certain domestic court proceedings to continue despite the filing of a bankruptcy. The automatic stay does not apply to the following actions.

  • Actions to determine paternity.
  • Actions to establish or modify an order for domestic support obligations.
  • Actions concerning child custody or visitation.
  • Actions for the dissolution of a marriage, except to the extent that such proceeding seeks to determine the division of property of the estate. (Before thinking about using this as reasoning to proceed with a divorce, give the bankruptcy trustee a call to determine what assets he or she will be pursuing).
  • Actions against the debtor for domestic violence.
  • Collection of a domestic support obligation from property that is not property of the bankruptcy estate. As mentioned above, be sure to discuss with the bankruptcy trustee prior to collecting against the debtor. Examples of property that is not property of the estate would be post-petition income in a Chapter 7 case or pension and retirement funds. Chapter 13 provides that all income of the debtor is property of the estate until the debtor receives a discharge, so do not attempt to collect against the post-petition wages of a debtor in a Chapter 13 or Chapter 11 bankruptcy.
  • Actions to garnish income of the debtor for payment of a domestic support obligation under a state law or statute. Again, do not pursue this remedy for a Chapter 13 or 11 debtor.
  • Actions to suspend driver license or professional license of the debtor pursuant to state law and the Social Security Act, section 466(a)(16).
  • Actions to report overdue support payments by a parent to a consumer reporting agency under 466(a)(7) of the Social Security Act.

It is important to remember that if the debtor had any interest in the property at the time of filing, the automatic stay DOES APPLY.   Only collection activities against post- petition income in a Chapter 7 or certain retirement accounts would be considered non- estate property.

Exemptions

We discussed exemptions earlier, but this section will provide a bit more detail on the subject. Section 522 of the bankruptcy code provides for the assets the debtor may retain and exclude from being used in the repayment of creditors. Pursuant to 11 U.S.C. 522(d)(10)(D), the debtor may exempt the right to receive alimony, support or separate maintenance to the extent reasonably necessary for the support of the debtor and any dependent of the debtor. Even though exempt, alimony and child support must still be disclosed on the bankruptcy petition.

While bankruptcy is rooted in federal law, the exemptions a debtor can take in property  are  based  on  state  law  exemptions,  with  few  exceptions.  Some  states  allow debtors to take the federal exemptions, while most opt-out, meaning that the debtor must take the state’s exemptions. Georgia is an “opt-out” state.

O.C.G.A. 44-13-100 is the statute dealing with exemptions a bankrupt debtor may take.  As of the writing of this guide, a Georgia debtor can take a $21,500 exemption in the equity of a primary residence (the homestead exemption), or $43,000.00 if married. The debtor may take a $43,000.00 exemption in a residence even if the spouse is not filing and has no ownership interest in the residence. If the Debtor does not need to use the homestead exemption, he may use up to $5,600.00 of that exemption to shield anything he pleases.  That mount is doubled for jointly filed cases.  The Debtor can also exempt up to

$5,000.00 of value in a vehicle, $5,000.00 in household goods, and the entire amount of a 401k retirement account. IRA’s are treated a little differently. The debtor may exempt an individual retirement account to the extent reasonably necessary for the support of the debtor. I find that in most cases in the Northern District of Georgia, many trustees choose not to pursue IRA accounts, even with six figure balances.

Claims in Bankruptcy

Claims in bankruptcy are 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; or (B) right to an equitable remedy for breach of performance if such breach gives rise to a right to payment, whether or not such right  to   an   equitable  remedy  is   reduced  to   judgment,   fixed,   contingent,   matured, unmatured, disputed, undisputed, secured, or unsecured. There are four types of claims in bankruptcy.

Administrative Claim

These claims are obligations incurred for the purpose of administering the bankruptcy estate, such as the trustee’s legal fees in seeking property to bring back into the estate for the benefit of creditors. There are many other examples, but just know that these claims must be paid 100%, subject to approval by the bankruptcy court. Other examples include accounting services (not pre-petition debts of the debtor, but services of an accountant hired by the trustee to help administer the estate), court fees, and other professional services that benefit the estate (even post-petition rent of the debtor).

Secured Claim

A secured claim is a claim that is collateralized by property of the estate or the debtor. Examples of this include mortgages or deeds to secure debt on real property, judgment liens secured by a Writ of Fiera Facias filed in the county in which the debtor lives, and purchase money security interests. Liens survive bankruptcy, so the bankruptcy only operates to wipe out the debtor’s personal liability. Judgment liens and non-purchase money security interest liens on household goods can be avoided to the extent they impair the debtor’s state law exemptions.

If a debtor does not want to keep paying on a car loan, the lender can repossess the car (after the case is closed or after receiving relief from the stay) and sell it to collect against the loan. The lender cannot, however, pursue the debtor for a deficiency balance. In effect, bankruptcy converts all secured loans from recourse debt to non-recourse debt in which the only relief is in rem relief.

Unsecured and Priority Claims

Unsecured claims are claims that are not secured by property of the estate or the debtor. Examples  include  medical  bills,  credit  card  debt,  and  personal  loans  with  no pledged collateral. These debts, with the exception of a few, are wiped out in bankruptcy. Priority Claims 11 U.S.C. § 507 lists out the priority of claims to be paid from the assets of the estate. Priority claims include certain taxes, administrative expenses, child support and alimony, payroll taxes, employee wages, and more. It is important to note that a property settlement in a Chapter 13 is NOT a priority claim.

Domestic Support Obligations Always Survive Bankruptcy

Section  523(a)(5)  provides  that  “a  discharge  under  section  727,  1141,  1228(a), 1228(b), or 1328(b) of this title does not discharge an individual from any debt for a domestic support obligation. So the first question to always ask in determining whether a divorce-related debt is dischargeable in bankruptcy is whether or not it is a Domestic Support Obligation. If it is, it is not dischargeable under any chapter of the bankruptcy code.Definition of Domestic Support Obligation

Definition of Domestic Support Obligation (“DSO”)

To be a DSO under 11 U.S.C. §101(14A), the debt must fall under the following four factors:

  1. It must be due to or recoverable by a spouse, former spouse, or child of the debtor or such child’s parent, legal guardian, or responsible relative; or a governmental unit;
  1. It must be in the nature of alimony, maintenance, or support (including assistance provided by a governmental unit) of such spouse, former spouse, or child of the debtor or such child’s parent, without regard to whether such debt is expressly designated;
  1. It must be established or subject to establishment before, on, or after, the date the bankruptcy case was filed as a result of a separation agreement, divorce decree, or property settlement agreement; a court order or determination made in accordance with applicable non-bankruptcy law by a governmental unit; and
  1. Not  assigned  to  a  nongovernmental  entity,  unless  the  obligation  is  assigned voluntarily for the purpose of collecting a deb

In a nutshell, under bankruptcy law, a “domestic support obligation” is any debt incurred before or after a bankruptcy filing that is owed to or recoverable by a spouse, former spouse, child or governmental unit; in the nature of alimony, maintenance or support; and established pursuant to the terms of a divorce decree, separation agreement, property settlement  agreement, court order or administrative determination. All four factors must be present to be considered a domestic support obligation.

Domestic Support Obligation vs Non-Domestic Support Obligation

The determination of whether an obligation is a domestic support obligation or not is important primarily for the determination of whether that debt will be held to be dischargeable in a Chapter 13 bankruptcy. This is because under either Chapter 7 or Chapter 11, any divorce-related debt, including property settlements re non-dischargeable. Pursuant to 11 U.S.C. §523(a)(15), a debt is excepted from a Chapter 7 discharge if it meets the following criteria:

  1.  The debt must be to a spouse, former spouse, or child of the debtor;
  1.  The  debt  must  not  be  a  domestic  support  obligation  (this  is  covered  in 523(a)(5);
  1.  The debt must have been incurred in the course of a divorce or separation or in connection with a separation agreement, divorce decree, or other order of the cour

In short, if a debtor has filed a bankruptcy case under any chapter other than Chapter 13, any divorce-related debt will be non-dischargeable.

 

Property Settlement Dischargeable Domestic Support Obligation Dischargeable Payment Plan for Child Support and Alimony Arrears

Chapter 7

No No No
Chapter 13

Yes

No

Yes

Chapter 11

No

No

Yes

 

In the Nature of Support?

The most difficult question to answer is whether the divorce-related obligation is “in the nature of support”. If the court determines that a debt is not in the nature of support, the obligation is not a domestic support obligation and can be discharged in a Chapter 13 bankruptcy.

The line is often blurred between what constitutes a support payment and what constitutes a property settlement, but courts look to federal law to make that determination.  In the Northern District of Georgia, there are a dozen or so cases interpreting what constitutes a domestic support obligation, though they all typically cite cases from other districts.  For instance, Judge Brizendine in In re Lauren D. Espinosa, Case No. 11-2130, has held that guardian ad litem fees of the Plaintiff are domestic support obligations pursuant to 11 U.S.C. §101(14) of the bankruptcy code.

There are  several factors  that  a  court  will  consider in  determining whether an obligation is a DSO or not.  Judge Margaret Murphy in the case of In re Robert T. Vaughn, Case No. 12-55199, stated that the following factors are to be considered in determining whether a particular obligation is an item of support:

(1) the disparity of earning power of the parties,

(2) the intent of the parties or the court,

(3) the adequacy of support, and

(4) the specific substance of the obligation assumed. Balthazor v. Winnebago County, 36 Bankr. 656 (Bankr. E.D. Wisc.1984).

Many other factors have been considered by other districts, but a good rule to go by is  if  the  obligation  is  necessary  to  enable  the  spouse,  former  spouse,  or  child  to maintain a certain quality of life, it is in the form of support payments.

The court will also consider whether or not the payment is to be made is in one lump sum or  multiple installments. Installment payments are more likely to be viewed “in the nature of support.” Even a payment of the value of a debtor’s business to a spouse can be considered a DSO is the payments are in installments and it appeas that the intent of the parties was to provide support for the ex-spouse. Additional factors the court may consider are

1) whether the spouse who brings the complaint is caring for minor children;

2) whether the obligation is subject to modification;

3) whether the obligation terminates upon the obligee’s death, remarriage, or emancipation of the children;

4) whether there was a waiver of alimony or support in the marital agreement;

5) the tax treatment of the obligation; and

6) the labels used in the decree or separation agreement.

Above all, the intent of the parties is crucial to the determination of whether an obligation is in the nature of support. If the parties entered into a separation agreement, their intentions at the time of the agreement will be considered. If the divorce goes to trial, the intent of the trial judge (or jury) will be considered. A state court’s designation or the parties designation of language in an agreement stating that a debt is in the nature of support or not is not binding on the bankruptcy court in determining the dischargeability of the debt. To quote the commonly advocated phrase: substance prevails over form. The court will look to the real nature of the debt based on federal case precedent.

The burden of proof is on the creditor, and bankruptcy courts narrowly construe the award based on its function.

Educational Expenses

In the 11th  circuit, educational expenses for a minor child are typically considered non-dischargeable. In re Harrell, 754 F. 2d 902 (11th Cir. 1985).  Depending on the case, even post-majority education expenses could be determined to be in the nature of support. In Harrell¸, the debtor signed a separation agreement providing that he pay all his son’s college and post-graduate educational expenses, obviously past the age of majority. Debtor filed Chapter 7 and argued that since he was not required under Georgia law to pay these expenses past the age of 18.  The 11th Circuit disagreed, reasoning that the bankruptcy code provides that what constitutes alimony, maintenance, or support is determined by federal law, not state law. The court found that since the parties intended for the educational payments to act as support, they were a domestic support obligation and non-dischargeable.

Hold Harmless Agreements

A hold harmless provision in a divorce decree creates an obligation from one spouse to another that is separate from the obligation to the original creditor.  The hold harmless agreement provides that one party shall indemnify and hold the other party harmless for the liability on a third party debt. So if both spouses are obligors on a $25,000 credit card debt, a hold harmless provision in which the debtor agrees to hold the ex-spouse harmless for the debt will create a non-dischargeable obligation in which the debtor must continue to make payments on the credit card if the court determines that the debt is in the nature of support.

A hold harmless agreement could contain the following language to create a separate divorce-related obligation:

“[spouse] shall indemnify and hold harmless [ex-spouse] for the following debts: [name debts].

Again, to determine whether the hold harmless agreement will be held to be a domestic support obligation, the court will look to the nature of the agreement. If the hold harmless agreement is for a credit card used to purchase luxury goods, it is more likely to be considered a property settlement rather than a domestic support obligation. If the hold harmless agreement is for a mortgage in which an ex-spouse of the debtor resides, it is likely to be considered in the nature of support and non-dischargeable in a Chapter 13 case. Other examples of bills or expenses that are likely to be DSO’s are medical expenses, health insurance payments, insurance premiums on disability or life insurance, and tax liabilities.

Chapter 7 and Domestic Support Obligations

In Chapter 7 bankruptcy, essentially all marital and domestic relations obligations are not dischargeable, regardless of whether they are support in nature, property divisions or “hold harmless” agreements, provided they were incurred by the debtor in the course of a matrimonial proceeding or a divorce action which resulted in a separation agreement, divorce decree, court order or administrative determination.

A debtor’s obligation to pay marital debts directly to a third party ( ie., pay the mortgage on former marital residence) and to hold the former spouse harmless on said debts is also deemed to be non-dischargeable if the obligation has the effect of providing support to the former spouse. A debtor’s duty to pay the following expenses are usually deemed to be in the nature of support and not dischargeable: educational expenses of a minor child; medical insurance coverage for a minor child; and life insurance, with the minor children as beneficiaries.

Chapter 13 and Domestic Support Obligations

In Chapter 13 bankruptcy, past due domestic support obligations owed by a debtor are not dischargeable. The only option afforded to a debtor is to pay the arrears in full over the life of a Chapter 13 plan. However, if a debt created by a separation agreement or judgment of divorce is not in the nature of support, it sometimes can be discharged in Chapter 13 without being paid in full. As we discussed earlier, property settlement debts are not dischargeable in a Chapter 7 pursuant to 11 U.S.C. 523(15); however, no sister provision exists in section 1328 of the bankruptcy code.

A Chapter 13 Plan, even if confirmed by the bankruptcy court, is subject to dismissal if the debtor fails to pay any post-petition or post-confirmation domestic support obligations, and a Chapter 13 discharge will not be entered by the bankruptcy court unless and until a debtor certifies that all domestic support obligations have been paid and that the debtor is current on such obligations.

Attorneys’ Fees

Attorneys’ fees owed to a debtor’s former spouse are almost always considered to be in the nature of support and thus a domestic support obligation that is non-dischargeable in bankruptcy. However, there are a few circumstances in which the attorneys’ fees will not be considered to be “in the nature of support.”

For instance, in the Vaughan v. Vaughan  case decided by Judge Murphy, an ex- spouse creditor was awarded attorneys’ fees under O.C.G.A. § 9-14-151 in connection with a Motion  for  Contempt  of  Child  Support.  In  the  underlying  Fee  Order,  the  state  court expressly refused to award fees under O.C.G.A. § 19-6-15 because the parties settled their dispute and neither party prevailed within the meaning of that code section. Furthermore, the state court also expressly declined to award attorneys’ fees under O.C.G.A. § 19-9-3 based upon the fact that the attorneys’ fees were awarded under O.C.G.A. § 9-14-15 rather than under Title 19, the Domestic Relations title. Therefore, the fees were held to be a non- domestic support obligation. The effect of this designation was that the collection efforts by the creditor ex-spouse were held to be in violation of the automatic stay because only collection of a domestic support obligation is excepted from the automatic stay.

Priority of Distributions in Bankruptcy

Let’s face it, 99% of bankruptcy cases are “no-asset” cases, meaning that there are no assets for the trustee to distribute to unsecured creditors. But let’s say the debtor actually has some assets for the trustee to seize and sell.   In that case, 11 U.S.C. §507 determines the order in which claims are paid.

Above all, domestic support obligations, as defined above, must be paid FIRST. The only exception is the trustee’s fees for actually pulling assets into the bankruptcy estate for distribution to a creditor owed a domestic support obligation must be paid before anyone. The logic is that the trustee should be fairly compensated for the work that actually results in a domestic support obligation getting paid.

Preferences and Domestic Support Obligations

One of the purposes of bankruptcy is to prevent a rush to the courthouse to obtain a judgment lien before any other creditor. Any payments to an insider within one year of filing or a non- insider within 90 days of filing bankruptcy will be considered a preferential transfer, meaning  that  the  debtor  is  improperly  preferring  one  creditor  over  another.  The bankruptcy  trustee  will  often  commence  legal  action  to  recover  the  funds  from  the preferred creditor for the bankruptcy estate so that all creditors will be treated equally.

Pursuant to 11 USC §547(c)(7), a payment on a domestic support obligation prior to the bankruptcy filing is not considered a preference and may not be recovered for the benefit of the bankruptcy estate. So in effect, a debtor could write an ex-spouse a check to pay off a domestic support obligation hours before filing a bankruptcy petition and have committed no wrongdoing. Moreover, the trustee could not recover this money for the benefit of creditors.  This makes sense, if you think about it, since DSO’s are paid out first in bankruptcy.

Notices to Holders of Domestic Support Obligations

Pursuant to the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act, Chapter 7 Trustees, pursuant to 11 U.S.C. §704(c), and Chapter 13 Trustees, pursuant  to  11  USC  §1302,  must  supply  the  following  notices  to  holders  of domestic support obligations.

  • Notice to holder of DSO that he or she may use the services of the state child enforcement agency for assistance in collecting the claim through and after the bankruptcy.
  • Notify the state child support agency of the debtor’s bankruptcy filing.
  • Upon discharge of the bankruptcy case, notify the holder of the debtor’s last known address and employer. Note: Trustees are permitted to rely on the debtor for name and address of the holder of the domestic support obligation. If the debtor does not know the name or address, a notice is only sent to the state child support agency.

The duties of the Chapter 7 trustee are probably of no interest to most attorneys, but if the debtor is an individual filing Chapter 11, then the obligation to provide this notice to domestic support obligation creditors falls on the debtor as the “debtor-in-possession” with all the powers AND dutie ons of a Chapter 7 trustee.

Creating an Unavoidable Lien to Protect DSO or Property Settlement Payments

One way to protect a client’s interest in a property settlement or domestic support obligation is by creating a lien on property jointly held by debtor and the creditor spouse. 11 U.S.C. §522(f)(1) allows debtors to avoid judicial liens that impair the debtor’s exemption. Naturally, liens that secure domestic support obligations are exempt from this avoidance.

The seminal case on lien avoidance under 522(f)(1) is the Farrey v. Sanderfoot, 500 U.S. 296 (1991), which involved the debtor’s attempt to avoid a lien created on the debtor’s property through a divorce. In the Farrey case, the Supreme Court held the fixing of a lien for the purposes of 11 U.S.C. § 522(f) is a “temporal” event governed by application of state law. Farrey, 500 U.S. at 296-300, 111 S.Ct. 1825. The Farrey opinion reasoned that in order for a lien to “fix” to a property interest, the property interest must predate the existence of the lien, providing that “. . . unless the debtor had the property interest to which the lien attached at some point before the lien attached to that interest, he or she cannot avoid the fixing of the lien under the terms of § 522(f)(1).” Farrey, 500 U.S. at 296, 111 S.Ct. 1825 (emphasis in original). The Supreme Court applied Wisconsin law to the Farrey facts to hold a lien created on behalf of an ex-spouse via a divorce decree could not be avoided under 11 U.S.C. § 522(f) because the lien came into existence simultaneously with the interest of the Debtor in the property in question. Farrey, 500 U.S. at 299, 111 S.Ct. 1825.

Let’s break this down. Debtor and spouse hold title to a house in joint tenancy, which means that each holds an undivided one-half interest in the house. When a divorce decree is entered and the assets divided, the debtor’s and spouse’s interests in the house are terminated and new interests are created by the entry of the divorce decree.

At the same time and in the same transaction, the divorce decree creates new interests in place of the old interests. Let’s say that like Farrey, debtor is given a fee simple interest in the house and the spouse is given a judgment for $30,000 and a lien on the house.

Under the Supreme Court’s view, the lien could not have fixed on debtor’s pre-existing undivided half interest because the divorce decree extinguished it. Instead, the only interest that the lien encumbers is debtor’s wholly new fee simple interest. The same decree that awarded debtor his fee simple interest simultaneously granted the lien tothe spouse. As the judgment stated, [debtor] acquired the property “free and clear” of any claim “except as expressly provided in this [decree].” Debtor took the interest and the lien

To make a long-winded explanation a little more concise, Debtor took the interest and the lien together, as if he had purchased an already encumbered estate from a third party. Since the debtor never possessed his new fee simple interest before the lien “fixed,” § 522(f)(1) is not available to void the lien.

The Eleventh Circuit had the opportunity to apply the Farrey analysis to facts under Florida law in Owen v. Owen, (In re Owen), 961 F.2d 170, 172 (11th Cir.1992), ruling on remand from Owen, 500 U.S. 305, 314, 111 S.Ct. 1833, 114 L.Ed.2d 350 (1991). The Eleventh Circuit found that a creditor’s judgment lien created in 1976 was fixed simultaneously with Debtor’s property interest acquired in a 1984 purchase. Owen, 961 F.2d at 172. The Owen court held that, “. . . there was never a fixing of a lien on an interest of the debtor, as the debtor had no property interest prior to the fixing of the lien.” Owen, 961 F.2d at 172. As such, the debtor could not void the lien on his property.

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I have dedicated my career to helping people and businesses navigate their way through bankruptcy. I have a particular interest in Chapter 11 cases and complex bankruptcy litigation. I also help people find the optimal student loan repayment plan and possible defense options best suited to their needs.

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