The Journal of The DuPage County Bar Association

Back Issues > Vol. 11 (1998-99)

Divorce: Discharging Debts in Bankruptcy
By Robert V. Schaller

Thousands of people get divorced each year. Frequently, divorces are precipitated by financial woes that crack the marital foundation. Escalating financial debt expands the cracks by putting increased pressure on the relationship. Massive, uncontrollable debt can cause the marital foundation to crumble.

Although these marriages don’t survive, the joint marital debts owed to creditors do survive the divorce! After divorce, debt collectors most certainly will harass one or both spouse. Plus, creditors are free to pursue all appropriate state law remedies. Worse, divorcees can expect to experience foreclosure, garnishment, repossession, liens, or levies. Hardly the fresh start one needs to begin a new life.

Bankruptcy is often considered by financially strapped divorcees as a method of solving their post-divorce financial woes. Consequently, family law attorneys must consider bankruptcy’s future impact on divorce settlements — especially when negotiating alimony, maintenance, or support issues and dividing marital property and marital debt. As amplified herein, skillful practitioners should keep in the forefront of their minds that pre-divorce, joint marital debt as well as obligations that arise as part of the division of marital property debt may be dischargeable in bankruptcy. But alimony, maintenance, and support obligations are non-dischargeable and must be paid regardless of bankruptcy.

Therefore, the challenge is deciding strategically how to divide marital, marital property, alimony, maintenance, and support. A spouse who is entitled to alimony but wants to limit bankruptcy related risks, may seek greater alimony payments. However, a spouse who is obligated to pay alimony and is contemplating bankruptcy, may seek reduced alimony in exchange for giving an increased share to the receiving spouse of any property settlement— including offering to hold the other spouse harmless for any joint marital debt. The correct decision depends on a client’s goals and tolerance for risk.

This article focuses on two types of divorce related debts whose dischargeability may be challenged after the alimony/property settlement paying spouse files for Chapter 7 bankruptcy. The first issue relates to the dischargeability of obligations of alimony, maintenance, and support. The second issue relates to the dischargeability of joint marital and other debts that arise in the course of a divorce.

Standards for Attacking Discharges

Chapter 7 of the US Bankruptcy Code provides the basic procedure designed to give divorcees or "debtors" a fresh start in life by jettisoning the accumulated burden of oppressive and often unmanageable pre-divorce debt loads. See 11 USC Section 701 et seq. Upon filing a Chapter 7 Petition, debtors generally will be discharged from unpaid bills, including: credit cards, car, mortgage, medical and other debts. Thereafter, debtors have no further obligation to pay these debts and creditors are forever enjoined from enforcing claims.

Judge Ginsberg of the US Bankruptcy Court for the Northern District of Illinois stated in a scholarly treatise: "A discharge voids any judgment, whenever obtained, that determines the personal liability of the debtor on any discharged debt; enjoins any judicial or non-judicial action to collect, recover or offset any discharged debt as a personal liability of the debtor; and enjoins the collection of certain claims against the debtor’s community property". Ginsberg & Martin on Bankruptcy, Fourth Edition, Section 11.01(B).

The scope of a debtor’s discharge is not boundless however. The Bankruptcy Code does provide statutory authority for denying the discharge of certain debts. For example, Code Section 523 identifies exceptions to the fresh start, discharge rule and deems these exceptions as "non-dischargeable" debt, which a debtor must pay. See 11 USC Section 523. However, an attack on dischargeability of certain debts must be made by filing an adversary proceeding in the US Bankruptcy Court within the narrow time constraints allotted for objection. See Bankr. R. 4007(c) (60 days following the first date set for the meeting of creditors); see also Beasley v. Adams, 200 B.R. 630, 632 (USDC, ND. IL 1996)(Grady, J). Late or "stale" attacks will be procedurally dismissed without a determination on the merits.

Making attacks on dischargeability even harder, the public policies underlying the Bankruptcy Code encourage a "fresh start" for debtors and require that exceptions to discharge be strictly construed against creditors and in favor of a fresh start for debtors. AT&T Universal Card Services v. Alvi, 191 B.R. 724, 728 (Bankr. N.D. IL 1996)(Ginsberg, J.); FCC National Bank v. Phillips, 1994 WL 168279 (Bankr. N.D. IL 1994)(Squires, J.). The party seeking to establish an exception to the discharge of debt bears the burden of proof—that burden is a preponderance of the evidence. Grogan v. Garner, 498 U.S. 279 (1991); In re Robert Sheridan, 57 F.3d 627, 633 (7th Cir. 1995). The "discharge" feature is essential to the notion of a fresh start. AT&T Universal Card Services v. Alvi, 191 B.R. 724, 728 (Bankr. N.D. IL 1996)(Ginsberg, J.). To further the policy of providing a debtor a fresh start in bankruptcy, "exceptions to discharge are to be construed strictly against a creditor and liberally in favor of a debtor." Goldberg Secs., Inc. v. Scarlata, 979 F.2d 521, 524 (7th Cir. 1992). That policy of protecting and favoring debtors is tempered, however, when the debt arises from a divorce or separation agreement. In re Crosswhite, 148 F.3d 879, 881 (7th Cir. 1998).

A. Discharging Alimony, Maintenance, and Support

In the divorce arena, a central issue relates to an ex-spouse’s ability to discharge an obligation to pay alimony, maintenance, and support obligations by filing bankruptcy (hereinafter, the ex-spouse obligated to pay is deemed the "Paying Spouse" and the ex-spouse receiving payments is deemed the "Receiving Spouse"). A related issue discussed later relates to the Paying Spouse’s ability to discharge debts other than alimony, maintenance, or support incurred in the course of a divorce or in connection with a divorce decree.

A Receiving Spouse who is objecting to the Paying Spouse’s debt discharge typically utilizes Section 523’s enumerated exceptions as a sword in an attempt to render the Paying Spouse’s obligations non-dischargeable. Section 523 provides the general scheme for establishing exceptions from discharge, and two subsections provide specific protection to the Receiving Spouse. Section 523(a)(5) establishes as non-dischargeable the Paying Spouse’s obligations of alimony, maintenance and support.

Section 523(a)(5) is the sharpest sword because of its broad statutory language specifically targeting divorced couples—declaring non-dischargeable marital obligations that are incurred by the Paying Spouse for alimony, maintenance or support of the Receiving Spouse. Section 523(a)(5) provides in relevant part that the Bankruptcy Code does not discharge a Paying Spouse from any debts "to a spouse, former spouse, or child of the debtor, for alimony to, maintenance for, or support of such spouse or child, in connection with a separation agreement, divorce decree or other order of a court of record, determination made in accordance with State or territorial law by a government unit, or property settlement agreement". 11. USC. Section 523(a)(5).

Therefore, Section 523(a)(5) sets out three requirements that must be met in order for a Paying Spouse’s debt to be non-dischargeable: (1) the underlying debt must be in the nature of alimony, maintenance, or support; (2) the debt must be owed to a former spouse or child; and (3) the debt must be incurred in connection with a separation agreement, divorce, or property settlement agreement or other order of a court of record. In re Reines, 142 F.3d 970, 972 (7th Cir. 1998)(citing Kinnally v. Fonnemann , 128 B.R. 214, 217 (Bankr. N.D.IL 1991); Wawak v. Smolenski, 210 B.R. 780, 782 (Bankr. N.D.IL 1997); Colon v. Gallegos, 1998 WL 787194 (Bankr. N.D. IL 1998)(Squires, J.).

Litigation frequently springs from the first test — requiring that the debt in question be in the nature of alimony, maintenance, or support. Courts must look to the substance of the underlying obligation to determine whether the obligation at issue is truly in the nature of alimony, support or maintenance (and thus non-dischargeable), on the one hand, or whether the obligation truly constitutes a division of property/debt (and maybe dischargeable), on the other hand.

The determination of whether a debt is "alimony, maintenance, or support" is a matter of federal bankruptcy law rather than state law. Jodoin v. Samayoa, 209 B.R. 132, 137-138 (BAP 9th Cir. 1997); In re Moeder, 220 B.R. 52, 54 (BAP 8th Cir. 1998); Colon v. Gallegos, 1998 WL 787194 (Bankr. N.D. IL 1998)(Squires, J.); Haas v. Haas, 129 B.R. 531, 536 (Bankr.N.D.IL 1989). In making this determination, the Court must look to the substance of the obligation and not to labels imposed by state law. But state law is not irrelevant and may provide relevant guidance. The bankruptcy court has the power and discretion to conduct an independent review of the divorce decree and factual inquiry into the true nature of any support. Jodoin v. Samayoa, 209 B.R. 132, 138 (BAP 9th Cir. 1997).

The fundamental inquiry then becomes whether the intent of the divorce court and the ex-spouses was to provide support or divide marital property. In re Woods, 561 F.2d 27,29 (7th Cir. 1977); In re Moeder, 220 B.R. 52, 55 (BAP 8th Cir. 1998) (the crucial issue is the intent of the parties and the function the award was intended to serve at the time of the divorce); Colon v. Gallegos, 1998 WL 787194 (Bankr. N.D. IL 1998)(Squires, J.). In determining whether a debt is in the nature of support/maintenance or whether it is properly characterized as a division of property, courts have considered the following factors:

whether the obligation terminates upon the death or remarriage of either spouse (termination of the obligation indicates the obligation was for support);

whether the obligation is payable in a lump sum or in installments over a period of time (obligation spread over time indicates the obligation was for support);

whether the payments attempt to balance the parties’ income (payments to balance income indicate the payments were for support);

the characterization of the obligation in the divorce decree (obligations described as support indicate the obligation was for support);

the placement of the obligation in the decree (obligations under the heading support indicate the obligation was for support);

whether there is any mention of support payments (separate mention of support payments indicates the obligation is not for support);

whether there are children who need support (if children are of the age when support is required, this indicates the payments may be for support);

whether there is a large differential in net income (a large differential in income would indicate the payments were for support);

whether the obligation was thought to be taxable to the recipient (payments thought to be taxable indicate the payments were for support); and

waivers of maintenance.

See In re Woods, 561 F.2d 27, 29-30 (7th Cir. 1977); Colon v. Gallegos, 1998 WL 787194 (Bankr. N.D. IL 1998)(Squires, J.).

B. Marital Debt and Other Debts

Incurred in Course of Divorce

Even if a Section 523(a)(5) attack on dischargeability is unsuccessful because a Court fails to deem the Paying Spouse’s debt "alimony, maintenance, or support", a Receiving Spouse may attack a bankruptcy discharge by utilizing other weapons in the arsenal. Section 523(a)(15) of the Bankruptcy Code was added as part of the Bankruptcy Reform Act of 1994 to expand the Section 523(a)(5) exception to discharge for marital debts. In re Crosswhite, 148 F.3d 879, 882 (7th Cir. 1998).

Section 523(a)(15) sets forth as non-dischargeable any marital debt other than alimony, maintenance or support that is incurred in connection with a divorce. However, Section 523(a)(15) then offers the Paying Spouse two exceptions to that rule of non-dischargeability under sub-subsections Section 523(a)(15)(A) and (B). Therefore, a Section 523(a)(15) property settlement debt is not dischargeable unless, under (A), the Paying Spouse does not have the ability to pay the debt from disposable income, or under (B), the benefit to the Paying Spouse in discharging the debt outweighs the detrimental consequences to the Receiving Spouse.

Section 523(a)(15) provides that the Paying Spouse is not discharged from any debt "not of the kind described in paragraph [523(a)(5)] that is incurred by the debtor in the course of a divorce or separation or in connection with a separation agreement, divorce decree or other order of a court of record, a determination made in accordance with State or territorial law by a governmental unit unless—

(A) the debtor does not have the ability to pay such debt from income or property of the debtor not reasonably necessary to be expended for the maintenance or support of the debtor or a dependent of the debtor and, if the debtor is engaged in a business, for the payment of expenditures necessary for the continuation, preservation, and operation of such business; or

(B) discharging such debt would result in a benefit to the debtor that outweighs the detrimental consequences to a spouse, former spouse, or child of the debtor". 11. USC. Section 523(a)(15).

This new discharge exception provision was enacted in large part to recognize that state protections for a divorced spouse and dependent children is no longer a simple matter of alimony and support payments. Property settlement arrangements are considered important components of the protection afforded individuals who, during marriage, may have depended on the debtor for their economic well being.

The Seventh Circuit addressed the burden of proof issue in In re Crosswhite, 148 F.3d 879, 881 (7th Cir. 1998). The Court concluded that the Receiving Spouse had the burden of proving that the Paying Spouse’s debt was incurred by the Paying Spouse in the course of the divorce or in connection with a divorce decree or similar agreement. However, the Seventh Circuit held that once that showing had been established, the burden of proving that the Paying Spouse falls within either of the two exceptions to non-dischargeability shifts to the Paying Spouse. In short, once the creditor’s initial proof is made, the debt is excepted from discharge and the Paying Spouse is responsible for the debt unless either of the following two exceptions can be proven by the Paying Spouse: (A) the "ability to pay" test, or (B), the "detriment" test. See also In re Moeder, 220 B.R. 52, 56 (B.A.P. 8th Cir. 1998); Jodoin v. Samayoa, 209 B.R. 132, 138 (BAP 9th Cir. 1997).

The "ability to pay" test of Section 523(a)(15)(A) requires the Paying Spouse to show an inability to pay the debt at issue. Taylor v. Taylor, 191 B.R. 760, 765 (Bankr. N.D. IL 1996)(Squires, J.); Hill v. Hill, 184 B.R. 750, 754 (Bankr. N.D.IL 1995)(DeGunther, J.). The test compares income against necessary expenses. Some courts have held only income of the Paying Spouse is considered in the determination (see Gantz v. Gantz, 192 B.R. 932, 936 (Bankr. N.D.IL 1996) (DeGunther, J.)); however, other courts have held that the failure to consider the financial situation of a Paying Spouse’s new wife constitutes error. See Beasley v. Adams, 200 B.R. 630, 634 (USDC, N.D.IL 1996)(Grady, J.).

The more frequently litigated issue regarding the "ability to pay" test is whether the Paying Spouse’s budgeted expenses are reasonably necessary. Again, courts are not in agreement. Some courts are reluctant to impose their own values on the Paying Spouse, and exclude only luxury items and obvious indulgences. However, other courts have found that only those expenses for basic needs should be considered and not those related to the Paying Spouse’s former status or accustomed lifestyle. See generally, Hill v. Hill, 184 B.R. 750, 754 (Bankr. N.D.IL 1995)(DeGunther, J.)

The "detriment" test of Section 523(a)(15)(B) was addressed by the Seventh Circuit in In re Crosswhite, 148 F.3d 879, 881 (7th Cir. 1998). There, the Court declared that the appropriate inquire under subpart (B) is the economic impact that the exception of the debts would have on the Paying Spouse and the Receiving Spouse. The Seventh Circuit adopted a "totality of the circumstances" approach to its economic inquiry.

Judge Squires considered five factors when employing the totality of the circumstances test: (1) the income and expenses of both parties; (2) the nature of the debt; (3) the former spouse’s ability to pay; (4) the number of dependents; and (5) the reaffirmation of any debts. Bolger v. Bolger, 1997 WL 851443 at 7 (Bankr. N.D.IL 1997)(Squires, J.). Judge Marovich added two additional factors: (6) the amount of the debt; and (7) the conduct of the parties. Taylor v. Taylor, 199 B.R. 37, 41 (USDC, N.D.IL 1996)(Marovich, J.). Plus, Judge DeGunther added an eighth factor: (8) whether the Receiving Spouse is jointly liable on the debts. Hill v. Hill, 184 B.R. 750, 756 (Bankr. N.D.IL 1995)(DeGunther, J.).

Finally, the legislative history needs to be considered when interpreting the "detriment" test of Section 523(a)(15)(B). The legislative history 140 Cong. Rec. H10752-1 (daily ed. Oct. 4, 1994).reveals that if discharging the Paying Spouse would inflict little or no detriment on the Receiving Spouse the debt must be discharged. Specifically, it provides:

"For example, if a nondebtor spouse would suffer little detriment for the debtor’s nonpayment of an obligation required to be paid under a hold harmless agreement (perhaps because it could not be collected from the nondebtor spouse or because the nondebtor spouse could easily pay it) the obligation would be discharged. The benefits of the debtor’s discharge should be sacrificed only if there would be substantial detriment to the nondebtor spouse that outweighs the debtor’s need for a fresh start."

Conclusion

Family law attorneys must consider bankruptcy’s future impact on divorce settlements when negotiating alimony, maintenance, and support issues as well as dividing marital property and marital debts. A wrong step may cost a client’s financial security. However, by considering bankruptcy’s impact, the family law attorney will best serve the client.

Robert V. Schaller is a sole practitioner in Oakbrook Terrace. His practice is concentrated in Bankruptcy Law. He is also a C.P.A. He received his Undergraduate Degree in 1982 from the University of Illinois-Urbana and his Law Degree in 1985 from DePaul University.


 
 
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