Questions abound as to bankruptcy as it relates to divorce. Most often, the questions involve whether a certain debt would be dischargeable by a client or the spouse. Lately, the questions surround the timing of filing a bankruptcy petition, and the all important question of whether attorney fees can be discharged in bankruptcy. It seems that, for better or for worse, divorce and bankruptcy will be intertwined for eternity. Media reports confirm that divorce is actually the second leading cause of excessive debt accumulation.1 As such, divorce often leads to bankruptcy.
The Bankruptcy Code2 has several specific provisions that relate to family law and divorce issues. As with all things related to bankruptcy since the watershed year of 2005, the past laws were significantly affected by the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act ("BAPCPA"). These broad changes expanded the law in some very important ways. This article focuses on the dischargeability of various divorce related debts in bankruptcy, including attorney fees, as well as the timing of filing a petition in bankruptcy for divorcing (or divorced) couples.
Understanding the Bankruptcy Discharge
The primary goal for most bankruptcy cases is the discharge of debt. The process begins when a debtor files a bankruptcy petition and fully discloses all assets and liabilities. Additionally, the debtor provides disclosure of certain financial information such as transfers of property, history and sources of income, lawsuits involving the debtor, and all other pertinent information that assists creditors and the bankruptcy trustee in analyzing the case. In exchange for compliance, and absent any other issues, a debtor typically receives a discharge of debts.
However, certain debts are not dischargeable under the Bankruptcy Code. With respect to divorce related debt, there are two specific provisions that apply. Under 11 U.S.C. Section 523(a)(5) certain "support" debts (payments) are non-dischargeable. Broader in scope and more comprehensive, 11 U.S.C., Section 523(a)(15) applies to debts incurred through the course of a divorce case.
Discharge of "Support" Payments
Simplicity is not often synonymous with the Bankruptcy Code. However, 11 U.S.C. Section 523(a)(5) perhaps is an exception. The section provides in pertinent part, that:
"(a) A discharge under section 727, 1141, 1228 (a), 1228 (b), or 1328 (b) of this title does not discharge an individual debtor from any debt . . . .(5) for a domestic support obligation;" (emphasis added) 3
The Bankruptcy Code defines Domestic Support Obligation at 11 U.S.C. 101(14A). That section provides:"The term "domestic support obligation" means a debt that accrues before, on, or after the date of the order for relief in a case under this title, including interest that accrues on that debt as provided under applicable nonbankruptcy law notwithstanding any other provision of this title, that is—
(A) owed to or recoverable by—
(i) a spouse, former spouse, or child of the debtor or such child’s parent, legal guardian, or responsible relative; or
(ii) a governmental unit;
(B) 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 so designated;
(C) established or subject to establishment before, on, or after the date of the order for relief in a case under this title, by reason of applicable provisions of—
(i) a separation agreement, divorce decree, or property settlement agreement;
(ii) an order of a court of record; or
(iii) a determination made in accordance with applicable nonbankruptcy law by a governmental unit; and
(D) not assigned to a nongovernmental entity, unless that obligation is assigned voluntarily by the spouse, former spouse, child of the debtor, or such child’s parent, legal guardian, or responsible relative for the purpose of collecting the debt." 4
That is a mouthful to say this: a bankruptcy debtor attempting to obtain a discharge of debt will be prohibited from discharging alimony or maintenance and child support payments.
What does a support recipient need to do to enforce this? Section 523(a)(5) applies to discharges under both Section 727 for Chapter 7 cases and Section 1328(b) for Chapter 13 cases. These types of debts are non-dischargeable automatically. A recipient of such payments who is a creditor in the bankruptcy case does not need to file suit within the bankruptcy case (known as an Adversary Proceeding) in order to preserve non-dischargeability.5 In short, the recipient needs to do nothing.
Discharge of Property Settlements and other Divorce Related Debts
Some practitioners will recall that under pre-BAPCPA law there was a distinction between property settlements (which may have been dischargeable under certain circumstances) and debts for support payments (which were, as now, non-dischargeable). With the enactment of BAPCPA in 2005, Congress amended Section 523(a)(15) eliminating certain affirmative defenses and expanding non-dischargeability to most property settlement and other debts incurred through divorce. In short, a marital dissolution obligation, not in the nature of support, incurred through a divorce judgment or separation agreement, is non-dischargeable. So, turning to property settlement debt incurred in a divorce, a promise by one spouse to pay a certain percentage of equity in a home to the other spouse would be non-dischargeable. Furthermore, an agreement by one spouse to pay certain debts, such as credit cards, would also be prohibited from discharge. The bankruptcy debtor spouse would be discharged from the debt to the credit card company, but any indemnification or hold harmless agreement with the former spouse would be enforceable by the former spouse.
Another BAPCPA change from prior law is that a creditor spouse does not need to file an Adversary Complaint in the underlying bankruptcy case to protect her or his rights.6 However, in an abundance of caution, a former spouse can still do so for the purpose having the matter determined in the bankruptcy court as opposed to a state court. This could be a prudent strategy, if there is any question as to whether the type of debt sought to be excepted from discharge falls within the meaning of marital debt in Section 523(a)(15).
Post-BAPCPA decisions determining whether a debt falls under Section 523(a)(15) have focused on a three part test. The Plaintiff must show that: (1) the debt in question is to a spouse, former spouse or child of the debtor; (2) the debt is not a support obligation of the type described in Section 523(a)(5); and (3) the obligation was incurred in a separation agreement, divorce decree or other order of a court of record.7
While a debt may be clearly excepted from discharge under Section 523(a)(15), the law only applies to a discharge under Chapter 7 and not Chapter 13.
Section 1328(a)(2) of the Bankruptcy Code specifies the non-dischargeable debts under Chapter 13 and does not reference Section 523(a)(15) non-support marital debts. Thus, assuming a debtor can propose a plan in good faith that fulfills all of the other requirements of Chapter 13, it is possible to discharge non-support marital debt in a Chapter 13 case. Thus, in a Chapter 13 case, a former spouse and creditor of the debtor will likely want to litigate the issue of whether the debt is characterized as one under Section 523(a)(15) (dischargeable) or under 523(a)(5) (non-dischargeable).
Discharge of Attorney Fees
Attorney fees incurred in certain domestic relations situations can be non-dischargeable in bankruptcy cases. Typically, if the bankruptcy debtor is your client and is attempting to discharge a debt owed to you for attorney fees, that debt will always be dischargeable. The rationale for this is that the attorney fees owed by your client do not qualify as a Domestic Support Obligation under Section 523(a)(5). Nor do they qualify under Section 523(a)(15) as the debt is not owed "to a spouse, former spouse, or child of the debtor and not of the kind described in paragraph (5)."
However, attorney fees awarded to a spouse and incorporated in a decree or order can be non-dischargeable. For instance, if you represent a client and have his or her attorney fees shifted to the other spouse and this arrangement is incorporated into an order, those attorney fees can be non-dischargeable. The most prudent course would be for the court to order that the fees are in the "nature of support" and the fees will fall under Section 523(a)(5) provided that the record and rationale are clearly articulated. If language determining the fees to be support is not included, there is still the possibility that the fees will fall under Section 523(a)(15) as marital debt incurred in the divorce or separation. Furthermore, the issue of standing to enforce non-dischargeability appears to allow the law firm or attorney who is owed the outstanding fees to bring the Adversary Complaint in the debtor’s bankruptcy case.8
Attorney fees incurred to enforce a provision of a divorce judgment can also be non-dischargeable under Section 523(a)(15). Thus if a spouse incurs attorney fees to enforce a property settlement obligation that is memorialized in the judgment, both the property settlement itself and the newly incurred attorney fees are likely to be non-dischargeable.9
Practical Considerations for Divorce Practioners
Attorneys drafting Domestic Relations orders will want to pay special attention to the wording of the orders to assure that a debt due their client will survive a bankruptcy of the other spouse. To the greatest extent possible, counsel will want to fashion orders which stipulate that the property to be distributed or payments to be made are in the nature of support. This will keep the debt under the definition of Domestic Support Obligation and ensure non-dischargeability under both Chapter 7 and Chapter 13 cases.
Further, counsel will want to create as much of a record as possible should the question of whether a payment is in the "nature of support" be raised in the future. As with the prior iteration of Section 523(a)(5), courts will likely focus on: 1) whether the obligation is subject to termination or reduction upon the occurrence of certain events (such as death or remarriage); 2) whether the obligation/payment is meant to balance the income of the parties; 3) whether the obligation is payable in installments or in a lump sum; 4) whether there are minor children that require support that were considered in the rationale for the payment; 5) whether the payments are in consideration of the relative physical health, and education of the parties; and 6) whether there is a need for support.10
In both statements to the court and in any written orders, counsel should clearly and concisely establish that the payment or obligation is for alimony or maintenance or child support. Any documents, correspondence and discovery that substantiate this should be retained. In situations where the obligation or payment is clearly not one in the nature of support, as with counsel will want to include indemnification language and hold harmless agreements to bring the debt under Section 523(a)(15).11
The Timing of Bankruptcy Filing: Before or After the Dissolution
When is the best time to file for bankruptcy? The answer depends on the circumstances of the parties and their level of mutual cooperation. However, the changes to the Bankruptcy Code from BAPCPA have removed most of the advantages of waiting to file until after the divorce is final. Why? Because as shown above, the Debtor cannot discharge most debt incurred as a result of the divorce (their own attorney fees being an important exception).
A bankruptcy before the divorce will save costs and attorney fees charged to the husband and wife for the bankruptcy. Typically the cost of a joint case is not much more than an individual case and the filing fees are the same. Thus, joint filing spouses can save roughly 50% by filing together while still married. Furthermore, the bankruptcy case can clear up issues involving debts and assets which may facilitate an easier divorce proceeding. If the parties have significant debt problems, then it is wise to consider filing before the divorce.
Bankruptcy in Mid-Divorce:
Filing during the divorce case, while fairly common, can cause considerable problems. Usually, this tactic is taken by one spouse to spite the other and delay divorce proceedings. Most proceedings are not stayed by a bankruptcy filing. However, property divisions are an exception. If there are assets to be divided, the bankruptcy trustee will now have to be involved in the matter. A division of assets will need to be fair, otherwise, the trustee can bring objections in the bankruptcy court. Bankruptcy trustee intervention in the divorce case usually means a higher fees and costs to the divorcing parties and higher scrutiny to property divisions. On the other hand, if there are no assets for the bankruptcy estate to administer, a mid-divorce filing has little effect.
After the divorce, a bankruptcy filing can bring greater scrutiny of the marital settlement agreement and the division of assets. If the division is not reasonable, then a bankruptcy trustee can bring an avoidance action such as in In Re Knippen.12 Debts incurred by one spouse and owing to the other during the bankruptcy proceedings are likely not dischargeable. Additionally, costs will be higher if both formerly married spouses file. This is also where debt allocation and hold harmless/indemnification clauses will be a critical factor, depending on whether counsel represents the filing or non-filing spouse, in those situations, as defined earlier in this Article.
To many attorneys, the Bankruptcy Code remains complex and technical. The changes brought by the Bankruptcy Abuse Prevention and Consumer Protection Act did little to change that perception. When it comes to the discharge of certain domestic relations-related debts, BAPCPA made some important changes seeking to both clarify and expand the former law. The waters are tricky, and be mindful of Illinois Rule of Professional Conduct 1.1 – when in doubt, ask a bankruptcy lawyer.
1 See http://www.bankrate.com/finance/debt/top-10-causes-of-debt-1.aspx, August 6, 2009.
2 All references to the Bankruptcy Code are to Title 11 U.S.C., Section 101 et. seq.
3 11 U.S.C. 523(a)(5)
4 11 U.S.C. 101(14A)
5 See 11 U.S.C. 523 (c)(1)
6 Prior to the enactment of BAPCPA in 2005 and pursuant to former Section 523(c)(1), a creditor seeking to except a debt from discharge under Section 523(a)(15) would have been required to file an adversary complaint within 60 days of the meeting of creditors (also called a Section 341 meeting). Congress amended Section 523(c)(1) omitting Section 523(a)(15) from the requirement.
7 See In re Williams, 398 B.R. 464, 468 (Bankr. N.D.Ohio 2008).
8 For example, see In re Bearden, 330 B.R. 214, 222-23 (Bankr.N.D.Ill. 2005) (Ch. 7 debtor’s obligation to law firm that had represented his former wife in divorce was debt "owed to a former spouse," for dischargeability purposes, even though it was payable directly to law firm).
9 See In re Golio, 393 B.R. 56 (Bankr. E.D.N.Y. 2008). This article does not address whether guardian ad litem fees, or other fees for attorneys appointed to represent children in divorce proceedings.
10 See In Re Kodel, 105 B.R. 729 (Bankr.,S.D. Fla 1989).
11 For example, see In re Walden, 312 B.R. 187 (Bankr.C.D.Ill. 2004) (obligation to pay mortgage payments and hold ex-spouse harmless is obligation owed to ex-spouse that may be nondischargeable under either § 523(a)(5) or (a)(15)).
12 In In Re Knippen, 355 B.R. 710 (Bankr. N.D. Ill. 2006), despite a valid dissolution of marriage judgment, the bankruptcy court found that a pre-bankruptcy transfer via a marital settlement agreement as a fraudulent transfer. The court avoided the transfer and awarded the bankruptcy trustee a judgment against the transferee spouse.
Arthur Rummler is a sole practitioner with an office in Glen Ellyn, Illinois. He concentrates his practice in all phases of bankruptcy, including consumer, business and trustee cases. Mr. Rummler is a 1987 graduate of the University of Michigan Ross School of Business Administration and a 1991 graduate of the Chicago-Kent College of Law. Actively participating in the DuPage County Bar Association, he is currently serving as a member of the DCBA Brief Board, Chairman of the Entertainment Committee and has appeared in Judge’s Night for the past two years. He makes his home in Downers Grove with his wife Claire and children Jackson and Christian.