New Jersey business law Article

DISCHARGEABILITY OF DIVORCE DEBTS IN BANKRUPTCY

Arthur H. Miller, Esq.

Miller, Miller & Tucker, P.A.

96 Paterson Street

New Brunswick, NJ 08901

Phone: (732) 828-2234

There are two types of exceptions to discharge of divorce debts in bankruptcy: (a) “Domestic Support Obligations” excepted under 11 U.S.C. § 523(a)(5), and (b) equitable distribution obligations excepted pursuant to 11 U.S.C. § 523(a)(15).

A “Domestic Support Obligation” is defined by the Bankruptcy Code under 11 U.S.C. § 101(14A) as a debt:

(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;

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.

Domestic Support Obligations are not dischargeable in cases filed under Chapter 7, 11, 12 or 13 of the Bankruptcy Code. 11 U.S.C. § 523(a)(5).

Equitable distribution obligations are not dischargeable in cases filed under Chapters 7, 11 or 12 of the Bankruptcy Code. Equitable distribution obligations are dischargeable in cases filed under Chapter 13 provided that the debtor receives a completed plan discharge under 11 U.S.C. § 1328(a). However, if the debtor received a “best efforts discharge” under 11 U.S.C. § 1328(b), the equitable distribution obligation is not discharged in the Chapter 13.

It is not necessary for a divorce debt creditor or a non-debtor spouse to request a determination of dischargeability from the bankruptcy court or appear in the bankruptcy case in order to determine the dischargeability of a divorce debt. Although this recourse is available, the creditor or non-debtor spouse can have the issue of dischargeability determined in an appropriate state court proceeding since state courts have concurrent jurisdiction with bankruptcy courts over the issue of dischargeability of divorce related debts. Loyko v. Loyko, 200 N.J.Super. 152, 156 (App. Div. 1985).

The filing of a bankruptcy petition under Chapter 7, 11, 12 or 13 of the Bankruptcy Code imposes an automatic stay under 11 U.S.C. § 362 against efforts to collect obligations of the debtor by creditors during the pendency of the bankruptcy case. This stay applies to non-debtor spouses as well as to third-party creditors owed marital debts. As long as the automatic stay is in effect, the creditor who wishes to proceed against the debtor in state court to collect a pre-petition marital debt must obtain relief from the automatic stay by motion in the bankruptcy court. However, in order to pursue the issue of dischargeability in the state court, no relief from the stay is necessary. The automatic stay ends in the case of a Chapter 7 case when the debtor receives his or her discharge or the case is dismissed. In a Chapter 13 case, unless the case is otherwise dismissed, the stay remains in effect until the debtor receives a discharge at the completion of the debtor’s plan payments. The Chapter 13 Plan will not be confirmed and the case will be dismissed if all post-petition Domestic Support Obligations have not been paid, or if the Plan does not provide for payment in full over the life of the Plan of all unpaid pre-petition Domestic Support Obligations.

Obligations such as child support and alimony are obviously nondischargeable as Domestic Support Obligations under § 523 (a)(5) regardless of what type of case was filed by the debtor. As noted above, this is also true of equitable distribution debts in Chapters 7, 11 and 12. Where counsel may need to seek a court determination of whether an obligation or a payment to a third party such as credit card debt or mortgage payment is actually “in the nature of alimony, maintenance or support” as a Domestic Support Obligation or is equitable distribution is when the debtor files a Chapter 13 petition and seeks to discharge the obligation.

The determination of whether a divorce related debt is a Domestic Support Obligation and, therefore, nondischargeable regardless of what type of bankruptcy case is filed by the debtor, rests upon the intent of the parties, if contained in the property settlement agreement, and on the intent of the court, if ordered by the court without a settlement. The question of whether or not an obligation is a domestic support obligation is a question of federal law and not state law. Winegarden v. Winegarden, 316 N.J.Super. 52, 60 (App. Div. 1998). This determination is made in a two-step process. If the language of the settlement agreement or court judgment is a clear expression of the intent to render the obligation nondischargeable as a Domestic Support Obligation, the court need go no further. Larbig v. Larbig, 384 N.J.Super. 17, 26 (App. Div. 2006), citing In re Gianakas, 917 F.2d 759, 762 (3^rd Cir. 1990). If the language is ambiguous, then the court must resort to extrinsic evidence to determine intent.

The Gianakas case is the leading federal case in the Third Circuit with respect to the factors to be applied to determine when a property settlement agreement or a court decree is ambiguous with respect to the intent of the parties, and whether the obligation should be held to be a nondischargeable Domestic Support Obligation. Where there is no clear expression of intent, the court will examine first the parties’ financial circumstances at the time of the settlement or decree, and second the function served by the obligation at the time of the settlement or decree. With respect to financial circumstances, whether one spouse had custody of the children, was or was not employed, their relative earning abilities and various other aspects of the parties’ financial circumstances are considered. With respect to the function issue, the court will consider whether the obligation serves to maintain daily necessities such as food, housing and transportation. Gianakas, supra, at 763. But see In re Bailiff, 2006 W.L. 4452991 (Bankr. D.N.J. 2006). The mere fact that an obligation is designated in the agreement or decree as a “property settlement” or “support” does not dispose of the issue, since labels in and of themselves are not sufficient to ascertain the intent of the parties. Gianakas, supra, at 762.

Whether the non-debtor spouse’s unpaid attorney’s fees were intended to be Domestic Support Obligations is fact sensitive. Factors considered include whether there was a significant disparity between the income of the nondebtor spouse and the debtor spouse at the time of the divorce, and whether the nondebtor spouse would not have been able to prosecute his or her divorce without assistance from the debtor in the form of payment of counsel fees. Winegarden, supra, at 683.

A “hold harmless clause” in the property settlement agreement where the debtor spouse agrees to indemnify the nondebtor spouse in the event the nondebtor is required to pay any of the marital debts, will be given weight by the court in making the determination as to whether the debts are nondischargeable. Winegarden, supra, at 60-61.

In order to protect a potential nondebtor spouse from having a divorce obligation held dischargeable in Chapter 13, it is recommended that language such as the following be inserted into the property settlement agreement or court order:

“In the event Party A decides at some future time to seek a bankruptcy

discharge of any of his obligations to Party B hereunder, Party A agrees and

recognizes that Party B is relying on all of Party A’s payment and indemnification

obligations to Party B and to third parties hereunder for Party B’s support and

maintenance (and the support of the parties’ children), regardless of the

characterization of a particular obligation as support, alimony, equitable

distribution or otherwise. Accordingly, in the event that Party B is required to

pay any of said obligations to any third party as a result of Party A’s failure to

pay the same, Party A will indemnify and hold Party B harmless from any and all

such obligations or payments, including attorney’s fees incurred to defend any

such claims.”

In a Chapter 13 case, counsel should be cautioned that it is always advisable, if you are representing a creditor, whether or not a spouse, to file a claim on behalf of the creditor, since creditors who do not file claims receive nothing from the Chapter 13 distributions, regardless if the creditor is named in the petition. In Chapter 7, there is no need to file a claim unless you receive a notice that there will be a distribution to creditors by the Trustee.

In the event of a filing by the debtor spouse seeking to discharge an equitable distribution obligation in a Chapter 13, the nondebtor spouse can attempt to avoid discharge by seeking to dismiss the case or convert it to Chapter 7 for cause under 11 U.S.C. § 1307(c) or to dismiss on the ground that the debtor is ineligible for Chapter 13 treatment because the total of his or her debts, either secured or unsecured, exceeds the permissible limit for the filing of a Chapter 13 case, under 11 U.S.C. § 109(e).

The information expressed above should not be construed as legal advice but merely information on the law that may be of interest to you. Remember, individual legal problems require individual solutions. Please contact Miller, Miller & Tucker, P.A. if we can help.