Debts, Divorce and Bankruptcy
| Publication year | 2009 |
| Pages | 0022 |
| Citation | Vol. 50 No. 2 Pg. 0022 |
2009 Fall, Pg. 22. Debts, Divorce and Bankruptcy
Volume 50, No. 2
Fall 2009
INTRODUCTION
During times of economic strength, divorcing parties are focused on valuing and dividing assets, typically the equity in the former marital residence, financial assets, and retirement accounts. In contrast, during difficult economic times, divorcing parties (and the courts) are frequently faced with the more daunting task of dealing with a marital home with negative equity, either one or both parties' inability to maintain the payments on the home mortgage, overwhelming debt loads and declining retirement values. In short, parties are often arguing over allocation of debts instead of distribution of assets.
In the current economic downturn, divorcing couples are also faced with the recent decline in the real estate market. As a result, divorcing couples may be unable to sell the former marital residence due to negative equity in the property. It may be that neither party can make payments on the former marital residence, and thus are unable to maintain the debt service on the former home or sell it. Even when one of the parties is financially able to maintain the payments on the former home, he or she may be unable to refinance the mortgage to remove the former spouse's name due to a lack of equity and tighter lending practices.
Another common problem during an economic downturn is that the parties cannot make payments on unsecured debts, such as credit card debt, during or after their divorce. These debts may have been incurred or increased during a period of unemployment or underemployment. Parties may rely on credit during the financially difficult transition from one household to two households. The costs of the divorce, including attorney fees, may have been financed. The allocation of these debts can be problematic during a divorce.
All of these factors increase the likelihood that one or both parties may consider filing bankruptcy either during or following a divorce. This article is intended to assist both the family law practitioner and the bankruptcy practitioner in identifying and addressing issues raised when divorce and bankruptcy intersect. This discussion assumes little or no prior knowledge of bankruptcy law. In the best-case scenario, the information provided will allow divorce counsel to proactively address these potential issues in a manner that is beneficial to both parties. Where this is not possible, counsel can also advise his or her clients as to the bankruptcy solutions that may or may not be available to assist in resolving the client's financial troubles.
A REVIEW OF CHAPTER 7 AND CHAPTER 13
Chapter 7 Bankruptcy
A chapter 7 bankruptcy case is the traditional liquidation bankruptcy. In exchange for a discharge of debts, the bankruptcy debtor submits control of his or her assets to the bankruptcy court. Assets which are not exempt under federal or state law are subject to sale by the bankruptcy trustee to pay the creditors in the case. New Hampshire bankruptcy exemptions are fairly generous and in the vast majority of chapter 7 bankruptcy cases, no assets are sold.(fn 1 ) In most chapter 7 cases, the court issues a discharge order and the case is closed in approximately six months.
With the passage of the Bankruptcy Abuse and Consumer Protection Act of 2005 (BAPCPA), Congress added "Means Testing" into the Bankruptcy Code.(fn 2 ) The Means Test is intended to gauge the debtor's ability to repay some or all of his or her debts. In order to be eligible to file a chapter 7 bankruptcy case, debtors must "pass" the Means Test. If the debtor is filing a chapter 13 bankruptcy case (discussed below), the Means Test may be used to determine what portion of the debtor's income is actually available to fund a chapter 13 plan and the duration of the plan.(fn 3 )
The Means Test considers all income received by the debtor and the debtor's spouse from any source during the six complete calendar months prior to the bankruptcy filing.(fn 4 ) The income received by the debtor's spouse is included even if the spouse does not file for bankruptcy.(fn 5 ) However the debtor may make a marital adjustment to deduct spousal income that is not contributed to household expenses.(fn 6 ) Furthermore, where the debtor is separated from his or her spouse, his or her spouse's income may be excluded.(fn 7 ) The debtor is also allowed to deduct certain expenses on the Means Test,including court-ordered support payments.(fn 8 )
Chapter 13 Bankruptcy
In contrast to a chapter 7 bankruptcy, a chapter 13 bankruptcy case is intended to allow a debtor with regular income to repay debts under court supervision. The debtor submits a repayment plan for approval of the court that calls for the repayment of some or all of his or her debts over a three-to five-year period.(fn 9 ) Instead of paying his or her creditors directly, the debtor makes a payment to the chapter 13 trustee, who disburses these payments to the creditors under the terms of the chapter 13 plan. The amount of the payment to the chapter 13 trustee depends upon a number of factors. Upon completion of the chapter 13 plan, the court issues a discharge order that applies to any remaining balances on the debts included in the bankruptcy.
One of the major advantages of filing a chapter 13 case is to deal with mortgage defaults and to avoid foreclosure. If the debtor is behind on a mortgage or other secured debt, the debtor can propose a plan to cure the arrearage on the secured debt over the life of the chapter 13 plan.(fn 10 ) The debtor often proposes to pay the regular (post-petition) payments on an ongoing basis directly to the secured creditor and then pay the amount of the arrearage through the chapter 13 plan. The debtor can file a chapter 13 case at any time prior to the completion of the sale to a high bidder at a foreclosure sale.(fn 11 ) The debtor will normally be responsible for the payment of the attorneys' fees and costs associated with the foreclosure sale.(fn 12 ) The effect of such a plan is to force the lender to start accepting regular monthly payments and to allow the debtor to cure the payment default through a three-to five-year payment plan.
The Discharge Order
The discharge order entered in either a chapter 7 or a chapter 13 case generally prohibits any of the debtor's pre-bankruptcy creditors from attempting to collect the unpaid balances of their claims from the debtor.(fn13 )However, where a debt is secured by the debtor's assets, as in the case of a mortgage or car loan, these security interests generally pass through bankruptcy unaffected.(fn 14 ) Furthermore, a non-filing spouse or ex-spouse will receive no protection from the debtor's bankruptcy discharge.(fn 15 )Therefore, to the extent that the non-filing spouse is personally liable on the debts discharged in the debtor's bankruptcy filing, the non-filing spouse will remain liable. The debtor's creditors will likely seek to collect upon their claims from the non-filing spouse to the extent that he or she is liable on those claims under state law.
THE AUTOMATIC STAY
Upon the filing of a bankruptcy petition, an automatic stay goes into effect which applies to all creditors, including a spouse or former spouse of the debtor.(fn 16 ) The automatic stay prohibits creditors from attempting to collect claims against the debtor or against property of the debtor's bankruptcy estate.(fn 17 ) Specifically, the stay prohibits the commencement or continuation of judicial actions or proceedings; the enforcement of judgments; attempts to obtain possession of property; the creation, 18 perfection or enforcement of liens, as well as other collection attempts. Thus, filing a bankruptcy petition is likely to halt pending divorce or post-divorce proceedings.
As to actions against the debtor the automatic stay lasts until the earliest of (1) the time the case is closed, (2) the time the case is dismissed, or (3) the time the debtor's discharge is granted or denied.(fn 19 ) As to actions against property of the bankruptcy estate, the automatic stay lasts until the property is no longer property of the estate.(fn 20 ) Property is no longer property of the bankruptcy estate when the case is closed or sooner, if the trustee affirmatively abandons such property.(fn 21 ) The court also has the authority to lift or modify the stay upon motion of the creditor, as discussed below.
Exceptions to the Automatic Stay
Although the automatic stay is broad, there are some statutory exceptions and the automatic stay does not prohibit all family law litigation or collection activity.(fn 22 ) In particular; the automatic stay does not apply to actions to determine paternity,actions to establish or modify a domestic support obligation, actions concerning child custody or visitation,or domestic violence actions.(fn 23 ) (fn 24 ) (fn 25 ) In addition, the automatic stay does not apply to an action to grant a divorce, to the extent such action does not also involve the division of property that isproperty of the bankruptcy estate.(fn 26 )
Whether the automatic stay applies to collection or enforcement of a domestic support obligation can be tricky.(fn 27 ) The exception cited above for actions involving domestic support obligations is only as to establishment or modification of the obligation. A separate exception exists for collection of a domestic support obligation but only from property that is not property of the bankruptcy estate.(fn 28 ) In a chapter 7 case, the bankruptcy estate is generally limited to property held by the debtor at the time of filing, and efforts to collect a domestic support obligation from post-petition income or property do not...
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