The Community Discharge: the Good, the Bad, and the Ugly

• Publication year: 2016
• Citation: Vol. 2016 No. 2
• Author: Elyza P. Eshaghi

The Community Discharge: The Good, The Bad, And The Ugly

Elyza P. Eshaghi

Elyza P. Eshaghi is an associate attorney at Shulman Hodges & Bastian LLP. Ms. Eshaghi concentrates her practice in Commercial Law and Bankruptcy and is experienced in various aspects of litigation, trustee representation, creditor representation, and debtor representation in the insolvency and bankruptcy context.

As the famous saying goes, the Devil himself could receive a discharge if he were married to Snow White.¹ What does this mean, exactly? Generally, the rule in bankruptcy is that an individual's discharge relieves only the "honest but unfortunate" debtor of liability for a debt. Anyone else liable on the debt with the debtor remains liable notwithstanding the discharge received by the debtor.² The general rule is markedly different in community property states.³ Contrary to the general rule, sometimes a "dishonest" non-filing spouse is able to reap the benefits of a filing spouse's discharge through what is commonly known as the "community discharge." In order to better understand the impact of a community discharge and how it works, it is important to note how community property is treated in bankruptcy and the basic principles behind a bankruptcy discharge. The best way to examine these concepts is in the context of a voluntary individual chapter 7 bankruptcy.

Once an individual files a voluntary petition under chapter 7 of the Bankruptcy Code, an "estate" is created.⁴The bankruptcy estate comprises all "legal or equitable interests of the debtor in property," and all "interests of the debtor and the debtor's spouse in community property," as of the commencement of the case.⁵ Generally, property interests and liabilities are determined under state law, but federal law determines how those interests are treated in a bankruptcy proceeding. Butner v. United States, 440 U.S. 48 (1979). Thus, we look to state law to determine what constitutes community property, and we look to 11 U.S.C. §§ 541(a)(2)(A)-(B) to determine what items of community property will be included in a married person's bankruptcy estate. Under 11 U.S.C. § 541(a)(2) (A), all community property under the sole, equal, or joint management and control of the debtor comes into the estate. Under 11 U.S.C. § 541(a)(2)(B), all community property that is subject to recovery for a claim against the debtor, or for a claim against the debtor and the debtor's spouse, comes into the estate. Thus, even if the debtor files individually, the non-filing spouse's interest in community property passes into the estate.⁶

In addition, an "automatic stay" goes into effect as of the date the bankruptcy petition is filed. Id. § 362. The automatic stay preserves property of the estate for equitable distribution to creditors and allows the debtor a breathing spell from collection efforts.⁷ Specifically, the automatic stay prohibits any act to enforce claims that arose before the bankruptcy petition was filed (commonly known as "pre-petition claims") against the debtor, the debtor's property, or property of the bankruptcy estate.⁸ The stay arises by operation of law, so it is automatic and no court order is required to activate the stay.⁹ In essence, the automatic stay acts as a blanket injunction that remains in effect until a bankruptcy court order is entered lifting the stay or the stay expires.¹⁰ The automatic stay will expire upon the earlier of: (1) the case closing, (2) the case being dismissed, or (3) the entry of a discharge order.¹¹ The automatic stay protects both the debtor's and the non-filing spouse's interest in community property, since the bankruptcy estate comprises both the debtor's and the non-filing spouse's interest in said property.¹² Accordingly, in community property states, the non-filing spouse receives the benefit of one of the most important protections afforded to the debtor without ever having to file for bankruptcy.

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The automatic stay, however, does not remain in effect indefinitely.¹³ How then, is the debtor afforded relief from creditor collection efforts after the bankruptcy case is closed? The answer is the discharge in bankruptcy that is received by the debtor. The primary reason an individual files for bankruptcy is to receive the protection that a discharge provides. The very purpose of the Bankruptcy Code is to provide a vehicle whereby insolvent debtors can reorder their affairs, make peace with their creditors, and "enjoy a new opportunity in life with a clear field for further effort, unhampered by the pressure or discouragement of preexisting debt."¹⁴ Once a discharge order is entered, the debtor is released from personal liability on the debts that were incurred pre-petition, unless a creditor successfully objects to the debtor's discharge or the dischargeability of a certain debt.¹⁵ Said another way, a bankruptcy discharge extinguishes "one mode of enforcing a claim—namely, an action against the debtor in personam."¹⁶ While a discharge extinguishes the right to enforce a claim against the debtor, the debtor's property remains liable for a debt...