The Intersection of Family Law and Bankruptcy: Look Both Ways Before Crossing, 0219 COBJ, Vol. 48, No. 2 Pg. 32

• Author: by Peter Cal and Jordan Fox
• Position: Vol. 48, 2 [Page 32]

48 Colo.Law. 32

The Intersection of Family Law and Bankruptcy: Look Both Ways Before Crossing

Vol. 48, No. 2 [Page 32]

The Colorado Lawyer

February, 2019

FAMILY LAW

by Peter Cal and Jordan Fox

This article discusses the treatment of domestic support obligations in bankruptcy cases.

When handling dissolution of marriage cases, expertise in both family law and bankruptcy law is necessary to maximize a client’s recovery and avoid significant risks.

This article addresses critical issues a practitioner must navigate when a client’s spouse or ex-spouse files a bankruptcy case before or after entry of a divorce decree. It explains key concepts necessary to understanding options in the family law context after a bankruptcy fling and discusses

■ the scope of the automatic stay and when a motion for relief from stay should be fled;

■ abstention;

■ the scope of the discharge under different chapters of the Bankruptcy Code;

■ plan confirmation issues and strategies to maximize recoveries in the event of a bankruptcy fling; and

■ best practices for crafting a state court dissolution and support order when a future bankruptcy fling is expected.

Key Concepts

Whether a debt is a domestic support obligation (DSO), what assets are property of the bankruptcy estate, and the chapter of the Bankruptcy Code¹ under which the debtor seeks relief are critical to determining whether the automatic stay applies and whether a debt is dischargeable in a bankruptcy case.

DSOs and Other Debts

In a bankruptcy case fled after a divorce proceeding, it is critical to understand the different treatment provided for the various types of debts incurred in the divorce proceeding. The Bankruptcy Code creates two categories for debts incurred in divorce proceedings: (1) DSOs (11 U.S.C. section 523(a)(5)); and (2) any other debt incurred in a divorce proceeding (11 U.S.C. section 523(a)(15) debts).²

DSOs have greater protection in the Bankruptcy Code than other debts incurred in a divorce proceeding in three important ways. First, DSOs cannot be discharged under any Bankruptcy Code chapter, but section 523(a) (15) debts can be discharged in a chapter 13 proceeding. Second, collection of DSOs generally isn’t subject to the automatic stay, but collection of section 523(a)(15) debts is subject to the automatic stay. Third, a DSO is treated as a first priority claim and is paid before other unsecured claims.

Section 101(14)(A) of the Bankruptcy Code defines a DSO as a debt that is owed to a spouse, a former spouse, or a child of the debtor that is in the nature of alimony, maintenance, or support and is established by a separation agreement, divorce decree, property settlement agreement, or court order. Whether a debt is a DSO is determined by federal bankruptcy law, not state law.³ To determine whether a debt is a DSO, the bankruptcy court analyzes the shared intent of the parties and whether the obligation, in substance, was support or in the nature of support. In determining the parties’ intent, the bankruptcy court looks to the underlying agreement itself, as well as the surrounding circumstances, such as employment status, level of education, and the need for support.

Regardless of how the parties label the obligation, if it has the practical effect of providing support, the obligation is a DSO.⁴ The Tenth Circuit has held that the term DSO is entitled to a broad application.^[5] DSOs can include not only payments to the former spouse, but also payments to third parties that have the practical effect of reducing the former spouse’s living expenses. For example, an obligation owed to a credit card company to pay a joint credit card debt of a former spouse⁶ or an obligation to pay a mortgage and hold the former spouse harmless from the obligation to pay the mortgage can both be characterized as DSOs.⁷ DSOs can also include attorney fees incurred in a state court proceeding related to the receipt or enforcement of DSOs.⁸

In sum, bankruptcy courts may have a broader view of what qualifies as a DSO than a family law attorney initially may expect. For example, what may appear to be a property transfer under state law could, under certain circumstances, be a DSO in a bankruptcy case.

Property of the Bankruptcy Estate

The Bankruptcy Code defines property of the estate very broadly to encompass all legal or equitable interests of the debtor in property as of the commencement of the bankruptcy case,⁹ with a few exceptions not relevant to this article. In a chapter 7 case, property of the bankruptcy estate does not include post-petition earnings or other property acquired by the debtor after the bankruptcy fling.¹⁰ However, in chapter 11 and 13 cases, property of the bankruptcy estate does include property acquired post-petition and post-petition earnings.¹¹

The Different Chapters of the Bankruptcy Code

The property that is included in the bankruptcy estate and the availability of a discharge vary under the different Bankruptcy Code chapters. It is thus important to identify at the commencement of the bankruptcy case the Bankruptcy Code chapter under which the debtor has chosen to file.

In general, an individual with few unencumbered assets who wants a discharge files a chapter 7 bankruptcy case. There are, however, limits on the amount of income an individual can earn and still be eligible for chapter 7 relief.¹² Subject to certain debt limits, an individual with regular income can file a chapter 13 bankruptcy case.¹³ In the chapter 13 case, an individual seeks to confirm a plan and pay his creditors from disposable income over a period of three to five years. Chapter 11 is also available to individuals seeking to reorganize and is generally used where the individual does not satisfy chapter 13’s debt limits or is not eligible for a chapter 7 case based on his income level. Chapter 12 is available for family farmers seeking to reorganize through a plan.

Scope of Relief

For debts incurred in a divorce proceeding, the scope of the discharge differs depending on the Bankruptcy Code chapter under which the debtor files a bankruptcy case. In a chapter 13 case, a section 523(a)(15) debt typically is paid through a plan on the same basis as other unsecured claims and is discharged when plan payments are complete, but a DSO is not discharged. Under chapters 7, 11, and 12, DSOs and section 523(a)(15) debts are not discharged.

The Automatic Stay

Among other things, a bankruptcy fling stays

1. the commencement or continuation of litigation against the debtor;

2. the enforcement of a judgment obtained before the commencement of the bankruptcy case against either the debtor or property of the bankruptcy estate;

3. any act to exercise control over property of the bankruptcy estate; and

4. any act to collect, assess, or recover a pre-petition claim against the debtor.¹⁴

The protection of the automatic stay is broad, and exceptions to the automatic stay are applied narrowly.¹⁵ The consequences to the client and the attorney for violating the automatic stay can be severe. Any act in violation of the automatic stay is void, even where there is no notice of the bankruptcy fling.¹⁶ An individual injured by a willful violation of the automatic stay can recover actual damages, including costs and attorney fees. The award of actual damages is mandatory.¹⁷ Punitive damages also can be awarded.¹⁸

There are exceptions to the automatic stay for certain types of family law proceedings. The automatic stay does not apply to the commencement or continuation of a civil action

■ to establish paternity;

■ to establish or modify an order for a DSO;

■ concerning child custody or visitation;

■ to dissolve a marriage, except to the extent the dissolution proceeding seeks to determine the division of property that is property of the estate; or

■ regarding domestic violence.¹⁹

Further, the automatic stay does not apply to the collection of a DSO from property that is not property of the estate,²⁰ to a wage garnishment,^[21] or to a criminal proceeding against the debtor, including a criminal contempt proceeding brought to enforce a pre-petition order of the state court.²²

A creditor must notify the state court in a pending proceeding of the bankruptcy fling. This is often done by filing a “Suggestion of Bankruptcy.” A creditor must also affirmatively cease all collection efforts, including taking steps to withdraw an income assignment or wage garnishment if it involves the collection of section 523(a)(15) debts.²³

When is a Debt a DSO?

As stated above, whether a debt created by a divorce decree is a DSO is determined by the intent of the parties and the court’s consideration of the surrounding circumstances. The Tenth Circuit has stated that the label attached to an obligation does not control, even if the relevant agreement is unambiguous.²⁴ In short, whether a debt is a DSO raises inherently factual issues.²⁵ In addition, even when the debt is a DSO, collection of the DSO is stayed upon the fling of a bankruptcy case, unless collection is from property that is not property of the bankruptcy estate or is based on a DSO wage garnishment.²⁶ For these reasons, it is often more judicious to seek relief from the automatic stay before proceeding in the pending state court divorce proceeding.

State Court Contempt Proceedings

Bankruptcy courts generally refer to contempt proceedings as civil (which are subject to the automatic stay) and criminal (which are not subject to the automatic stay). Colorado state law refers to remedial sanctions and punitive sanctions for contempt.^[27]A contempt proceeding seeking remedial sanctions is civil, and one seeking punitive sanctions is criminal.²⁸

When pursuing a contempt...