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The Complex World Of Interspousal Claims In Bankruptcy, by Kathy Moran

  • Tort claim or divorce claim
  • Claims addressed in final decree
  • Breach of fiduciary duty to spouse
  • Characterization isn’t either/or
  • Avoiding discharge of spousal claims

The Bankruptcy Code and Its Impact on Attorneys’ Fees in Divorce in Arizona, by Lawrence D. Hirsch, September, 2020 (PDF)

An attorney’s duty of loyalty and married clients – article by Cathy Moran.

The following is a reprint of Ms. Moran’s article:

conflicts with spouses“Are your loyalties divided

When a married couple books a bankruptcy consultation, you have an immediate problem: There be dragons, as early map makers helpfully provided.

Because, as a lawyer friend of mine says:  

Anytime there are two people sitting across from you, you have a conflict of interest.

That pithy expression has stuck with me and made me continually aware that even a happily married couple may have different legal interests. Add a little marital discord, and the opportunities for conflict blossom.

Duty of loyalty

The ABA Rule of Professional Conduct 1.7 addresses conflicts among current clients.

California, wouldn’t you know, has a slightly more verbose rule

… a lawyer shall not represent a client if the representation involves a concurrent conflict of interest. A concurrent conflict of interest exists if:

(1) the representation of one client will be directly adverse to another client; or

(2) there is a significant risk that the representation of one or more clients will be materially limited by the lawyer’s responsibilities to another client, a former client or a third person or by a personal interest of the lawyer.

Where are the conflicts between spouses

Two potential conflicts leap out at me:

  • the treatment of separate property in a joint bankruptcy case
  • claims of one spouse against the other

Take a look at any differences between the liability under state law of separate property of one spouse for debt, contrasted with the liability of property of the estate under Bankruptcy Code 726. Under California law, one spouse’s separate property would not be liable for debts of the other spouse; under 726, separate property IS liable for those debts.

So the interests of the two spouses sitting across from your desk may be adverse in ways they’ve never considered.

When the couple is planning or in the midst of a divorce, there is the possibility of claims one spouse may have against the other for breach of fiduciary duty.

Query whether a discharge in a joint bankruptcy would bar such claims as the divorce proceeded.

So one of the questions on my screening questionnaire that new clients fill out before we sit down asks if they are separated from their spouse or considering divorce. If the answer is yes, we proceed with caution.

Coping with conflicts

I have no hard and fast rules on what to do when they acknowledge they are heading for divorce. But, it triggers the discussion about conflicts with the couple.

I need to assess whether they appear to be able to communicate and work together toward getting out of debt. Are they each ready to make full disclosure of assets and liabilities? What are the consequences of a deliberate omission on the other spouse? How are the expenses of responding to trustee inquiries targeted at one spouse to be paid? And then there is the cost of any adversaries that might be filed.

Further, I need to analyze and discuss with the couple whether separate bankruptcies would advantage one spouse or another. Without that, I haven’t done my job.

More often than in other situations, I tend to send out a letter following our meeting that makes a record of our discussion about conflicts.

If we, the couple and I, decide that I will represent them in a joint case, one of my ground rules is that anything either one tells me, I will be free to share with the other.  In other words, I will not keep the secrets of one spouse from the other.

Further, if an actual and insurmountable conflict or divergence arises, they are told upfront that I will withdraw and represent neither of them going forward.

It’s worth remembering that while spouses are permitted to file a joint bankruptcy case, they are not required to.

Chapter 13 is different

Finally, if Chapter 13 is the prudent choice for them, in light of tax or real estate issues, I won’t represent a couple intending to separate in a joint 13.  A successful 13 requires years of cooperation;  the court doesn’t understand “my half of the payment” when there’s a financial default.

I can’t say these are foolproof practices or the only ones you can adopt.  I can say you need to think the conflicts issue through before you become embroiled.

Steer clear of the dragons.”

The considerations are:

(1) There is no need for a Motion for Relief from Stay for the Family Court to enter a divorce decree, a child custody order or a support order;

(2) The Family Court can not divide non-exempt community property unless the Trustee has abandon it.

(3) The Family Court can enter orders dividing exempt community property and property not property of the estate such as pensions, 401k and the like.  However, Family Court may be reluctant to do so.  There are few Superior Court Judges that understand community property let alone Bankruptcy law.

(4) As to community debt why aren’t you waiting for discharge to prevent any apportionment of community debts?

“The dissolution decree’s apportioning of the community debts is usually accompanied by a hold-harmless provision: the spouse to whom a particular debt is assigned will hold the other spouse harmless for that debt. The assigned spouse is obliged to pay the particular debt, and, in the event that the debt is not paid, the other spouse can pay that debt and seek recovery of that debt from the non-paying spouse. In a Chapter 7 bankruptcy, the non-paying former spouse can discharge that obligation to pay the creditor, but he or she cannot discharge the hold-harmless provision and the potential obligation to repay the other former spouse.”  from Gary R. Stickell, Attorney at Law, P.C

Possible language for divorce decree as related to bankruptcy:

Wife (Husband) intends to file bankruptcy. Therefore no debts are allocated to wife and therefore wife is not ordered to hold harmless husband (wife) regarding any debt.  or

There is no division of debts.  Each of the parties anticipate filing bankruptcy and discharging the unsecured debts of the marriage.

In re Cooke (Fiebelkorn v Cooke), 3:19-bk-10014-DPC (Chapter 13, 6/16/20) Divorce settlement – parties agreed to transfer Cooke title to marital home, then Cooks to refinance and pay Fiebelkorn half of profit. Refinance not done, Cooke filed 13, attempting to discharge obligation.  Fiebelkorn alleges embezzlement.  Court found debt dischargeable re Section 523(A)(2)(a).

Heilman v. Heilman (In re Heilman) BAP No. EW-09-1150-HMoPa, 430 B.R. 213; 2010 Bankr. LEXIS 1386 (9th Cir BAP, April 26, 2010) The bankruptcy appellate panel held, however, that the community debt was a pre-petition debt which was discharged in the debtor’s bankruptcy case, and the hold-harmless provision in the divorce decree did not revive the discharged debt. On the date of the debtor’s bankruptcy petition the spouse held a contingent claim against the debtor for contribution on the community loan debt, and the debtor’s discharge extinguished the debtor’s liability on the contingent liability. Further, the hold-harmless provision was based on the debt which was discharged and thus did not constitute a reaffirmation of the debt, and the provision of the divorce decree requiring the debtor to pay the debt was void and unenforceable.

Mele vs Mele, BAP No. WW-13-1173-DTaKu, Bk. No. 11-24015-MLB, Adv. No. 12-01271-MLB (9th Cir.11/5/2013) “While the bankruptcy court’s decision to except a portion of the Property Settlement Judgment from John’s chapter 13 discharge pursuant to § 523(a)(4) as a defalcation of his fiduciary duties to the marital community between him and Kimberly may be defensible as a matter of policy, it appears “to override the balance Congress struck in crafting the appropriate discharge exceptions for Chapter 7 and Chapter 13 debtors.” Davenport, 495 U.S. at 563.”

“Based on the foregoing analysis and discussion of § 523(a)(4) and relevant authorities, we conclude that the bankruptcy court erred as a matter of law in determining that Washington common law established the marital relationship as in the nature of an express or technical trust, imposing fiduciary duties on spouses to manage community property for the benefit of the marital community during marriage, for purposes of establishing the elements of a § 523(a)(4) claim. Accordingly, we REVERSE.”

If It’s Consensual, a Plan Can Discharge a Nondischargeable Debt

Dragnea v. Dragnea (In re Dragnea), 17-02248 (Bankr. E.D. Cal. Oct. 29, 2019) By consent, a chapter 11 plan can discharge an individual’s nondischargeable debt, even a matrimonial debt that is excepted from discharge under Section 523(a)(15). The husband contended that parties may not override Section 523(a)(15). Judge Klein responded by saying that chapter 11 can be used “as a vehicle contractually to modify otherwise nondischargeable debt.” He said, “Nothing is remarkable about an agreement compromising nondischargeable debt.” Likewise, he said, there is nothing “untoward about including a settlement in a chapter 11 plan.”

Attorney fees award dischargeable in chapter 13

In re Henry Voss III, BAP No. ID-20-1053-SGF Chapter 13 case Ms. Voss filed a proof of claim based on the attorney fees judgment, stating that the claim qualified as a priority domestic support obligation under § 507(a)(1). Mr. Voss objected to the claim, arguing that it was not a domestic support obligation under either § 507(a)(1) or § 523(a)(5).  Ms. Voss responded that the attorney fees judgment was a nondischargeable priority domestic support obligation. The bankruptcy court then considered the relevantstate law regarding fee awards and examined the state court’s findings and concluded that the fee award was in the nature of spousal support as the state court based it on Ms. Voss’s financial need. It, therefore, ruled that the attorney fees judgment was a nondischargeable domestic support obligation under § 523(a)(5).  Affirmed by 9th Cir. BAP.

Adam v. Dobin (In re Adam; 9TH CIR.)  BAP CC20-14-1416-PaKiTa (4/6/15) Affirming the bankruptcy court, the Bankruptcy Appellate Panel of the Ninth Circuit held that the bankruptcy court did not err in granting summary judgment that the creditor’s claim against the debtor was excepted from discharge under Sect. 523(a)(15). The BAP reasoned that the trend in recent case law was to construe Sect. 523(a)(15) expansively to cover a broader array of claims related to domestic relations within the discharge exception.  In sum, the trend in recent case law is to construe § 523(a)(15) expansively to cover a broader array of claims related to domestic relations within the discharge exception. See, e.g., In re Wise, 2012 WL 5399075, at *6 (Bankr. E.D. Tex. Nov. 5, 2012) (§ 523(a)(15) “rendered as non-dischargeable virtually all obligations arising between spouses as a result of a divorce decree.”); Quarterman v. Quarterman (In re Quarterman), 2012 Bankr. LEXIS 4924, at * 9-10 (Bankr. D. Ariz. October 17, 2012) (“The Section is not limited to simply divorce decree judgments alone but excepts any debt incurred by the debtor in the course of divorce or any debt in connection with a divorce decree.”). In re Ginzl, (Bkrtcy.M.D.Fla.) July 6, 2010: Discharge – Obligations imposed by marital settlement agreement were nondischargeable. Obligations which a Chapter 7 debtor incurred prepetition in connection with his divorce, pursuant to the terms of a marital settlement agreement signed by the parties and incorporated into a final judgment of divorce, consisting of the debtor’s obligation to his ex-wife for permanent periodic alimony, for a lump sum payment from anticipated proceeds of the sale of marital property, for the assumption and payment of mortgages and homeowners’ association dues, for the payment of a deficiency on a joint income tax return, and for payment of reasonable attorney fees that the ex-wife incurred in enforcing his obligations under the marital settlement agreement, were nondischargeable, as domestic support obligations or obligation incurred in connection with his divorce that were not support. The Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) eliminated the distinction between domestic support obligations and other obligations arising from divorce.

Child support, alimony, property settlement: Sections 523(a)(15) and 1328(a) or (b): What is and is not dischargeable? There are two issues involved. The first is whether the divorce decree provision can be considered “in the nature of” alimony or child support. That includes actually-specified alimony and child support along with anything that operates as a substitute for or supplement to alimony or child support. If the obligation fits that category, it would be considered non-dischargeable. Conversely, if the provision operates as a division of property or debt, it is generally not considered alimony/support, and it could be dischargeable under the right circumstances. There are situations where a division of debt is so one-sided that the party that benefits could be considered to receive alimony/support, e.g. where a custodial parent is not working. In that case, the relief from paying debts allows that party to free up resources to support the children, i.e., operating in the nature of alimony/child support. First, look at the decree. If it addresses dividing debts and assets in a completely separate section from the provision on the award of alimony/support, it is more likely, though not necessarily certain, to be considered division of debt or property which is potentially dischargeable. It’s really a case-by-case situation.

The second issue is what type of bankruptcy is filed? If it is a Chapter 7, then even a division of property or debt obligation to hold the ex- harmless would not be discharged because of Section 523(a)(15). If the debtor files Chapter 13 and gets a general discharge under 1328(a), then an obligation to divide property or debt (that is not “in the nature of” alimony/support) would be dischargeable because 523(a)(15) doesn’t apply to a 1328(a) general discharge. However, it does still apply to a 1328(b) hardship discharge. Thanks to Darrell Ihns.

Cozart v. Wilson (In re Wilson), 4:18-ap-00495-BMW (Bankr. D. Ariz. Nov. 13, 2019) – 11 U.S.C. § 523(a)(5) and (15): Denying the debtor-defendant’s motion for summary judgment, the court held that even though the debt is not payable to the debtor’s ex-spouse, its benefit flowed to the ex-spouse and therefore falls within the scope of §523(a)(5) and 523(a)(15). Here, the Court cannot find that the debt owed to Mr. Cozart does not fall within the scope of § 523(a)(15) merely because it is owed to Mr. Wilson’s ex-spouse’s family law attorney, who is not an enumerated payee, rather than to his ex-spouse, who is an enumerated payee, given that the benefit of the debt flowed to Mr. Wilson’s ex-spouse. 

Over-payment for daycare assistance and food stamps – is that DSO?

In re Dennis and In re Halbert. No. 18-2988 & 18-2952 (7th Circuit 6/27/19).   Debtor Dennis filed a Chapter 13.   The Illinois Department of Human Services (DHS) filed a priority claim on the basis that the overpayment of daycare assistance was a DSO.   Debtor Halbert filed a Chapter 7 and sought the turnover of an intercepted tax refund.  DHS claimed that Debtor was illegible for food assistance and claimed in the defense to the turnover action that it was for a DSO.   The definition of DSO under 101(14A)(B) includes “support” provided by a governmental unit.  DHS claimed these benefits were for minor children and hence support.   The Court found that the debts were not in the nature of support, but rather the money was for benefits paid to the Debtors to which the Debtors were not entitled.  The Court referenced the cases were a parent overpays for support; those Court have held such an overpayment is not a DSO.  The 7th found of the payment of these benefits to which the Debtors were not entitled were not DSOs.

Issue: is judgment for attorneys fees = DSO and not dischargeable in chapter 13?

In re Hurst 2:18-BK-03882-DPC, Adv 2:18-ap-00282-DPC (5/24/19) Before this Court are a Motion and Counter-Motion for Summary Judgment to determine whether a state court judgment for attorneys’ fees is a domestic support obligation (“DSO”). Kimberly Lauren Hurst (“Ms. Hurst”) holds a judgment (“Judgment”) against Aaron Joseph Hurst (“Debtor”) arising from a divorce case #FC2014-009478 (“Divorce Case”) in the Superior Court of Arizona, Maricopa County (“State Court”). Ms. Hurst contends the Judgment is a DSO. Debtor contends the Judgment should not be treated as a DSO and is therefore dischargeable.
This Court now finds that, under the facts of this case, the Judgment is a DSO within the meaning of 11 U.S.C. § 101(14A). The Judgment is non-dischargeable under § 523(a)(5).

Funds subject to constructive trust:

In re Pardee, (Bkrtcy.N.D.Okla.) July 22, 2010: Bankruptcy Estate – Funds that were subject to constructive trust could not be claimed as exempt by debtor with respect to trust beneficiary. Funds which were being held in a Chapter 7 debtor’s individual retirement account (IRA), but which were subject to a constructive trust imposed by a state-court order in favor of the former wife of the debtor’s deceased husband, were not bankruptcy estate property. Thus, the funds could not be claimed as exempt by the debtor with respect to the former wife’s interest in the fund.

Birt vs Birt, 1 CA-CV 03-0258 (Az Ct App Div 1, 8/12/04) Appellant Judith M. Birt (“Wife”) appeals from the trial court’s denial of her motion to set aside the decree of dissolution of her marriage to Appellee John Mark Birt (“Husband”). We hold that when a party to a dissolution action files a petition in bankruptcy shortly after entry of the decree to avoid the decree’s effect on allocation of community debts and such discharge may significantly affect the non-discharged spouse’s qualification for spousal maintenance, child support and the equitable division of community property, the trial court should vacate those portions of the decree pursuant to Arizona Rule of Civil Procedure 60(c)(6)(“Rule 60(c)(6)”) so it can provide relief to the non-discharged spouse. Based on the record presented here, the superior court erred when it denied Wife’s motion. We reverse that order and remand for further proceedings consistent with this decision.

In re Beverly , 374 B.R. 221 (9th Cir.BAP 2007) affirmed in part, dismissed in part by In re Beverly, 551 F.3d 1092 (9th Cir. 2008). BAP reversed the Bankruptcy Court by finding that Debtor and his former wife committed fraudulent transfers. Their divorce decree awarded the debt to the future Bankrupt while the former wife got all of the non-exempt property. The non-exempt property would have been enough to satisfy all of the debt. Contrast with In re Bledsoe, 569 F. 3d 1106 (9th Cir 2009) where the Court of Appeals found that the mere allegation that the property settlement of divorce decree did fairly divide property was insufficient under §548 without proof of actual fraud.

The intersection of divorce and bankruptcy:

In re Kiley, 15-27838 (Bankr. D. Utah Dec. 4, 2018) Absent a rollover into an account that might be exempt, Section 541(a)(5)(B) came into play. That section brings property into the estate that the debtor receives within 180 days of bankruptcy as a result of a property settlement or divorce decree.

Divorce decree does not control obligation to pay student loan

In re Carrion, Jr. (U.S. Department of Education v. Carlos Carrion, Jr.) 9th Cir BAP, No. SC-18-1234-FBKu (5/31/19) Debtor remained liable for the entire amount of his own educational loan debt even though he agreed to a 50-50 division of the debt with his ex-wife in their marital settlement agreement. Bankruptcy court misapplied California law, reverse and remand.

In re Jennings, 2:18-bk-11759-DPC, 9/23/19.  Trustee’s Objection to Claimed Exemption Debtor’s interest in ex-spouse’s deferred compensation.
After reviewing the parties’ briefs and hearing oral argument on the issue, this Court finds that the relevant marital settlement agreement created an interest for Debtor in her ex-husband’s deferred compensation plan and that the Debtor’s interest in the deferred compensation plan is exempt under applicable Arizona law. The Trustee’s Objection is overruled and Trustee’s Sale Motion is denied.