Synopsis: When parties divorce, they frequently continue to have financial obligations that bind them together despite the dissolution. Bankruptcy is an attractive remedy for such problems but the advent of new federal legislation has complicated an area already filled with potential problems for both the couple and their attorneys. Familiarity with the available remedies and being alert to the consequences of bankruptcy and how it interacts with marital settlements is critical for an effective family lawyer.

One of the most typical encounters people have with the legal system is obtaining a divorce. Separation and divorce are traumatic under the best of circumstances. They are made more so when people discover that the financial arrangements so painfully worked out in divorce court mean little to nothing once one of the parties seeks relief under the Bankruptcy Code. While this can be very disappointing to the parties, it can be very troublesome to the attorneys who representes them. They are compelled to explain why what the state court judge ordered means nothing. Also, and perhaps worse, clients who waived important rights to get a settlement that turned out to be a mirage may be very upset. Needless to say, this can create problems. How can this be prevented, and what is really going on?

The first thing that everyone must understand is that upon the filing of a proceeding in bankruptcy court, all prior financial deals are off. All contracts and promises are subject to review, either entirely or in part, and compliance with what seemed like a firm arrangement may not be necessary. When handling negotiations for a divorce, a wise attorney should always keep in the back or his or her mind the question, "What will happen if this party files a bankruptcy petition?" Like all bankruptcy practitioners, I have had people literally leave the county court house, having received a divorce, and walk to my office to file bankruptcy. This can be very disappointing to the party on the other end of the deal.

For the non-bankruptcy specialist, we should first note that there are basically three different chapters under the Bankruptcy Code through which a person can seek relief.

Chapter 7, or what is called the liquidation case, is the type of case where an individual who does not have the ability to repay his debts can file and discharge, with some exceptions, all unsecured debts. While some debts are nondischargeable, most are. Any assets the filing person has that exceed his exemptions will be turned over to the trustee to liquidate. The money obtained will then be used to pay the filing party's debts to the extent possible. Keep in mind that a person can move and may file in any state where he or she has resided for the greater portion of 180 days preceding the filing. This means that while the party involved may have too much to lose if he filed in one state, he may file if he relocates to another, more debtor-friendly jurisdiction. By doing that he would not lose the property that is considered a guarantee against filing (and compliance with the terms of the decree.)

Chapter 13 is designed to allow people who have an ability to pay their debts an opportunity to do so to the extent possible. They are free from all collection activity and are able to reduce claims secured by property to the value of the security. They also can adjust interest rates. Additionally, they can pay off unsecured debts by paying a mere percentage of the debts in many cases. Lastly, certain types of debts that are nondischargeable in a Chapter 7 are dischargeable in a Chapter 13. This means that a creditor who has a claim that might not be discharged in a Chapter 7 may very well have the claim reduced to a small percentage in a Chapter 13, with the balance discharged. This is what bankruptcy lawyers call the "super discharge" of Chapter 13.

Chapter 11 is typically used for businesses to reorganize. However, individuals can and do file Chapter 11, so a settlement with a doctor or business executive may not be as iron clad as one might think. The advantages of filing Chapter 11 are the granting of an immediate discharge upon confirmation, a longer period to repay debts (Chapter 13 is limited to five years), and a higher debt amount can be treated than is available in a Chapter 13 with its $250,000 in unsecured debt limit. The super discharge of Chapter 13 is, however, missing in a Chapter 11 proceeding.

Many people have a tendency to think all debts involved with a divorce are nondischargeable, but this is not the case. Some are nondischargeable in Chapter 7, 11, or 13. Claims arising from the support of a dependent or former spouse are non-dischargeable.

(a) A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt . . . (5) to a spouse, former spouse, or child of the debtor, for alimony to, maintenance for, or support of such spouse or child, in connection with a separation agreement, divorce decree or other order of a court of record, determination made in accordance with State or territorial law by a governmental unit, or property settlement agreement, but not to the extent that . . . (B) such debt includes a liability designated as alimony, maintenance, or support, unless such liability is actually in the nature of alimony, maintenance, or support;¹

As with many areas of the law, what should be obvious is not so due to facts that cloud the issue. Past-due child support is clearly a debt that falls within the protections of Section 523(a)(5). However, due to various competing forces, it is not so easy to make other determinations. For instance, an ex-wife may want to get money from her former spouse, but also to continue to receive it if she remarries. Even if remarriage is not a concern, the ex-wife may not want to pay taxes on it, as would be required if it were traditional alimony. This can result in the money that is being paid to the former wife not being protected from discharge under § 523(a)(5).

Obligations may be nondischargeable as money owed for support even if it is not paid to the spouse but rather someone else who assisted the spouse. The most common example is the lawyer who represented an ex-wife who claims that the awarding of fees is nondischargeable because the ex-wife (typically) required the legal representation to get what she needs to support herself in the years ahead. This, of course, opens up the whole question of the parties' respective abilities. At one end, the easy case is the mother with small children and no job skills with a long marriage. At the other end is the professional woman with no children and a marriage of short duration. Different results will occur despite identical language in a decree. In most districts with which I am familiar, however, it seems the courts tend to rule that such attorney fees are nondischageable under § 523(a)(5).

Many times decrees are encountered where lump sums of money, or payments over time, are called maintenance when they are actually not. Additionally, some state court judges have attempted to resolve the issue by stating in their decrees that the sums are nondischargeable. The parties likewise will sometimes put such terms in the decrees. Bankruptcy is an area that is within the exclusive jurisdiction of the federal government and the determination of such issues solely within the power of the federal bankruptcy judge. All such attempts to usurp this authority are doomed to failure.

This issue of whether a debt may or may not be for support creates a hidden time bomb for counsel. If the debt is truly for support, no adversary complaint to object to discharge needs to be filed. But if your analysis is wrong and you attempt to collect post filing on the debt, you are liable for a violation of the automatic stay or, if discharged already, the discharge order. It also can be a violation of the Fair Debt Collection Practices Act, with its minimal damages and fees potential. Before you think it means nothing, let me note a case where almost $200,000 was paid out by the party who violated the automatic stay.

The potential damages leads wise counsel to always file an adversary complaint. The question for the divorce attorney is, "Who will pay for it?" Does your client think the fees you have already been paid include this extra work? Are you admitted to practice in federal court? Do you want to be? Such adversary complaints can be very time consuming, and the parties who typically hate each other have little incentive to settle. Better figure you will have 12 to 16 hours in it before you are done, and get a retainer up front. If you keep track of your time on such matters, it will get depressing very quickly unless you receive a good retainer.

As if this was not problem enough for the hard-working domestic lawyer, Representative Patricia Schroeder (Colorado) successfully sponsored, before she left Congress, Section 523(a)(15). This section involves debts ordered to be assumed under the divorce decree. Section 523(a)(15) provides:

(a) A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt . . . (15) not of the kind described in paragraph (5) that is incurred by the debtor in the course of a divorce or separation or in connection with a separation agreement, divorce decree or other order of a court of record, a determination made in accordance with State or territorial law by a governmental unit unless

(A) the debtor does not have the ability to pay such debt from income or property of the debtor not reasonably necessary to be expended for the maintenance or support of the debtor or a dependent of the debtor and, if the debtor is engaged in a business, for the payment of expenditures necessary for the continuation, preservation, and operation of such business; or

(B) discharging such debt would result in a benefit to the debtor that outweighs the detrimental consequences to a spouse, former spouse, or child of the debtor;²

The first difficulty to which counsel must be alert, is that liability on an indemnification order under § 523(a)(15) will be discharged unless a timely objection to discharge is filed. The deadline for filing an objection (adversary complaint) is 60 days from the first date set for the meeting of creditors. Since notice will go to your client, you must alert your client to her or his remedies. It also means they must get in to see you at once, and that the decision to file an adversary must be quickly made. Naturally, the cost of such litigation must be considered. As noted earlier, anybody who thinks he will get such a matter concluded in under 10 hours is kidding himself; usually it will be a lot longer.

Here are a few points of interest to consider when drafting documents or evaluating decrees. Merely ordering a party to pay a marital debt is not enough. The courts have ruled that such an order does not create any new obligation on the part of the debtor and, hence, will not give rise to a § 523(a)(15) type of debt. Instead, the decree should order the person to pay it and hold the spouse harmless.

Next the issue of burden of proof must be considered. The adversary complaint must be filed. Then the burden of proof shifts to the debtor to prove one or both reasons for the debt to be discharged. These are: 1) the debtor does not have the ability to pay the debt from income not reasonably necessary to be expended for maintenance or support of the debtor or a dependent of the debtor; and 2) that discharging the debt would result in a benefit to the debtor that outweighs the deferment to the former spouse or child of the debtor.

Of course, to anyone who practices bankruptcy in an area of the country where the U.S. Trustee's office is aggressive in reviewing cases for compliance with § 707(b) of the Code, this raises an interesting conflict. Section 707(b) provides:

(b) After notice and a hearing, the court, on its own motion or on a motion by the United States trustee, but not at the request or suggestion of any party in interest, may dismiss a case filed by an individual debtor under this chapter whose debts are primarily consumer debts if it finds that the granting of relief would be a substantial abuse of the provisions of this chapter. There shall be a presumption in favor of granting the relief requested by the debtor.

Hence it would be logical to suppose that any Chapter 7 case that does not draw an objection from the trustee under § 707(b) should clearly be a case where the debtor should also escape the imposition of § 523(a)(15). Perhaps calling the U. S. trustee as an expert by the debtor might be a good way of establishing that an independent government expert has concluded that debt relief under Chapter 7 is proper. I have never seen this done, but it does raise an interesting strategy.

Of course, any client must be made aware that merely winning an adversary complaint holding that the indemnification order is a nondischargeable debt does not get them any money, nor does it get the bill paid. The creditors still have a right to pursue and collect from the non-filing spouse but will not be able to collect from the debtor spouse. All the non-filing spouse can do now is pay off the debts, then attempt to collect the money by normal collection activity or possibly contempt proceeding from the filing former spouse. The debtor has all of his or her remedies available, such as filing a new case under Chapter 13, even though previously a Chapter 7 was filed so as to stop the collection actions by a former spouse. Or the debtor-spouse may relocate to a distant jurisdiction like Texas where collection, it seems, is almost impossible.

With all of these potential problems involved, wise domestic counsel must consider carefully how best to structure a settlement to avoid such problems, for problems avoided are better than problems solved. The first step might be trying to get adequate security for the promise. A mortgage or deed of trust on the real estate, or a second lien on a prized possession such as a Harley-Davidson, might help. Taking a greater percent of pension money, getting higher child support, or having the possible debtor ordered to get a note signed by both he and a close relative as a co-obligor might work. Recording your divorce judgments to establish liens on real estate is critical, especially if the real estate is located in a foreign jurisdiction from where the divorce took place.

The domestic attorney must also keep in mind that, for many people, filing bankruptcy is not a negative action, but actually the opportunity to discharge debts and start free. None of us want any married couple to get a divorce unnecessarily, but we all realize that some people are better off divorced. Similarly, in many divorces people are better off with no bills. Thus, encouraging the parties to file bankruptcy allows them to focus on providing for their children, not their creditors, in the future. It will also remove a sore subject between the parties in the years ahead, which is to everyone's benefit.

When contemplating a divorce settlement, the careful attorney will consider what might be lost in the event of a bankruptcy filing. Then negotiate a settlement where you give up to the former spouse things that would be lost in a bankruptcy, while keeping items that are exempt. An example might be waiving claims to non-residential real estate in exchange for claims on ERISA-qualified pension plans. The five P program (Prior Planning Prevents Poor Performance) will reap rewards here as elsewhere.

As to the problem of § 523(a)(15) issues, the practitioner needs to realize that while this section applies to a Chapter 7 proceeding, it does not apply to a Chapter 13 case. This is due to the discharge provisions of § 1328:

(a) As soon as practicable after completion by the debtor of all payments under the plan, . . . the court shall grant the debtor a discharge of all debts provided for by the plan or disallowed under section 502 of this title, except any debt . . . (2) of the kind specified in paragraph (5), (8), or (9) of section 523(a) . . .

Thus, the debtor can file a Chapter 13, repay his debts to the best of his ability (this typically means a small percentage of the total), and discharge the remaining balance to include the money owed pursuant to the decree that might be nondischargeable in a Chapter 7 due to § 523(a)(15). While it is true the debtor will have to pay some money to his creditors, he will avoid expensive, time-consuming litigation with uncertain outcomes. For most people, certainty in results has its own reward. Plus, of course, the creditors can be paid something. Naturally, in the event of a debt still owed by the former spouse, creditors who are not paid in full can still proceed against the non-filing former spouse for their money.

The biggest problem of most married couples is money. Accordingly, upon dissolution, this same lack of money continues to be problematical. While social planners in Congress have attempted to solve human problems with laws that, in reality, do little, the little they do accomplish can create serious problems for the attorney who is not familiar with the issues. By careful planning and analysis, you can avoid the pitfalls put into your path by Congress, allow your clients greater financial freedom, and just maybe improve their lot in life generally by a careful selection of available remedies.

Endnotes

1 11 U.S.C. § 523(a) (1994).

2 Id. at 15. Effective October 22, 1994.

Mr. Mullin graduated with honors from St. Louis University in 1970 where he as admitted to the Phi Beta Kappa Honor Society. He graduated from the University of Chicago Law School in 1973 and served thereafter in the U.S. Army, leaving with the rank of Captain.

Since 1977, he has been involved in the practice of law in St. Louis, where he has specialized in providing low cost legal solutions for consumers with a special emphasis in consumer bankruptcy matters. In September, 1997, he received The Missouri Bar's Michael L. Roser Excellence in Bankruptcy Practice Award. Currently his office handles the largest percentage of Chapter 7 or 13 cases filed by individuals. He is a frequent speaker on bankruptcy matters for The Missouri Bar and has written prior articles for the Journal of The Missouri Bar.

1998, T. J. Mullin