MY EX FILED BANKRUPTCY! WHAT DOES IT MEAN!

Frequently, immediately after the entry of a Final Decree of Divorce, one of the spouses will file for Bankruptcy. In the past, this meant that many of the terms of the Decree of the Marital Dissolution Agreement were meaningless or ineffectual for the non-bankrupting spouse who remain indebted on debts incurred in the marriage. The bankrupting spouse historically could evade responsibility for the marital debts assigned to that spouse in the divorce by including property division debts in the Petition for Bankruptcy, and undermine the Court’s equity power by seeking and receiving a discharge in Bankruptcy on those marital debts. The non-bankrupting spouse consequently is subject to injustice who remains liable for these marital debts. However, this circumstance is changed.

The BAPCPA
In 2005, Congress enacted the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA).  Congressional intent was to enact a bankruptcy reform that promoted “the economic protection of dependent spouses and children under state law is no longer accomplished solely through the traditional mechanism of support and alimony payments,” §523(a) (15). The law was significantly changed to further the underlying public policy of §523, favoring the enforcement of familial obligations with regard to dischargeability of marital obligations over the Bankruptcy Code’s “fresh start policy.” The law applies to all bankruptcy cases filed on or after October 17, 2005.

Historical Perspective
“Affirmative defenses” permitted the court to discharge property settlement obligations and the like, notwithstanding the obligation may otherwise have qualified as a non-dischargeable debt within the scope of §523(a)(15). Section 523(a)(15), first implemented in 1994, excepted nonsupport-related debt from discharge unless: 1) the debtor did not have the ability to pay the debt from income or property not reasonably necessary for the support of the debtor or a dependent of the debtor, or 2) if discharging such debt would result in a benefit to the debtor that outweighed the detriments to a spouse, former spouse, or child. These affirmative defenses, rendering virtually any debt or obligation falling under §523(a)(15) absolutely non-dischargeable were eliminated by the new act. As one court succinctly noted:

Under the former version of §523(a)(15), the [c]ourt would be required to assess whether the award constitutes maintenance, alimony or support, which are automatically non-dischargeable, as opposed to some other form of debt for which the merits of a discharge would have to be weighed through a multi-factor balancing test…. However, BAPCPA makes this evaluation process largely irrelevant since currently any debt arising from a divorce proceeding which would not fall under §523(a)(5) is nevertheless excepted from discharge under §523(a)(15).

Simply stated, under current §523(a)(15), a debtor may not receive a discharge if the debt is “to a spouse, former spouse, or child of the debtor and 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.”

Family law practitioners and state court judges exercising concurrent jurisdiction with the bankruptcy court must use caution not to cite or rely upon cases that may no longer be good law due to the BAPCPA, a certain trap for the unwary.

Moreover, practitioners and judges alike must be cognizant that even under the BAPCPA, there is still an important distinction between a Ch. 7 and individual Ch. 11 proceeding and a Ch. 13 proceeding. Stated succinctly, a consumer debtor may choose to liquidate under Ch. 7 or reorganize under Chs. 11 or 13 (depending on the amount of outstanding indebtedness). A consumer debtor who successfully liquidates under Ch. 7 will receive a discharge, which is effectuated by the entry of a discharge order. A consumer debtor who successfully obtains court approval of a reorganization plan under Chs. 11 or 13 generally will receive a discharge following the completion of all payments required by the plan. As in a Ch. 7 proceeding, domestic support obligations may not be discharged in a Ch. 13 proceeding. However, unlike a Ch. 7 proceeding now under the BAPCPA, other types of obligations and debts arising out of a separation or divorce, including property settlements, are still dischargeable in a Ch. 13 proceeding.

Date of Incurring Debt Generally Irrelevant
Under the BAPCPA, debts of a debtor/spouse incurred prior to the marriage will be held non-dischargeable provided the non-debtor spouse’s obligation to pay emanates from a marital settlement agreement or final judgment of divorce. Timing for debts is irrelevant because the marital settlement agreement or final judgment creates a “new” obligation that is controlling for bankruptcy purposes. One court observed:

The critical issue under §523(a)(15) is not the timing but the nature of the debt. Entry into the Marital Settlement Agreement created significant new legal consequences because it extinguished some pre-existing obligations between the former spouses and created new ones. Despite any previous obligations or arrangements, the Marital Settlement Agreement created new rights to payment that were independent of the debtor’s pre-existing liability.

Of course, a marital settlement agreement or final judgment cannot alter either party’s personal liability to third-party creditors, but the agreement or judgment can now create an enforceable obligation running from one former spouse to the other within the exception to discharge under §523(a)(15). Spouses can now rely in indemnity clauses which are enforceable.

Also, attorneys should caution clients about novation type situations as occurred in Cooper v. Cooper, Case No. 09-30751, Adv. Pro. No. 09-3068 (Bankr. E.D. Tenn. May 10, 2010). In Cooper, the former wife was awarded the marital home, and the former husband/debtor was required to pay the mortgage until satisfied. His business began to decline, and he could not continue paying the mortgage. He was, however, able to obtain a loan to pay off the mortgage on the marital home and keep his business operational. In order to do so, the former wife agreed to use the marital home as collateral for the new loan, the note for which both parties executed. In the former husband’s subsequent bankruptcy proceeding, his obligation to the former wife was not non-dischargeable under §523(a)(15), because the new loan constituted a new debt not covered by or arising out of the parties’ marital dissolution agreement or divorce decree.

Hold Harmless and Indemnification Provisions
Oftentimes, in marital settlement agreements or final judgments, when one spouse is obligated to pay a joint debt or debt of the other spouse, a family law practitioner includes a clause directing the obligated spouse to indemnify and hold the other spouse harmless therefrom. Such a provision is clearly preferable for bankruptcy purposes.

Before the BAPCPA, courts were divided on whether debts owed to a third party related to a separation or divorce agreement required such a clause to be within §523(a)(15). Some courts required an indemnification and hold harmless proviso to create a direct liability from the debtor to the former spouse, while other courts did not, reasoning that the obligation thereunder to pay such debts ran from the debtor to the ex-spouse without an express indemnification or hold harmless clause.

However, post-BAPCPA cases evince a clear indication that indemnification and hold harmless clauses are not necessary to a finding of non- dischargeability. As one court concluded:

Despite the fact that the Marital Settlement Agreement did not alter either parties’ personal liability to third party creditors, it did create, or at least declare, an enforceable obligation running from Debtor [former wife] to Plaintiff [former husband]. Plaintiff’s right to an enforceable obligation arising out of the Marital Settlement Agreement created new legal rights that are clearly within the exception to discharge in §523(a)(15). This conclusion is not dependent on the presence of a hold harmless clause, but is bolstered by such language.

Debts No Longer Dischargeable
As a result of the BAPCPA, debts and obligations that have been held to no longer be dischargeable simply by virtue of the debts arising out of a divorce proceeding include, but are certainly not limited to, property equalization and equitable distribution payments, lump sum distributions and payments, credit card and charge account obligations, mortgage and HELOC payments, homeowner’s association dues, income tax obligations, automobile loan payments, indemnification and hold harmless obligations, medical bills, attorneys’ fee obligations between the spouses incurred in matters unrelated to the divorce, and sanctions awarded for contemptuous conduct.

A Tennessee Case On Non-dischargeablity

The Court of Appeals in the Eastern Section in Yatoni-Prestwood vs Prestwood, 397 S.,W.3 393 (T.N. Ct. App. E.S. 2012) held that “in a divorce decree to hold harmless or indemnify a spouse for joint obligations incurred during a marriage creates a “new” debt, running solely between the former spouses. It is this “new” debt which is “incurred” through the divorce decree, and which is non-dischargeable; the parties’ personal liability with respect to their joint third-party creditors remains, however, otherwise subject to the applicable legal process. As explained in the case of In re Clark [207 B.R. 651, 657 (Bankr.E.D.Mo.1997) .”

Please note, the exception to discharge for “hold harmless” agreements may not provide protection from creditors for the non-debtor spouse. The debts owed to the joint creditors are discharged as to the debtor only. The obligation that is not dischargeable in these situations is a debtor’s responsibility to hold his non-debtor, ex-spouse harmless. The non-debtor ex-spouse may look to the debtor for reimbursement pursuant to any non-dischargeable “hold harmless” obligations, but the non-debtor ex-spouse is not immune from pursuit by the primary joint creditors.

Attorneys’ Fees
Attorneys’ fees awarded in a divorce proceeding are now clearly non-dischargeable, whether in the nature of support under §523(a)(5) or otherwise, such as in connection with the equitable division of property, and whether the award is payable to the debtor’s spouse, former spouse, or directly to counsel. One court recently articulated:

It is undisputed that the . . . attorney’s fees awarded by the [s]tate [c]ourt are debts that were incurred by the [d]ebtor in the divorce proceedings. As such, it is irrelevant whether those awards constitute true support obligations, because even if not encompassed within §523(a)(5), they are non-dischargeable pursuant to §523(a)(15). Additionally, it should be noted that the fact that the attorneys’ fees are payable directly to [counsel] and not to [former spouse], does not remove these debts from the scope of §523(a)(15).

Of course, a debtor’s liability for his or her own attorneys’ fees incurred in a divorce proceeding are still dischargeable, but notwithstanding any such discharge, if the divorce court had awarded the client’s former spouse to pay any of such “discharged” fees, that award would remain undischarged.

Contempt in Tennessee

Bankrupting spouses are not exempt from the Court’s power to exercise its contempt authority for the enforcement of Final Decrees and Marital Dissolution Agreements. Gibbs vs Gibbs, Ct, App. of TN, at Knoxville, June 22, 2016, Slip Copy2016 WL 4697433, held that Contempt is appropriate for the enforcement of orders related to Final Decrees of Divorce of marital Dissolution Agreements. They are contractual in nature but due to merger, these orders are subsect to the application of the Contempt powers of the court:

The judicial remedies for breach of a provision in a marital dissolution agreement depend on whether the provision has merged into the divorce decree and thereby remains in the court’s control. Contempt is the proper remedy for the breach of provisions that remain in the court’s control. Both contempt and breach of contract are proper remedies for the breach of provisions that have been approved and incorporated but not merged into the final decree.

Holifield v. Holifield, No. W2012-00806-COA-R3-CV, 2014 WL 527641 (Tenn. Ct. App. Feb. 10, 2014)

It is true that the automatic stay provision may impede the Court use of contempt powers, however, the automatic stay provision does not affect the non-dischargeability of the debts of the bankrupting spouse. Spouses faced with the automatic stay of a bankruptcy petition must move the court to lift the stay to allow contempt proceedings consistent with the provisions of the section 523 bankruptcy code and the Final Decree of Divorce.

Conclusion

The BAPCPA has changed the ability of a spouse to discharge marital debts in bankruptcy. Judges, lawyers and spouses can feel certain that bankruptcy no longer has the power to disturb the equity of the divorce decree by discharging marital debts in bankruptcy. In short, the BAPCPA now gives non-bankrupting ex-spouses the statutory authority to enforce marital debts in final decrees.