One of the most common areas in which bankruptcy and family law cases collide pertains to a bankruptcy debtor attempting to discharge a debt or obligation owed to his or her spouse or ex-spouse.


Prior to the significant changes in 2005, a debtor could argue in his or her Chapter 13 Bankruptcy that the spousal support ordered previously in a State Superior Court divorce imposed a financial hardship.  In certain cases where financial hardship was appropriately demonstrated, the Courts would then allow for the spousal support obligation to be discharged in the bankruptcy. 


With the changes in 2005, Federal Bankruptcy Law simply does not allow for the discharge or elimination of spousal maintenance or child support (together referred to under the bankruptcy code as domestic support obligations) under any circumstances.  See 11 U.S.C. § 523(a)(5).  Further, the Bankruptcy Code defines domestic support obligations quite broadly, as a debt that “accrues before, on, or after the date of the order for relief in a case under this [bankruptcy] title, including interest that accrues on that debt as provided under applicable non-bankruptcy law . . . that is owed to or recoverable by a spouse, former spouse, or child of the debtor or such child’s parent, legal guardian, or responsible relative; or a governmental unit.    11 U.S.C. § 101 (14A). 


While debts for domestic support obligations, 523(a)(5), cannot be discharged in any type of bankruptcy, other debts owed to a former spouse can be discharged in a Chapter 13 case.  These debts are listed in 11 U.S.C. 523(a)(15) and include debts “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, or a determination made in accordance with State or territorial law by a governmental unit. 


There is some speculation in the case law that Congress may have inadvertently omitted (a)(15) debts from the list of debts that cannot be discharged in a Chapter 13 case.  Nonetheless, 523(a)(15) is not on the list found in 11 U.S.C. § 1328(a)(2) which itemizes those debts not dischargeable in a Chapter 13 case, and Bankruptcy Judges have determined that their job is not to question Congress, but to follow the law as it is written, and have accordingly established case law permitting the discharge of non-support obligations to a spouse or former spouse or a child through a Chapter 13 Bankruptcy.


Accordingly, the question that immediately arises is:  What debts to former spouses will be non-dischargeable  as maintenance or support under (a)(5), and which debts will be discharged as other obligations under (a)(15).  Bankruptcy case law has made it clear that the title or nomenclature used in state court is not binding, and that the Court must make an independent determination categorizing the debt.  Furthermore, federal law is utilized in determining if the recipient needed spousal support, rather than state law.  In re Strickland, 90 F.3d 444, 446 (11th Cir. 1996); Harrel v. Harrel, 754 F.2d 902, 905 (11th Cir. 1985). 


Issues often arise in cases which parties and attorneys  make decisions for tax purposes or bankruptcy purposes to call debts equalization payments rather than spousal maintenance, or spousal maintenance instead of an equalization payment.  Practitioners must understand that simply calling an equalization payment “spousal maintenance” in a property settlement agreement or a consent decree will not automatically protect that debt from being discharged as a debt owed to a former spouse under (a)(15). 


One factor that the Courts will consider is the name given.  However, the Bankruptcy Court must look beyond the label and consider the circumstances of the payor and the payee.    Cummings v. Cummings, 244 F.3d 1263, 1265; (11th Cir. 2001).


HYPOTHETICAL #1:  Is the Debt Non-Dischargeable Support, or Dischargeable Property Equalization?


Let’s examine this through a hypothetical case:  Several years ago, PAYOR and PAYEE entered into a settlement agreement after extensive negotiations.  PAYOR would receive the business, and PAYEE would receive the real estate and certain other assets.  The settlement agreement then stated that PAYOR would pay PAYEE $X,XXX.00 per month for 5 years as and for a property equalization payment. 


On its face, because it is titled “property equalization,” PAYOR is able to file a Chapter 13 bankruptcy and seek to have the debt discharged.  However, PAYEE may decide to fight this case in Federal Court, challenging the discharge and claiming that the debt arises under (a)(5), and not under (a)(15).  The Bankruptcy Court must then make an independent determination classifying this debt as either 1) spousal maintenance, 2) equalization payment, or 3) a hybrid or combination of spousal maintenance and equalization payments.  If the debt is determined to be spousal maintenance, it is not dischargeable under 11 U.S.C. 523(a)(5).  If the debt is determined to be an equalization payment, the debt would be dischargeable under 11 U.S.C. 523(a)(15).  If the Court determines that it is a hybrid, the Court must determine the portion that was truly support in nature and allow this claim to be non-dischargeable in the bankruptcy, and permit the remainder to be discharged in the bankruptcy.


Any practitioner who has been involved in negotiations understands how under these limited facts, the actual need could have been either support or equalization.  The parties and attorneys may have called this equalization so that PAYEE could shortly remarry, and still receive her support, rather than agreeing to non-terminable spousal support.  The parties could have agreed to designate this as an equalization payment to prevent the tax burden from being shifted to PAYEE from PAYOR.


Depending upon the circumstances, PAYEE could have been in need of short term spousal maintenance, which may have comprised some piece of the full series of payments agreed to by the parties; PAYEE could have been in need of long term spousal maintenance, which may have comprised a larger piece of the full series of payments or even the entire series of payments; or the entire series of payments could have been exactly what it was designated, an equalization payment. 


In a contested trial in the Bankruptcy Court, a finding that PAYOR’s business was $1,000,000.00 more valuable than PAYEE’s real estate, would lead to the conclusion that the $500,000.00 equalization payment was required to equalize the distribution of these two assets.  Conversely, PAYEE would want to show that she was in need of long term support at the time of the dissolution of marriage and that her real estate had the same approximate value as PAYOR’s business (eliminating any need for an equalization payment).


The 2005 change in Federal Bankruptcy Law removing the power from the Bankruptcy Court to discharge a debt for spousal maintenance can be justified by the fact that child support and spousal maintenance are modifiable, and the debtor can go back into the state court and argue that his support obligation needs to be changed because of his or her change in circumstances.  Thus, the debtor is not without recourse, just without recourse in the Bankruptcy Court. 


However, A.R.S. § 25-319(C) adds a dangerous element to this type of case in Arizona.  A.R.S. § 25-319(C) provides that by agreement of both parties, the spousal maintenance can be designated as non-modifiable.  By so designating the payments, the payor has now lost the ability to go back into State Court and to argue that his or her payments should be reduced or eliminated due to a change in financial circumstances.  The debtor can no longer argue for this in Bankruptcy Court, which until 2005 court have discharged the spousal maintenance whether or not it was designated as modifiable.  The only avenue of recourse now remaining for the Debtor is to go into Federal Court in a Chapter 13 case, and argue that all or at least most of his payments were for non-support purposes.  Perhaps the “non-modifiable” terms of the agreement will provide some support the Payor’s claim that this was a non-support payment, because the support was to persist regardless of the Payee’s continued need for such support.  However, the Court must look at the full picture.



HYPOTHETICAL #2:  Should I Seek To Eliminate The Obligation In A State Court Post Dissolution Case or a Bankruptcy?


In another type of case, the difference in the Federal Bankruptcy Law pertaining to spousal support applied by the Bankruptcy Courts and Arizona Law set forth in A.R.S. § 25-319(A-B) and its related case law can cause problems. 


To create another hypothetical, suppose PAYOR brings a post-dissolution case in the State Court to terminate a spousal maintenance claim.  Further, suppose that PAYOR’s claim is that the monthly payments to the ex-spouse and the obligation to continue to pay the ex-spouse’s insurance through the business assigned to PAYOR during the marriage are both in the form of spousal maintenance.  The State Court may agree that the monthly payments are support and terminate this support obligation, and at the same time the State Court may not agree that the payment of insurance is support but rather an equalization payment based upon the award to PAYOR of the full business. 


Under this hypothetical, the State Court could only terminate the spousal maintenance provisions, but would not have the ability to terminate the non-support equalization payments.  If PAYOR then decides to pursue a Chapter 13 Bankruptcy, PAYOR could request to have the non-maintenance payments towards the ex-spouse’s insurance discharged under (a)(15).  Federal law would look to see if these payments were related to the support of the ex-spouse, and providing medical insurance could be argued to be supportive in nature, despite the State Court’s prior ruling.  Accordingly, the Federal Bankruptcy Court may determine that the payment of medical insurance is support, and is therefore not dischargeable under (a)(5).   To resolve such a potential problem, PAYOR and his or her attorney would want to lock PAYEE into specific testimony at the first trial as to whether PAYEE believes the payments are support or equalization in nature.  Once PAYEE is locked into one side, principles of estoppel could be used when PAYEE later seeks to argue the other side in the second trial.  Furthermore, while not binding, the State Court’s ruling on this issue would be extremely influential to the Bankruptcy Court.


Ultimately, most payments to a former spouse can be eliminated, if the payor’s circumstances have dramatically changed for the worse.  Support payments and other “domestic support obligations” must be modified or eliminated through the state court post decree modification process, and non-support payments can be eliminated through a Chapter 13 Bankruptcy proceeding. 


HYPOTHETICAL #3:  Can I discharge unusual obligations to a spouse through a Chapter 7 case filed before the divorce is finalized?



One final hypothetical illustrates a difficult situation that may occur in cases where a federal bankruptcy and a state divorce are sought simultaneously or nearly simultaneously.  Upon the filing of a bankruptcy, federal law imposes the Automatic Stay, which, similar to the Preliminary Injunction automatically arises in each case immediately upon filing.  As discussed in the article by this same author entitled Bankruptcy Issues in Family Law Cases,  published in the May 2009 edition of this Family Law News publication, the Automatic Stay (11 U.S.C. § 362)  precludes the State Court from proceeding with the division of assets and debts unless and until the stay is lifted by the Court during the pendency of the bankruptcy, or at the conclusion of the bankruptcy case by operation of law.  At the conclusion of a successful bankruptcy, the temporary Automatic Stay is replaced by the permanent Discharge Injunction (11 U.S.C. § 524 (Effect of Discharge)).  This permanent discharge provides:


(a)  A discharge in a case under this title –

(1)  Voids any judgment at any time obtained, to the extent that such judgment is a determination of the personal liability of the debtor with respect to any debt discharged (in a Chapter 7, 9, 11, 12, or 13) . . .

(2)  Operates as an injunction against the commencement or continuation of an action . . . to collect, recover, or offset any such debt as personal liability of the debtor . . .


As discussed above, spousal support would not be dischargeable under either a Chapter 7 or Chapter 13, where as a property equalization payment is dischargeable under a Chapter 13 but not under a Chapter 7.  However, in a case where a client knows he or she may be required to make a payment that is neither equalization nor maintenance to a former spouse, this hypothetical will explore what would occur if a party files for and successfully obtains a Chapter 7 discharge after the dissolution of marriage case has been filed, but before the dissolution case is finalized at the State Court. 


An important bankruptcy concept is understanding when a claim arises or a debt exists.  11 U.S.C. 101 (5) provides the definition of a “claim” as a “right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured . . .”  Furthermore, a debt in bankruptcy is defined by 11 U.S.C. 101(12)  as a “liability on a claim.”  Because of this broad definition of claim and debt, bankruptcy cases have often found that the claim or debt existed as soon as either party understood that a disagreement may arise in the future.


By completing the Chapter 7 case and receiving the Chapter 7 discharge while the divorce case is pending, the debtor must still make any payments to his PAYEE or child that fit under the exceptions to discharge contained in both 11 U.S.C. 523 (a)(5) and (a)(15).  However, by obtaining the discharge, and having listed his or her soon-to-be ex-spouse in the bankruptcy as having a potential claim, the debtor may have prevented the Court from going forward in making a determination of other types of liabilities, such as a tort claim, a claim for contribution to jointly owned property, and other pendant claims being aired in the divorce that are not support or property equalization issues. The discharge injunction, as stated in 11 U.S.C. 524, quoted above, “voids any judgment at any time obtained” that would be discharged in a bankruptcy and further “operates as an injunction against the commencement or continuation of an action . . . to collect, recover, or offset any such debt.”  It becomes clear from the broad definition of claim and debt, 11 U.S.C. 101, that if such debt is a part of the divorce case, that the claim has arisen with the commencement of the divorce case, if not even before that. 


Debts that qualify under either 11 U.S.C. 523(a)(5) or (a)(15) are not discharged in a Chapter 7 Bankruptcy.  At first glance, the definition of (a)(15) may cause a practitioner to believe that all debts to a spouse or former spouse must fall under one of these two categories ((a)(15) states ““to a spouse, former spouse, or child of the debtor and not of the kind described in paragraph (5) . . .”  While this language does make it clear that not all debts to a spouse or former spouse are “domestic support obligations,” the full language does leave room for a third category. 


The first category is domestic support, which would include debts to a spouse, former spouse, or child of the debtor and . . . of the kind described in paragraph (5.)  The second category would include debts to a spouse, former spouse, or child of the debtor (not domestic support) 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, or a determination made in accordance with State or territorial law by a governmental unit.  The third category would include debts to a spouse, former spouse, or child of the debtor (not domestic support) that is incurred by the debtor but not  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, or a determination made in accordance with State or territorial law by a governmental unit.  At first, the practitioner may observe that the difference between the second and third category is only a matter of timing, in that the Divorce Court just has not had the opportunity to accept the separation agreement, enter the decree or other order of the court.  Perhaps this observation is correct, however the difference in timing is important.  Once the discharge is obtained in a Bankruptcy, the State Court is prevented by the discharge injunction of 11 U.S.C. 524 from accepting the separation agreement or entering the decree or other order of the court.


            If this strategy is to be used, the Chapter 7 Bankruptcy must be filed before the State Court enters an order or decree or accepts the separation agreement of the parties.  The Chapter 7 discharge must be obtained prior to any order being entered against the spouse.  (Once the case is filed, the automatic stay makes this second task quite simple).  Once an Order has been entered or a separation agreement has been accepted by the Court, the pendant claim is now a part of the divorce and would be difficult to separate out from other debts dischargeable only through a Chapter 13 as claims under 11 U.S.C. 523(a)(15).  By failing to advise a client of the need to file a simpler and cheaper Chapter 7 Bankruptcy, the client may be left with the only option being to file a more costly and complicated Chapter 13 case to discharge his liability on a pendant claim included in the divorce case. 


            This strategy will not work in an equitable division of assets and debts situation, as the State Court, charged with equitably dividing assets and debts of the parties could easily divide the assets in such a way that the debtor would not be required to pay any monies to the spouse or ex-spouse.  Furthermore, an equalization payment does not arise until the assets and debts are divided, and would therefore not have been a claim that existed prior to the commencement of the Chapter 7 Bankruptcy filing, and would not have been discharged in the bankruptcy case.  While most obligations that arise from a divorce will be either support in nature or property equalization in nature, this strategy may work in cases where one spouse has asked the Court to utilize pendant jurisdiction to hear other types of claims not typically associated with a divorce case.


            Because of the tremendous increase in bankruptcy filings, family law practitioners will continue to be faced with questions and concerns from clients and prospective clients that require explaining Arizona divorce law as well as aspects of Federal Bankruptcy Law.  The family law practitioner must continue to increase his or her understanding of bankruptcy to properly advise clients, and must also know and understand when aspects of a particular case are over that  practitioner’s level of understanding.  When in doubt, be sure that you have a bankruptcy attorney on your speed-dial to discuss your difficult cases. 

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