BANKRUPTCY What Every Divorce Lawyer Needs to Know Robert H. Adams Sara J. Senesac Najjar Denaburg, P.C. 2125 Morris Avenue Birmingham, Alabama 35203
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The Automatic Stay 1. Applicability of the Automatic Stay - What is Covered
The automatic stay is a tool unique to bankruptcy law. It is effective immediately upon the filing of a bankruptcy petition. 11 U.S.C. §362 provides as follows: (a) Except as provided in subsection (b) of this section, a [bankruptcy petition] operates as a stay, applicable to all entities, of – (1) the commencement or continuation, including the issuance or employment of process, of a judicial, administrative, or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case under this title, or to recover a claim against the debtor that arose before the commencement of the case under this title; (2) the enforcement, against the debtor or against property of the estate, of a judgment obtained before the commencement of the case under this title; (3) any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate; (4) any act to create, perfect, or enforce any lien against property of the estate; (5) any act to create, perfect, or enforce against property of the debtor any lien to the extent that such lien secures a claim that arose before the commencement of the case under this title; (6) any act to collect, assess, or recover a claim against the debtor that arose before the commencement of the case under this title; (7) the setoff of any debt owing to the debtor that arose before the commencement of the case under this title against any claim against the debtor; and (8) the commencement or continuation of a proceeding before the United States Tax Court concerning the debtor. The automatic stay also protects third-party non-debtors in certain circumstances. 11 U.S.C.
§1301, a provision unique to Chapter 13, provides: (a) Except as provided in subsections (b) and (c) of this section, after the order for relief under this chapter, a creditor may not act, or commence or continue any civil action, to collect all or any part of a consumer debt of the debtor from any individual that is liable on such debt with the debtor, or that secured such debt, unless – (1) such individual became liable on or secured such debt in the ordinary course of such individual’s business; or (2) the case is closed, dismissed, or converted to a case under Chapter 7 or 11 of this title. In order for this section to be effective against a judgment creditor, the debt in question must be a consumer debt. In re Stovall, 209 B.R. 849 (Bankr. E.D. Va. 1997). There are exceptions to §1301 and circumstances under which relief from the stay can be granted to pursue a codebtor. Three such exceptions are: 1. As between the debtor and the codebtor, it was in fact the codebtor that received the consideration for the claim held by the creditor; The debtor’s plan does not propose to pay the claim; The creditor’s interest would be irreparably harmed if the stay was not lifted.
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In the divorce context, it will be helpful to know whether the automatic stay also protects your client when the spouse files Chapter 13. For example, if your client co-signed on the spouse’s car note (a consumer debt), and the spouse files Chapter 13, assuming the debtor-spouse has the car and provides for payment in full of the car note in the Chapter 13 plan, your client cannot be sued or even dunned by the creditor as long as the payments are made and insurance is in effect. 2. Applicability of the Automatic Stay - What is Not Covered
The automatic stay does not apply to all actions against the debtor, however. 11 U.S.C. § 362(b) provides: The filing of a [bankruptcy petition] does not operate as a stay – (1) under subsection (a) of this section, of the commencement or continuation of a criminal action or proceeding against the debtor; (2) under subsection (a) of this section – -2-
(A) of the commencement or continuation of an action or proceeding for – (i) the establishment of paternity; or (ii) the establishment or modification of an order for alimony, maintenance, or support; or (B) of the collection of alimony, maintenance, or support from property that is not property of the estate . . . and certain other situations inapplicable to domestic relations cases. It is important to note that a criminal contempt proceeding would fall under this section, and would seemingly not be stayed, however, the typical contempt proceeding seeks collection as well as civil and criminal punishment and would therefore be stayed. In re Allison, 182 B.R. 881 (Bankr. N.D. Ala. 1995) (civil contempt proceeding to collect pre-petition support is stayed). The harsh sanctions available for violating the stay suggest that it would be prudent to obtain relief from the stay, or obtain a declaration that the stay does not apply, before initiating or continuing most actions against a debtor in bankruptcy. In re Pody, 42 B.R. 570 (Bankr. N.D. Ala. 1984). 3. Violation of the Automatic Stay
Any action taken in violation of the automatic stay in the 11th Circuit is not just voidable, but void. Borg-Warner Acceptance Corp. v. Hall, 685 F.2d 1306 (11th Cir. 1982). It is of no significance whether the violation is intentional or mistaken, except with respect to the punishment or sanction which may be determined against the creditor. An individual that is harmed by a wilful stay violation can recover his or her actual damages including attorneys’ fees and, under some circumstances, courts have allowed punitive damages. In re Crysen/Montenay Energy Co., 902 F.2d 1098 (2d Cir. 1990). Other circuits have held, however, that actions in violation of the stay are voidable and not automatically void and further, that a Bankruptcy Court has the power under §362(d) to lift the automatic stay so that what would otherwise be a void action can be retroactively authorized. See, e.g., Easley v. Pettibone Michigan Corp., 990 F.2d 905 (6th Cir. 1993); In re Soares, 107 F.3d 969 (1st Cir. 1997). A divorce proceeding is both in rem, regarding the marital status of the parties, and in personam, regarding the division of property and support obligations. The automatic stay would not apply if the only result to be obtained in the divorce proceeding is the divorce itself. The automatic stay protects the debtor’s property, not his/her marital status. In re Elrod, 91 B.R. 187 (Bankr. M.D. Ga. 1988). In most cases, the practical effect of the automatic stay on domestic relations proceedings is two-fold: any division of property made by the divorce court which awards property of the estate to a debtor’s spouse in violation of the stay is void, and the party (and the attorney, as well) who violates the stay may be liable for damages. To avoid losing the fruits of your labor and the risk of liability, the divorce practitioner should routinely obtain relief from the automatic stay to proceed -3-
with most domestic relations cases. C. Obtaining Relief From the Automatic Stay
The automatic stay lasts until the earliest of the time the case is closed or dismissed, or a discharge is granted or denied; or until it is terminated, modified, or lifted upon motion by a party upon proper notice and hearing. 11 U.S.C. §362(d) provides: On request of a party in interest, and after notice and a hearing, the court shall grant relief from the stay provided under subsection (a) of this section, such as by terminating, annulling, modifying, or conditioning such stay – (1) for cause, including the lack of adequate protection of an interest in property of such party in interest; or (2) with respect to a stay of an act against property under subsection (a) of this section, if – (A) the debtor does not have an equity in such property; and (B) such property is not necessary to an effective reorganization . . . . Relief from the stay is obtained by filing a Motion for Relief from Automatic Stay with the Clerk of the Bankruptcy Court for the district and division in which the debtor has filed the bankruptcy petition. There is a $75.00 fee for filing a Motion for Relief. A child support creditor or his/her representative who files Form B281, available in the Bankruptcy Clerk’s office, is exempt from payment of the filing fee. A child support creditor is defined as the person to whom the debtor has a primary obligation to pay child support as well as any entity to whom such support has been assigned if pursuant to § 402(a)(26) of the Social Security Act or if such debt has been assigned to the Federal Government or to an State or political subdivision of a State. The debtor’s attorney, the trustee, the bankruptcy administrator, and in some divisions, also the debtor, must be served with a copy of the Motion for Relief. In some divisions, relief will be granted automatically if no objection is filed within the time prescribed. In most divisions, a hearing will be scheduled and you will have to appear and carry your burden. 11 U.S.C. §362(g) provides that the movant-creditor has the burden of proof on the issue of the debtor’s equity, and the party opposing the relief, i.e. the debtor, has the burden of proof on all other issues. Warning: be prepared to carry your burden. Do not assume that just because you have found several cases which support your position, you do not have to introduce evidence to prove your position. While most bankruptcy judges are courteous to those who practice infrequently in their courts, some can be notoriously difficult on those who come to court unprepared. Before venturing into unchartered territory, it would be best to discuss what is likely to happen with an -4-
attorney familiar with the judge before whom your motion is set. You should also contact the debtor’s attorney (and the trustee if you are proceeding against the debtor’s property) in advance of the hearing to determine whether your motion will be contested. If the matter is likely to be contested, you must have your witness(es) and evidence in court at the appointed time. Most federal courts, including bankruptcy courts, do not want to become involved in domestic relations proceedings. The Eleventh Circuit has stated, in dicta, that “relief [from the automatic stay] should be liberally granted in situations involving alimony, maintenance or support in order to avoid entangling the federal court in family law matters best left to state court.” Carver v. Carver, 954 F.2d 1573, 1578 (11th Cir. 1992). D. What is Property of the Estate
Pursuant to 11 U.S.C. §541, when a case is filed under the Bankruptcy Code an estate is created. That estate, the debtor’s estate, is comprised of property, wherever it may be located and by whomever it may be held. It consists of legal or equitable interests which the debtor held in such property at the time the case was filed. It includes tangible or intangible property, causes of action and possessory interests such as leaseholds. In addition to property owned by the debtor at the time the case was filed, property of the estate also includes any interest in property that the debtor acquires or becomes entitled to acquire within 180 days after the date of filing, which the debtor receives by virtue of inheritance, property settlement agreement, divorce decree, or as beneficiary of a life insurance policy. 11 U.S.C. §541(a)(5). Specifically excluded from property of the estate are future earnings of an individual debtor after the commencement of the case in a Chapter 7 proceeding under 11 U.S.C. §541(a)(6). Postpetition payments to a Chapter 7 debtor for services rendered pre-petition, however, do constitute property of the estate. If the services were performed pre-petition, earnings for those services would belong to the estate. In re Andrews, 80 F.3d 906 (4th Cir. 1996). An important exception to what is included in the debtor’s estate is an ERISA qualified plan. The debtor’s interest in an ERISA qualified plan is generally excluded from property of the estate under 11 U.S.C. §541(c)(2). This code section excludes from property of the estate an interest in a plan or trust that contains a transfer restriction (anti-alienation clause) which is enforceable under relevant non-bankruptcy law. Patterson v. Shumate, 504 U.S. 753, 112 S.Ct. 2242, 119 L.Ed.2d 519 (1992). Therefore, if under relevant and applicable state law a qualified plan is exempt from the reach of creditors it remains exempt under bankruptcy law. This includes IRAs provided the IRA is exempt under state law. Meehan v. Wallace, 102 F.3d 1209 (11th Cir. 1997); In re Harless, 187 B.R. 719 (Bankr. N.D. Ala. 1995) Even though a debtor may have access to IRA funds, the 11th Circuit in Meehan nevertheless determined that the IRA was not property of the estate. A QDRO which awarded a spouse a vested interest in the debtor’s ERISA qualified plan would likely exclude the spouse’s interest from the debtor’s estate as well. The Bankruptcy Court has the jurisdiction to determine what is property of the estate. -5-
However, as a general rule property interests are created and defined by state law. Butner v. United States, 440 U.S. 48, 99 S. Ct. 914, 59 L.Ed.2d 136 (1979); T & B Scottsdale Contractors, Inc. v. United States, 866 F.2d 1372 (11th Cir. 1989). II. Dischargeability
When an individual files for bankruptcy protection, the ultimate relief the debtor seeks is a discharge of indebtedness under Chapters 7, 11, 12 or 13. Through discharge, a debtor is seeking a fresh start which is the underlying policy of the Bankruptcy Code. Not every debtor is entitled to a discharge or a fresh start. Certain debts are non-dischargeable automatically, without any action by the creditor, and other debts must be declared non-dischargeable upon the filing of an action by the creditor. Two such provisions are applicable in domestic relations cases. 11 U.S.C. §523(a) excepts from a Chapter 7 discharge 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 – (A) such debt is assigned to another entity, voluntarily, by operation of law, or otherwise (other than debts assigned pursuant to section 402(a)(26) of the Social Security Act, or any such debt which has been assigned to the Federal Government or to a State of any political subdivision of such State); or (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 ... (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 -6-
detrimental consequences to a spouse, former spouse, or child of the debtor . . . . Alimony, maintenance, and support obligations as described in § 523(a)(5) are not dischargeable in a Chapter 7 or Chapter 13 and the creditor need not take any action to prevent those debts from being discharged. However, pursuant to § 523(c)(1), those debts described in § 523(a)(15) are discharged unless on request of the creditor to whom such debt is owed, and after notice and a hearing, the court determines such debt to be excepted from discharge. How does the divorce practitioner determine whether it is a § 523(a)(5) or § 523(a)(15) debt? It is not as simple a question as it might seem. The state court may determine whether the debt arising from the divorce is dischargeable under § 523(a)(5). Thaggard v. Pate, 180 B.R. 659 (M.D. Ala. 1995). However, what constitutes an alimony, maintenance, or support obligation in the bankruptcy context is not determined by state law but by federal law. In re Harrell, 754 F.2d 902 (11th Cir. 1985). The language of the divorce decree is not binding on the bankruptcy court, because the language of § 523(a)(5) requires that the obligation be “actually in the nature of support.” Therefore, the bankruptcy court must make a simple inquiry into whether the particular obligation is actually in the nature of support, on a case-by-case basis. Id. For example, in In re Delaine, 56 B.R. 460 (Bankr. N.D. Ala. 1985), one spouse was ordered to make the mortgage payments for the other spouse as long as the other spouse remained unmarried or until the child reached the age of nineteen, then the house would be sold and the proceeds divided. The court held that this obligation was not dischargeable because it was in the nature of support under § 523(a)(5). The court also held that the debtor’s obligation to pay joint medical debts and the former spouse’s attorney’s fees were also in the nature of support. However, the debtor’s obligation to make the mortgage payments on the lake house and the former spouse’s automobile were dischargeable. The Delaine case is still the leading authority on dischargeability of support obligations under § 523(a)(5). § 523(a)(15), which appeared in 1994, provides for the additional non-dischargeability of property settlement debts under certain circumstances which were previously dischargeable. Since the Delaine case was decided before the addition of § 523(a)(15), those debts the Delaine court held non-dischargeable should be examined for dischargeability under § 523(a)(15). If it is not readily apparent that the debt is non-dischargeable under § 523(a)(5), then a complaint to determine dischargeability should be filed. A child support creditor or his/her representative who files Form B281 is exempt from payment of the $150.00 filing fee. Furthermore, you should always assert first that the debt is non-dischargeable under § 523(a)(5), then in the alternative, that the debt is non-dischargeable under § 523(a)(15). If the debt is found to be nondischargeable under § 523(a)(5), then the inquiry ends. If, however, the debt is not nondischargeable under § 523(a)(5), then the inquiry turns to the debtor’s ability to pay and the benefit/detriment analysis.
Under § 523(a)(15), the creditor-spouse must present sufficient evidence to establish that -7-
§ 523(a)(15) is applicable. The burden then shifts to the debtor-spouse to rebut this evidence and to present sufficient evidence to establish inability to pay and/or detriment. Then the creditor-spouse must rebut the debtor-spouse’s evidence regarding inability to pay and/or detriment. In re Stone, 199 B.R. 753 (Bankr. N.D. Ala. 1996). Although dischargeability issues are most relevant in the context of Chapter 7 bankruptcies, a creditor-spouse must be aware of the Chapter 13 “super-discharge.” Under 11 U.S.C. § 1328, a Chapter 13 debtor may obtain a discharge from all debts provided for by the plan, except § 523(a)(5) debts. Even though a Chapter 13 plan may provide for payment of property settlement obligations in the plan, they need not be paid in full, and once payments are completed under the plan, the obligation would be discharged. Therefore, it would be prudent to file an objection to confirmation of the plan if the debtor’s plan proposes to pay these § 523(a)(15) debts less than fully. However, if the court still confirms the plan, the remainder of these § 523(a)(15) debts will be discharged in the Chapter 13. III. Proofs of Claim
If a creditor is listed by the debtor in the bankruptcy petition, the creditor will receive notice from the bankruptcy court of the filing. The notice will also inform the creditor of the automatic stay, the Chapter under which the debtor has filed, the date and time of the first meeting of creditors (also known as the 341 meeting), and the deadline, if any, to file a proof of claim. Typically, the notice will include a proof of claim form with the general information already included. It is also customary in a no-asset Chapter 7 case for the notice to advise the creditor to refrain from filing a proof of claim. Obviously, there is no need for the creditor to file a proof of claim if there will be no distribution. In the event assets are discovered, the creditors will receive notice to file their claims. Bankruptcy Rules 3001 through 3008 deal with the procedural guidelines for filing claims. Rule 3001 requires among other things that the proof of claim be in writing and must conform substantially to the Official Form, which is available in the Clerk’s office if not provided with the notice. The proof of claim must be executed by a creditor or an authorized agent of the creditor. If the claim is based on an interest in property of the debtor which secured the claim or based on some other writing, the original or a duplicate of the writing is required to be attached to the proof of claim. A creditor claiming a security interest in property of the debtor must attach to the proof of claim evidence that the security interest has been perfected i.e. recorded mortgage, recorded UCC-1 financing statement, possession of a certificate of deposit, etc. A certified copy of the Final Judgment of Divorce or other order should be attached to a proof of claim for debts arising out of a divorce. Do not aggregate the claims onto one proof of claim form – a separate proof of claim with supporting documentation attached should be completed for each claim (child support arrearage, attorney’s fees, unpaid medical expenses, etc.). In a Chapter 7 liquidation case, Chapter 12 family farmer case, or Chapter 13 individual debt -8-
adjustment case, a proof of claim is timely filed if it is filed not later than ninety days after the first date set for the meeting of creditors. In a Chapter 11 case, the deadline for filing a proof of claim is set by the Court. Creditors should pay careful attention to a notice commencing a case under Chapter 11 to determine whether the Bankruptcy Court has established a deadline for filing claims. It has become customary in Chapter 11 cases that the bar date for filing claims is set later into the case. This can be a trap for unwary creditors, so the safer rule again is to file the claim early rather than waiting for the bar date. When a Chapter 11, 12 or 13 case is converted to a Chapter 7 case, a new time period for filing a proof of claim is established by the Court under Bankruptcy Rule 1019(2). If no claim was filed in the Chapter 11, 12 or 13 case a written proof of claim must be filed in the converted Chapter 7 case in order to be allowed. The creditor cannot rely on the fact that the debtor may have properly scheduled the claim without dispute or contingency in the original case. Claims actually filed by a creditor in the old case before conversion, are deemed filed in the new Chapter 7 case under Bankruptcy Rule 1019(3). Under 11 U.S.C. § 502, a proof of claim is deemed allowed unless a party in interest objects to the creditor’s claim. Note: not only the debtor or trustee may object to a creditor’s claim, but any party in interest for good cause shown. In re Thompson, 965 F.2d 1136 (1st Cir. 1992). In every case filed under the Code regardless of the Chapter, it is required that a meeting of creditors occur. The Court is not allowed to preside or even attend the §341 creditors meeting. At the creditors meeting, creditors are allowed to examine the debtor under oath concerning any matter legitimately related to the claim. However, because the Court does not preside at the creditors meeting difficulty can arise with respect to objections to questions, refusal to answer, etc. In addition to examining the debtor, this is an opportunity for the creditors to hold certain elections. In Chapter 7 or 11 cases, creditors can elect a creditors committee. In Chapter 7 cases, creditors can elect a case trustee. There is seldom a good reason for a former spouse to attend the 341 meeting, but it usually makes for a more interesting 341 meeting when one does.
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