Can this marital residence be saved? Declaring Bankruptcy to prevent foreclosure after divorce

Picture the following: while divorcing, the custodial parent is granted exclusive use and occupancy of the marital residence with the children. The noncustodial parent is then directed to pay the monthly mortgage payment and other carrying charges on the marital residence. For whatever reason, the noncustodial parent falls behind on those payments, the house enters foreclosure, and a sale is scheduled. To stay in the marital residence, the custodial spouse is forced to file a motion seeking to either compel payment or hold the noncustodial parent in contempt.

Can the noncustodial parent stay the foreclosure, avoid contempt, and obtain more time to make the payments by filing a Chapter 13 bankruptcy petition? In certain circumstances the answer is yes, and attorneys representing debtor spouses should investigate this option at the earliest opportunity, perhaps even before the divorce is final.

Chapter 13 bankruptcy permits debtors to ‘reorganize’ their debts into a manageable repayment plan. Debtors propose a repayment plan, whose contents are determined by 11 U.S.C. § 1322, to make installments to creditors over three to five years based upon the debtor’s income. These creditors are paid back varying amounts, depending on the type of each debt and its classification within the plan. As a result, a Chapter 13 bankruptcy petition not only stays the foreclosure proceeding upon the filing of the petition but also allows the debtor to bring the past-due payments current over a reasonable period of time. Once a reorganization plan is filed the debtor is permitted to resume making regular monthly mortgage payments, with the bank being mandated to accept these payments.

Pursuant to the special rules regarding mortgages on a residence in a Chapter 13 bankruptcy, the debtor spouse can utilize this particular chapter to ‘save’ the marital residence and permit the custodial spouse and their children to remain in the house, so long as the noncustodial parent remains current with the payments. Bankruptcy law also affords the custodial spouse additional protection. Under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”), not only are strict child support and maintenance payments deemed nondischargeable and specially protected, but payments toward a mortgage or home equity line of credit are also now assumed to be a part of child support or maintenance. It no longer matters whether the mortgage or home equity payments were specified as child support, maintenance, or part of a property settlement. These payments are now deemed specially protected and nondischargeable pursuant to 11 U.S.C. § 523(a)(15).which “expresses Congress’s recognition that the economic protection of dependent spouses and children under state law is no longer accomplished solely through the traditional mechanisms of support and alimony payments. In re Golio, 393 B.R. 56, 61 (Bankr. E.D.N.Y. 2008).

Upon submission of the plan, the debtor may separately classify certain debts to ensure they are repaid in full, so long as this classification is not unfairly discriminatory under 11 U.S.C. § 1322(b)(1). The bankruptcy courts have settled on a test to determine whether a separate classification should be allowed in a Chapter 13 bankruptcy plan, which test looks at (1) the basis for the separate classification, (2) how necessary this classification is to the debtor’s rehabilitation, (3) if same is proposed in good faith, (4) whether those discriminated against will receive any meaningful distribution if the classification is permitted, and (5) the difference between the amount those discriminated against would receive if the classification was permitted and if it was not permitted.

The bankruptcy court in the Eastern District has held that a debtor’s plan, wherein child support arrears are included, satisfied the foregoing test in that “(1) [t]he separate classification of a non-dischargeable debt has a rational basis; (2) is necessary to the Debtor’s overall rehabilitation, since he desires to pay the child support arrears during his plan, and it will allow him to be free from all debts once he completes the plan; (3) the classification is proposed in good faith; there is no evidence nor any objections before the Court that would lead the Court to believe the plan is not; (4) there is a meaningful 25% distribution to unsecured creditors in the class being discriminated against which is more than they would receive in a Chapter 7 liquidation case (25% versus 0%); and (5) more than they would receive under a three-year plan where all of the Debtor’s disposable income was devoted to the plan and the unsecured creditors were treated in one class (25% versus 17%).”

In re Husted, 142 B.R. 72, 75 (Bankr. W.D.N.Y. 1992).

For noncustodial parents unable to make these payments, Chapter 13 bankruptcy could be considered the preferred filing, as “[n]umerous courts have allowed separate classification under a Chapter 13 plan for debts that would otherwise be non-dischargeable under 11 U.S.C. § 523 or under 11 U.S.C. § 1328(a)(2) such as child support.”Husted, 142 B.R. at 74.

A debtor could separately classify the debt made up of the other carrying charges to ensure payment in full through the repayment plan. This is vital to any purging of contempt, as the court-ordered carrying charges of the marital residence can include payments toward utilities, taxes, homeowner’s insurance, etc., which the debtor will wish to include in any reorganization plan.

If the parties are still married, a successful Chapter 13 Bankruptcy filing requires not only the income and expenses of the filing debtor, but also that of the creditor spouse. The court, the trustee, and the creditors will then evaluate the household’s financial position and determine the propriety of the debtor’s proposed plan. It is therefore strongly suggested that matrimonial counsel for the parties work in conjunction, not only with each other but also with any bankruptcy counsel, so that the marital residence may be saved and the creditor spouse and children may continue to reside there.

By complying with a full repayment plan, the noncustodial parent would ultimately be in compliance with the state court order to satisfy the carrying charges on the marital residence. Arguably, the debtor would then properly avoid, or ‘purge,’ the prior contempt, all without having to furnish a lump sum amount ordered pursuant to an adjudication of contempt. Additionally, this would address the custodial parent’s main concern: that the debtor cures the defaults, permitting the custodial parent and the children to remain in the marital residence. A Chapter 13 bankruptcy filing could then result in that elusive win-win situation for all involved. It should be strongly considered as a possible solution for counsel confronted with a debtor who has been ordered to pay carrying charges but fell behind in the context of a matrimonial proceeding.

Heath S. Berger is a partner in the firm of Steinberg, Fineo, Berger & Fischoff, P.C., concentrating in the area of bankruptcy law and matrimonial law. Jessica A. Gould is an associate with the Firm, concentrating in the area of matrimonial law.