In a time of greater economic complexity and financial hardships, bankruptcy has become more than just a tool of financial survival. When coupled with divorce, it often leads to a true fresh start. The timing of either the filing for relief under the Bankruptcy Code or filing a divorce proceeding can be critical and there are important factors to consider when contemplating either.
Bankruptcy Before Divorce
Filing a joint bankruptcy case before a divorce can be beneficial because it could save a married couple thousands of dollars in attorney’s fees and court costs. When a husband and wife file jointly for bankruptcy the discharge of their debts is easily understood. The main advantage to the married couple filing for bankruptcy before divorce is to know, before going into the divorce process, how the parties’ debts and property rights will be handled. The parties will each be released from personal liability for the marital debts that are dischargeable.1 How the parties’ debts will be handled depends upon whether the married couple files for relief under chapter 7 or chapter 13 of the Bankruptcy Code.
The discharge of the couple’s joint debts can eliminate a potentially contentious issue in a contested divorce case, or one that could delay or prevent the parties from entering into a separation agreement or a property settlement agreement. On the other hand, if both the husband and wife are still living together, even if the divorce is imminent, it is important to remember that the income of both spouses will be included in the Means-Test Calculation2 to determine which bankruptcy chapter the married couple is eligible for.3 Thus, in certain cases it may make sense for the couple to wait until they have legally separated before filing bankruptcy in order to avoid a presumption of abuse under the Means Test. Declaring bankruptcy before divorce doesn’t make sense for every couple, particularly if either the couple or one spouse has non-exempt equity in any personal or real property.4 If a joint bankruptcy case is filed by the parties prior to entering into a divorce agreement or prior to the entry of a judgment of divorce, any and all property owned by the parties, or that the parties have an interest in, is property of the bankruptcy estate5 and can be liquidated for the benefit of creditors’ claims. Accordingly, in order to effectively counsel a husband and wife who are filing a joint bankruptcy petition it is important to determine the amount of equity in any and all personal or real property owned by the parties. To the extent there are marital assets with equity it may be advisable for the parties to enter into a divorce agreement prior to filing bankruptcy in order to maintain control over the division of marital assets.
Bankruptcy While Divorce is Pending
If only one spouse files for bankruptcy after a divorce is commenced, but prior to the entry of a judgment of divorce or a divorce agreement, the result is more complex. The automatic stay6 in bankruptcy impacts any property division in a divorce proceeding, but does not apply to (i) paternity tests, (ii) establishment or modification of a domestic support obligation as defined under the Bankruptcy Code,7 (iii) collection of a domestic support obligation from property that is not property of the estate as defined under Bankruptcy Code §541 and controlling authority, (iv) actions for child custody or visitation, (v) actions for marriage dissolution other than as to issues of property division, such as granting a divorce, (vi) income withholding under domestic support obligations, (vii) interception of a tax refund, or (viii) withholding or restriction of a driver’s or other professional, occupational or recreational licenses. However, divorce attorneys and/or divorce judges frequently do not fully understand the nuances and effects of a bankruptcy filing on a divorce proceeding and err on the side of caution. Typically a divorce proceeding comes to a screeching halt until the bankruptcy case is closed or a Bankruptcy Court order directs that the divorce case may proceed. Often a chapter 7 trustee will not oppose the non-filing party’s request for relief from the bankruptcy stay8 in order to proceed with prosecuting the divorce to judgment; however, enforcement may be stayed until either a settlement is reached and/or any issues concerning property of the estate have been determined.
Negotiating a property settlement in the middle of bankruptcy can be complicated. Debts related to a property settlement are presumed to be nondischargeable in bankruptcy, and the obligated parties will still be responsible to honor those pre-filing agreements.9 However, since the determination of property rights includes the payment of debts, the bankruptcy will often help resolve some of those issues.
Bankruptcy After Divorce
After entering into a divorce agreement or the entry of a judgment of divorce, ex-spouses are no longer eligible to file a joint bankruptcy case,10 and would have to file an individual bankruptcy case limited to discharging his or her liability alone on a joint debt.11 Thus if one ex-spouse does not pay his or her share of the debts, the creditors may seek to collect such unpaid debts from the other non-filing ex-spouse. More importantly, the divorce settlement is only between the parties and is not binding on their creditors or other third parties and may not be binding on a Trustee.12 Courts have held that the Rooker-Feldman doctrine, which is a recognition of the principle that federal courts, other than the United States Supreme Court, lack authority to exercise appellate review over a state court’s judicial decision, does not apply where a bankruptcy trustee seeks to set aside an underlying settlement agreement approved by the matrimonial court prepetition, as the bankruptcy trustee was not a party to either.13
With respect to determining the dischargeability of maintenance, alimony or support, the amended Bankruptcy Code14 eliminates the distinction between orders providing for the division of property and orders providing for the support of a spouse or child. Nearly all obligations, including legal fees incurred in connection with a separation or divorce agreement or other family law-related order, including those to a spouse, former spouse or child are nondischargeable in a case pending under chapters 7, 11, 12 or 15 of the Bankruptcy Code.15
Bankruptcy and Matrimonial Legal Fees
Courts have held that a debtor’s obligations for nonpayment of attorney’s fees incurred by the former spouse in the collection of debts are nondischargeable pursuant to the Bankruptcy Code.16 However, Courts have differed as to whether attorney’s fees directly payable to a former spouse’s counsel as opposed to a former spouse are dischargeable under a narrow interpretation of Bankruptcy Code §§523(a)(5) and (15) as those provisions do not list obligations owing to a spouse’s counsel as being excepted from discharge.17
When an attorney learns that both a bankruptcy and divorce are imminent, potential conflicts of interest need to be considered in representing that couple. First and most important, an attorney has the duty not to represent one client if the representation would be directly adverse to the interests of that attorney’s other client.18 Given the nature of a divorce, a bankruptcy attorney must always carefully consider this duty when considering whether to represent a soon to be divorcing spouse in a joint chapter 7 case. A second ethical limitation to an attorney’s ability to represent a couple in a joint filing for bankruptcy if they are planning to divorce is the general prohibition that an attorney may not represent a client if the representation of that client would be materially limited by an attorney’s responsibility to another client.19 Even if an attorney believes that the interests of the couple planning to divorce are not adverse when they file a joint chapter 7 bankruptcy petition, the attorney must consider whether he/she will be limited in his/her representation of either the husband or the wife by his or her professional duties to the other party. In certain circumstances, when an attorney breaches his or her ethical duties to a debtor(s) and commits malpractice, a trustee will investigate and may pursue such malpractice claims against debtors’ attorney for the benefit of the debtors’ creditors.
The timing of a bankruptcy filing and divorce filing rests on the complex interplay of many factors, including the non-exhaustive list of factors described above. It is important that attorneys in both areas of the law understand these factors when advising couples who are contemplating filing both bankruptcy and divorce cases.
Kenneth P. Silverman serves is a member of the panel of the United States Bankruptcy Trustees for both the Eastern and Southern Districts of New York and leads the Bankruptcy and Creditors’ Rights Group of SilvermanAcampora LLP. His office, SilvermanAcampora LLP, is lcoated in Jericho and he can be reached at (516) 479-6300 or KSilverman@SilvermanAcampora. com.
Mark J. Friedman recently opened The Law Offices of Mark J. Friedman P.C. in Syosset. He is a former colleague of Kenneth Silverman with experience in bankruptcy and other creditor related rights. He can be reached at (516) 653-2480 or MFriedman@FriedmanPC.com.
1. 11 U.S.C. §727.
2. Debtors filing for bankruptcy relief are required to complete either Official Bankruptcy Form 22A or 22C (Statement of Current Monthly Income and calculations). Bankruptcy Form 22A is the form chapter 7 debtors will complete for “means testing” purposes; Form 22C is the form chapter 13 debtors will complete. [The Official Bankruptcy Forms can be found on the Administrative Office of the U.S. Courts website.]
3. 11 U.S.C. §707(b)(2)(A)(ii).
4. The New York State bankruptcy exemptions are found in several different statutes.
5. 11 U.S.C. §541. See Musso v. Ostashko, 468 F.3d 99 (2d Cir. 2006), In re Ostashko, 333 B.R. 625 (Bankr. E.D.N.Y. 2005).
6. 11 U.S.C. §362.
7. 11 U.S.C. §101(14A).
8. 11 U.S.C. §362.
9. 11 U.S.C. §523(a)(15).
10. 11 U.S.C. §§109; 11 U.S.C. §§302.
11. 11 U.S.C. §727.
12. In re Zerbo, 397 B.R. 642 (Bankr. E.D.N.Y. 2008) Plaintiff chapter 7 trustee commenced an adversary proceeding against debtor’s former spouse and asserted claims under 11 U.S.C. §§544 and 548 and N.Y. Debt. & Cred. Law §§273, 275, 276, 276-a, 278 and 279. The court first concluded that the Rooker-Feldman doctrine did not apply and the trustee could sue to set aside the divorce decree and the underlying settlement agreement, as the trustee was not a party to either. The Court further concluded that, absent extrinsic fraud or collusion among the divorcing parties, the division of marital assets between the parties was not a fraudulent transfer. The Court found that the division of marital assets as agreed to between the parties conclusively established reasonably equivalent value based on the former spouse’s concessions.
14. Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 Amendments, 11 U.S.C. §523(a)(15).
15. Chapter 13 Exception – In cases where there has been a complete consummation of a confirmed Chapter 13 plan (all required payments have been made), the obligations to a spouse, former spouse or child is discharged. Any individual, even if self-employed or operating an unincorporated business, is eligible for chapter 13 relief as long as the individual’s unsecured debts are less than $360,475 and secured debts are less than $1,081,400. 11 U.S.C. §109(e). These amounts are adjusted periodically to reflect changes in the consumer price index. A corporation or partnership may not be a chapter 13 debtor. Id.
16. 11 U.S.C. §523(a)(15).
17. 11 U.S.C. §§523(a)(5); 11 U.S.C. §§523 (a)(15). See In re Golio, 393 B.R. 56 (Bankr. E.D.N.Y. 2008) The Court held that the non-debtor former wife’s requests that the attorneys’ fees awarded to her and the fees and costs incurred in commencing an adversary proceeding against the debtor to comply with orders of the obligations incurred by the debtor be deemed nondischargeable was granted. Applying the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 amendments to 11 U.S.C. §523(a)(15), the judgments were clearly awarded by the state court in connection with a divorce decree and to enforce prior orders of the state court concerning the divorce judgment were nondischargeable. See also In re Klem, 362 B.R. 585 (Bankr. W.D.N.Y. 2007) The Court entered judgment in an adversary proceeding commenced by plaintiff law firm against the debtor declaring that an award of the firm’s fees to the debtor’s former spouse in marital dissolution proceedings was not dischargeable under 11 U.S.C. §523(a)(15).
18. DR 5-105 [1200.24] Conflict of Interest; Simultaneous Representation. 19. Id.
Nassau County Bar Association ALL Rights Reserved
15th and West Streets | Mineola, NY 11501 | (516) 747 4070 | Fax (516) 747 4147