Spring 2018: Bankruptcy After Divorce: Protecting The Bargained-For Contract

by Grace Roessler, Esq

Parties enter into a separation agreement, finally ending what has been a roller coaster ride of a divorce. It is time to reset - physically, emotionally, and financially. But what happens when one party isn’t able to financially keep his/her head above water after a divorce? Some turn to bankruptcy. In 2016, more than 760,000 people filed for bankruptcy in the United States.1 Given the financial strain divorce places on families, it is reasonable to assume parties may have to file bankruptcy to stay afloat post-divorce. Consequently, parties, practitioners, and judges alike should craft separation agreements and judgments that contemplate bankruptcy filings, clearly identify the non-dischargeable obligations of the parties, and set out the parties’ rights in the event that one party files for bankruptcy.

Basic Bankruptcy

Obligations are subject to discharge based on the type of bankruptcy filing. Individuals have a choice of filing under the federal bankruptcy code, but Chapter 7 and Chapter 13 appear to be the most common filings in the domestic relations world, and apply to individuals. The Department of Justice defines Chapter 7 bankruptcy as “a liquidation proceeding available to individual consumers and businesses. The assets of a debtor that are not exempt from the reach of creditors are collected and reduced to money, and the proceeds are distributed to creditors in accordance with a priority scheme established by the Bankruptcy Code. A consumer debtor receives a release from debt, except for certain debts that the statute excludes from discharge.” Chapter 13 is “used by individual consumers to reorganize their financial affairs under a repayment plan that must be completed within three to five years. To be eligible for chapter 13 relief, a consumer must have regular income and may not have more than a specified amount of debt.”

Dischargeability provisions are governed by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”), and apply to all bankruptcy cases filed after October 17, 2005. Under Chapter 7 and 13, the following debts are discharged: credit cards, medical bills, lawsuit judgments against a party, some debts arising from car accidents, obligations under leases and contracts, personal loans, and promissory notes. Under Chapter 13, some debts arising from property settlements in divorce proceedings may be discharged, along with condo, co-op, HOA fees, debts for loans from retirement plans, and debts that couldn’t be discharged in a previous bankruptcy.

Under Section 523(a)(5), a discharge under the title does not discharge an individual from any debt for a domestic support obligation. Under Section 523 of the Bankruptcy code, “Domestic Support Obligations” (“DSO”) are not dischargeable under Ch. 7 of Ch. 13. Under 11 U.S.C. Section 101 (14A) DSO’s are defined as “debt… owned to or recoverable by (i) a spouse, former spouse, or child of the debtor or such child’s parent, legal guardian, or responsible relative… in the nature of alimony, maintenance, or support of such spouse, former spouse, or child of the debtor of such child’s parent, without regard to whether such debt is express so designated;…established… by reason of a (i) separation agreement, divorce decree, or property settlement agreement.”

The bankruptcy court looks at a number of criteria to determine the “nature of the support” within the meaning of Section 523(a)(5), including the following: (1) actual substance and language of the agreement; (2) financial situation of the parties at the time of the agreement; (3) the function served by the obligation at the time of the agreement; (4) and whether there is any evidence of overbearing at the time of the agreement that should cause the court to question the intent of a spouse.2 The courts also consider the following factors: (1) the parties’ employment history and prospect for financial support; (2) whether one party received marital property; (3) the number and frequency of payments; (4) whether it would be difficult for the former spouse and children to subsist without the payments; (5) the length of the marriage; (6) the economic disparity of the parties; (6) whether the spouse who brings the complaint is caring for the minor children; (7) age, employability, education levels of the parties; (8) the label in the decree or agreement; (9) whether the obligation terminates upon the obligee’s death, remarried, or the emancipation of the children; (10) whether there is a waiver of alimony or support in the marital settlement agreement; (11) the availability of state court remedies to modify or enforce the obligation; and (12) the tax treatment of the obligation.3

The following obligations generally qualify as a DSO: child support; alimony; obligations to pay future educational expenses (see In re Harrell, 754 F.2d 902 (11th Cir.1985); obligations to pay future health care costs of children (see In re Robinson, 193 B.R. 367 (Bankr. N.D. 1996); an obligation to make monthly payments of the mortgage in lieu of support (In re Herbert, 321 B.R. 628 (EDNY 2005); and car payments (In re Merrill, 252 B.R. 497 (B.A.P. 10th Circ. 2000).

Generally, a Qualified Domestic Relations Order to transfer retirement or pension assets is not considered a debt and is non-dischargeable by bankruptcy (Patterson v. Shumate, 112 S. Ct. 2242 (1992).

A party whose ex-spouse files for bankruptcy wants to ensure that the ex-spouse is forced to continue to pay his/her obligations under the agreement/judgment of divorce.

Protection Against Discharge: Separation Agreement Drafting and Court Action

Parties may protect against possible obligation discharges by drafting clear separation agreements that lay out the intent of the parties if and when a bankruptcy is filed. Some drafting tips include:

(1) Add a bankruptcy section to the Separation Agreement, with the following provisions:

(a) Require the parties to notify each other in writing of his/her intention to file bankruptcy at least thirty days’ prior to the party’s filing for bankruptcy, and include in the written notification which type of bankruptcy the ex-spouse intends to file. This provision will give an unsuspecting spouse time to consult with a bankruptcy or family law attorney to determine whether he/she may need to file an objection with the bankruptcy court against their ex-spouse’s request for discharge, and monitor the proceedings.

(b) Specifically deny each party relief from all obligations as a result of any bankruptcy filing. The bankruptcy court should refer to these provisions when discussing the intent of the parties, and it may be useful to define the parties’ intention to be held responsible for their obligations and property divisions per the terms of their contract in spite of a bankruptcy filing.

(c) Require the filing party to file a copy of the Separation Agreement or Judgment of Divorce/Modification with the bankruptcy filing to ensure notice to the bankruptcy court of the filer’s obligations

(2) Add language to the Separation Agreement which attempts to expand the list of non-dischargeable obligations by meeting the “Domestic Support Obligation” criteria. Child support and alimony are non-dischargeable. However, it may not be obvious that obligations like payment of extracurricular activities and college contributions are considered “in the nature of support”. Thus, crafting language that meets the DSO factors is essential for protecting one’s rights to enforce those obligations of the ex-spouse filing bankruptcy.

Aside from crafting a well written agreement, there are other ways in which parties can protect against an ex-spouse from attempting to discharge his/her obligations. Secured liens are not dischargeable. Consequently, obligations for future payments should be secured if possible, including obligations for payment of attorney’s fees or future payments as part of final property division. As noted above, certain property division debts may be discharged in a Chapter 13 bankruptcy, which should encourage parties to secure the obligation with a lien. If a party will not agree to secure the loan in the separation agreement, it may be necessary to file a lien with the probate and family court as a separate action.

Discharge v. Modification: Know the Difference

It is important to note that non-dischargeable obligations in a bankruptcy may still be subject to modification by the probate and family court if a party brings a complaint for modification and the obligation seeking to be modified merged in the Judgment of Divorce. It is not unlikely that a party filing for bankruptcy will also file a complaint for modification to reduce his/her support and/or change the obligation terms of the judgment based on an alleged material change in circumstance- the filing of bankruptcy. Thus, even if a party is successful in requiring the filing party to continue to pay certain obligations set forth in the Separation Agreement, the amounts of those obligations may be subject to change if they merged with the Judgment of Divorce. If the chance of a party’s post-divorce bankruptcy filing is high, the parties should consider adding language to the separation agreement that specifically denies the filing of bankruptcy as a material change in circumstances. This requirement will set the bar higher for him/her to receive requested relief from his/her obligations.

Effect of Bankruptcy on Property/Liability Division and Next Steps

Property division in a judgment of divorce is final, absent some form of fraud or misrepresentation by one of the parties on the court. Parties generally share debt under the assumption that each party will be responsible for her/her share. However, if an ex-spouse files a Chapter 13 bankruptcy to liquidate assets, and is permitted to discharge his/her property settlement obligations, it leaves one party effectively out of luck. In the event that an ex-spouse is discharged from his/her property settlement obligations, it may be appropriate to file an equity action in order to re-balance responsibility of debts/obligations of the parties.

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[1] Department of Justice – Annual Reports of Significant Accomplishment (2016)
[2] Johnson v. Johnson, 397 B.R. 289 (Bankr. M.D.N.C. 2008)
[3] Id. At 297.

Grace C. Roessler is a domestic relations attorney at the firm of Mirick, O’Connell, DeMallie & Lougee, LLP in Boston. Grace thanks Attorneys Paul Carey and Kate Foley of the Mirick O’Connell Bankruptcy Group for their assistance in production of this article.