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BANKRUPTCY REFORM AND PROPERTY SETTLEMENTS
© 1994 National Legal Research Group, Inc.
Obligations arising from property settlements will no longer be dischargeable in bankruptcy except in limited circumstances, thanks to federal legislation signed by President Clinton and enacted into law on October 22, 1994. The new law the Bankruptcy Reform Act of 1994, Pub. L. No. 94-394 - also contains several changes that will upgrade the protection afforded by the Bankruptcy Code to alimony and child support obligations.
The changes are set out in S. 304, entitled "Protection of Child Support and Alimony," to be codified in specified sections of Title 11 of the United States Code . Section 702 of the Act specifies that the amendments apply only to cases filed after the date of enactment (October 22, 1994).
I. New Exception to Discharge
The most significant change wrought by the new law is the new exception that protects property-settlement obligations from discharge in bankruptcy, subject to two exceptions. The scope and meaning of those two exceptions will undoubtedly be the subject of much litigation in coming months and years.
Statutory Language. The Act frames the exception in wordy and arcane terms. To the list of debts that are excepted from discharge, the Act adds this exception for any debt
(15) not of the kind described in paragraph (5) [liabilities in the nature of alimony, maintenance, or 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, a determination made in accordance with State or territorial law by a government 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 detrimental consequences to a spouse, former spouse, or child of the debtor[.]
11 U.S.C. S. 523(a)(15).
Meaning of Exception. The key language of this amendment excepts from discharge debts incurred "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." Arguably, this language is broad enough to include not only deferred payments intended as part of the property distribution but also hold harmless provisions and debts for counsel fees and experts' fees incurred in divorce proceedings.
Limitations. The two limitations to the new exception will make it difficult, however, to reliably predict whether a particular obligation will be dischargeable or not. Under those exceptions, a property settlement obligation remains nondischargeable if the debtor does not have the ability to pay or if the benefit of discharge to the debtor outweighs the detriment to the creditor spouse.
Limitation (A) applies and makes the debt dischargeable where the debtor cannot pay it and still have funds "reasonably necessary" to support himself and his dependent or to run his business. Obviously, courts will have to grapple with what "reasonably necessary" means; this wording gives practitioners leeway for creative advocacy.
Limitation (A) does not call for balancing the debtor's support needs against the creditor spouse's support needs. If, however, the creditor spouse needs the disputed debt to be paid for support, counsel could attempt to have it excepted from discharge under the existing exception for liabilities in the nature of alimony, maintenance, and support.
Limitation (B) applies and makes the debt dischargeable where the benefit of discharging it outweighs the detrimental consequences to a spouse, former spouse, or child of the debtor. This limitation appears primarily to call for a comparison of the economic circumstances of the former spouses at the time of the bankruptcy , but arguably, other facts should be considered, such as the spouses' relative earning capacities, their relative opportunities to acquire assets in the future, and whether the debtor filed for bankruptcy primarily as a way to escape the obligation to the creditor spouse. Courts will have to grapple with what the terms "benefit" and "detriment" mean; this wording, like the phrasing of the other limitation, leaves plenty of room for creative arguments.
Both limitations should be construed so that they remain what they are - exceptions to the general rule of nondischargeability. Arguably, congressional intent will be frustrated unless the limitations apply only in very unusual circumstances. Given the general rule of nondischargeability, courts should exercise care to prevent spouses from declaring bankruptcy primarily as a means to avoid property settlement obligations.
In a sense, Congress passed the buck to the courts when it included these two limitations. The new law does not enable family lawyers to predict with certainty whether their clients' award will be protected if the other spouse files for bankruptcy. For this reason, it is still preferable, if at all possible, to make sure that the award to the creditor spouse is secured with an interest in property of the other spouse.
II. Upgraded Protection for Alimony and Support
The amendments did not change the existing exception for alimony, maintenance, and child support. Under 11 U.S.C. S. 523(a)(5), such an obligation is nondischargeable, subject to two limitations: the obligation is dischargeable if it has been assigned to a third party or if it is not actually in the nature of alimony, maintenance, or support.
Priority for Alimony and Support Debts. Under the new law, claims for debts to spouses, former spouses, or children, for alimony, maintenance, or support are given a seventh priority in 11 U.S.C. S. 507(a), subject to the same two limitations [see preceding paragraph] that apply in the context of exceptions to discharge for alimony, maintenance, and support debts. Under those two limitations, the debt will not enjoy priority if it has been assigned to a third party or if it is not actually in the nature of alimony, maintenance, or support.
Protection for Alimony and Support Debts Secured by Judicial Lien on Exempt Property. The Act also added protection for alimony and support debts secured by a judicial lien on exempt property. Under the new language of 11 U.S.C. S. 522(f)(1), the debtor may not avoid a judicial lien on exempt property for a debt to a spouse, former spouse, or child for alimony, maintenance, or support. The new provision is subject to the same two limitations that apply in the context of priority and exceptions to discharge. That is, the lien may be avoided if the support debt has been assigned to a third party or if it is not actually in the nature of alimony, maintenance, or support.
Exception of Support Payments from Preference Provisions. Under the new law, payments for alimony and support are not preferential transfers that the trustee in bankruptcy has the power to avoid under 11 U.S.C. S. 547(c). Hence, a bankruptcy trustee may not recover alimony and support payments received by the creditor spouse on the eve of the bankruptcy filing. The same two limitations apply as in the context of the provision recognizing priority for support debts and protecting a support debt secured by a judicial lien.
Exceptions to Automatic Stay. The Act added additional exceptions to the automatic stay. As a result, the automatic stay does not apply to paternity proceedings, establishment or modification of alimony and support orders, and collection of such payments from property that is not part of the bankruptcy estate.
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