Crosswhiting The Debtors Fresh Start Recent Decisions Regarding the Non-dischargeability of Marital Obligations

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Apr 2003

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The fundamental concept that every debtor is entitled
to a clean slate under the Bankruptcy Code has long been limited by the
inability of the debtor to discharge an obligation to pay family support or
debts arising from a divorce decree or separation agreement. Sections 523(a)(5)
and (15) of the Code explicitly set forth that support obligations and marital
debts are excepted from discharge, subject to certain prescribed limitations.
The Seventh Circuit, in the benchmark case of <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
re Crosswhite, 148 F.3d 879 (7th Cir. 1998)</a>,
best articulated the theory that "the debtor should not use the
protection of a bankruptcy filing in order to avoid legitimate marital and child
support obligations." It is apparent from reading the cases in the Crosswhite genre that courts are continuing to constrict the
ability of debtors to discharge support and support-related obligations.

Two
different federal appellate courts recently faced the issue of determining the
dischargeability of debts labeled as "property distribution" owed
to the creditor spouses in state divorce proceedings. In the matter
of <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… re Werthen, 282 B.R. 553 (B.A.P.
1st Cir. 2002)</a>, the Bankruptcy Appellate Panel for the First Circuit
found that installment payments owed by the debtor to his former spouse
emanating in part from the creditor's marital share in the debtor's
ownership interest in his family business were not dischargeable in bankruptcy.
The court found, inter alia, that the
amount and structure of the payments were "in part made in lieu of more
generous alimony awards," <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
B.R. at 560</a>. As such, the court agreed with the trial court below
that the installment payments were intended to provide support to the creditor
and the children of the parties.

The Eleventh Circuit reached a similar conclusion in the matter
of <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… v. Cummings, 244 F.3d 1263 (11th Cir. 2001)</a>. Here, a
Florida divorce court awarded to the creditor spouse the sum of $6.3 million as
an "equitable distribution award," payable by the debtor in three
equal installment payments. The Eleventh Circuit noted with particularity that
the divorce court indicated that the creditor spouse would depend on the
equitable distribution award to support herself and the children of the
parties. The court further noted that state divorce courts often designate a
support obligation as "property settlement" and thereafter adjust
alimony awards depending on the nature and amount of marital assets available
for distribution (citing <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=9…
re Gianakis, 917 F.2d. 759 (3rd Cir. 1990)</a>).

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It is apparent from reading the cases in the Crosswhite genre that courts are continuingto constrict the ability of debtors to discharge support and support-related obligations.
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Another federal appellate court recently analyzed the issue of whether legal fees
ordered to be paid by the debtor to the creditor's family court attorneys
arising from custody proceedings are dischargeable in bankruptcy. In <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=3…
re Maddigan, 312 F. 3d 589 (2nd Cir. 2002)</a>,
the Second Circuit held that the award of legal fees creates a debt that is not
dischargeable in bankruptcy. The court found that the fact that "a debt
is payable to a third party does not prevent classification of the debt as
being owed to the (debtor's) child." <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=3…; An interesting secondary issue in the Maddigan matter arose from the fact that the debtor and the
mother of the debtor's child were never married. The Second Circuit
stated that the amendment of §523(a)(5) in 1984 to include "other
orders of courts of record" (in addition to separation agreements and
divorce decree) was specifically made to "plug the loophole that allowed
fathers of children born out of wedlock to escape child support obligations in
bankruptcy." <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=3…; (citing the dicta of the district court in <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
re Magee, 111 B.R. 359, 360 (M.D. Fla. 1990)</a>).

There
have been several recent noteworthy opinions from the bankruptcy trial courts
relating to dischargeability of marital obligations. For one, in <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=%… re Brown, ___ B.R. ___</a>, 2003
Bankr. Lexis 80 (Bankr. W.D. Pa. 2003), the Bankruptcy Court for the Western
District of Pennsylvania ruled that an obligation of a debtor to pay to a
creditor spouse a sum in consideration of the award to the debtor of the
marital business was not dischargeable in bankruptcy, even though the parties
agreed, by a "so-ordered" stipulation signed after the divorce decree,
that the obligation was equitable distribution and not spousal support
(apparently in an prescient attempt by the debtor to establish a basis for
discharge of the debt). The Brown court
held that it "must look beyond the label attached to a given obligation
to establish its true nature," 2003 Bankr. Lexis 80, pg. 9, citing
<a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=9…, supra, 917 F.2d. at 762</a>. The
court further found, in the absence of any stated intention by the state
divorce court, that the obligation in question was intended to provide support
to the creditor spouse. This finding was based on the review by the Brown court that by function of the imposition of the
subject obligation by the trial court, the award provided a semblance of parity
with respect to the parties' income, and that it enabled the creditor
spouse to provide herself with the necessities of life. There is no doubt that
the Brown ruling further
amplifies the sentiment expressed in Werthen and Cummings that the actual pecuniary effect of an obligation set forth in a
marital decree outweighs the characterization of such obligation by the parties
or the court of decree.

The
bankruptcy court for the District of Connecticut recently faced the balancing
test set forth as part of §523(a)(15) of the Code. The test provides that
upon a showing by the creditor that a debt was incurred in the course of a
divorce, the burden thereafter shifts to the debtor to show that the debtor is
unable to pay the debt or that the benefit of a discharge to the debtor
outweighs the detrimental consequences to the creditor. The bankruptcy court
found in <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
re Rogan, 283 B.R. 643 (Bankr. D. Conn. 2002)</a>,
that the debtor, a young associate at a mid-sized law firm, failed to meet his
burden under the balancing test to the extent that he could not establish as a
matter of law his right to discharge under the test. The court explicitly noted
inter alia that based on the
debtor's prospects for an increase in income and his relatively young
age, the debtor would not be unduly burdened by the non-discharge of his
obligation.

<h3>Recent Opinions Permitting Discharge</h3>

The news was not all bad for debtors seeking to discharge marital obligations. The
bankruptcy court for the Central District of Illinois handed the debtor a
victory in <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=%… re Bucher, ____ B.R.____</a>, 2003
Bankr. Lexis 96 (Bankr. W.D. Ill. 2003). The court directed that certain debts
owed to various creditors could be discharged by the debtor, notwithstanding a
divorce decree that the debtor was responsible for the debts and would hold the
spouse harmless from those debts. The court found under §523(a)(15) of the
Code that the debtor was unable to pay the subject debts based on her net pay
and her other obligations, and thus held that discharge was therefore
reasonable.

A debtor was also successful in <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
re Bailey, 285 B.R. 15 (Bankr. N.D. Okla.
2002)</a>. The bankruptcy court for the Northern District of Oklahoma
found that the intent of an installment award owing to a creditor spouse, even
though labeled as "alimony" in part, was to compensate the spouse
for the marital value of the debtor's business. The court rejected the
creditor's allegation of "quasi estoppel," which such allegation was made based on the
prescribed ability of the debtor to treat the payments as deductible for
federal income tax purposes. The basis for such rejection was that the court
found that neither party had considered the tax consequences of the award prior
to the agreement incorporated into the decree. The court further opined that
the parties intended the payments to constitute only the marital value of the
business, notwithstanding the creditor's assertions to the contrary.

<h3>Conclusion</h3>

Notwithstanding the rulings in Bucher and Bailey, it appears that the trend in the bankruptcy
judiciary throughout the nation is to further strengthen the ability of
creditor spouses to enforce marital obligations, even as such rulings further
erode the debtors' ability to truly achieve the "fresh start"
contemplated by the Bankruptcy Code. It is evident from all of the recent case
law that mere "labels" of a particular obligation within a divorce
decree or agreement will be viewed as having no import in a subsequent
adversary proceeding brought by a creditor spouse, and that the intention of
the parties and/or the practical effect of the obligation to the parties is
what will be reviewed within the proceeding. Family law practitioners
representing the "obligor" within the scope of a marital proceeding
would be well advised, if possible, to structure a payment sequence so that
such debt is truly one for distribution, and not for spousal or family support.
Of course, the hard part will be to convince a future bankruptcy judge or
tribunal that the structure survives the Crosswhite test.

Journal Authors

David Meth

Journal Date

Tuesday, April 1, 2003 - 12:00

Bankruptcy Rule

2003