Dispositions of Marital Property Aren’t Always Beyond the Avoiding Powers

For every rule, there’s an exception.

On January 30, we reported the Paris decision by Bankruptcy Judge David D. Cleary of Chicago, which could be read (improperly) to mean that a division of marital property in a judgment of divorce is inviolable in bankruptcy. To read about Paris, click here.

In an opinion on January 25, Bankruptcy Judge Nicholas W. Whittenburg of Chattanooga, Tenn., found an exception to the general rule when he explained why an award of marital property to someone other than a spouse can be set aside as a fraudulent transfer.

Amicably, a couple divorced and divided marital property between themselves. In addition, the consent decree put 46 acres of undeveloped land into an irrevocable trust for the benefit of their two children. The divorcing parents were the co-trustees.

Two and half years later, the husband filed a chapter 7 petition. The trustee attacked the trust as a constructive fraudulent transfer under Georgia law. On cross motions for summary judgment, the trust contended there was no triggering creditor under Section 544(b)(1) and that divorce decrees are beyond the reach of the avoiding powers.

The Triggering Creditor

Section 544(b)(1) allows a trustee to “avoid any transfer of an interest of the debtor in property . . . that is voidable under applicable law by a creditor holding an unsecured claim that is allowable under section 502.”

As the triggering creditor, the trustee pointed to a creditor that the debtor had scheduled as having an undisputed, unsecured claim for $3,600. The trust argued that the creditor did not qualify because the creditor never filed a proof of claim before the bar date. Judge Whittenburg said that the argument was “not without support.”

“For several reasons,” Judge Whittenburg said, “a majority of courts have recognized that the failure to file a proof of claim does not disqualify a creditor from being the triggering creditor under Section 544(b).” Among other authorities, he cited the Collier treatise.

In addition to focusing on the statute’s use of the word “allowable,” Judge Whittenburg observed that the failure to file a proof of claim “does not extinguish a creditor’s status as a creditor” and would not bar the creditor from opposing discharge or dischargeability or moving for dismissal of the case.

Having identified a triggering creditor, Judge Whittenburg denied the trust’s motion to dismiss on that basis.

An Inviolable Divorce Decree?

Judge Whittenburg turned to the question of whether a transfer effected pursuant to a divorce decree could be avoided as a constructively fraudulent transfer for lack of consideration. He began by observing that the children would not have received any property had it been a contested divorce. He deduced that it was a “gratuitous transfer” by the couple for the benefit of their children.

The trust relied on Ingalls v. Erlewine (In re Erlewine), 349 F.3d 205 (5th Cir. 2003), where the matrimonial court had divided property unequally in favor of the husband because the wife had wasted property. Although the Fifth Circuit declined to upset a final divorce judgment, Judge Whittenburg said that the case was “factually distinguishable.”

While the division of property in Erlewine had been fully litigated, the disposition of marital property in the case before him was on consent. Had the divorce been litigated, Judge Whittenburg said that the Georgia court would not have awarded the 46 acres to the children.

Because the creation of the trust was a gift for the children, Judge Whittenburg granted the trustee’s motion for summary judgment, finding that there was a triggering creditor and that the transfer was made without consideration when the debtor was insolvent.