The case of mismatched law: alimony and bankruptcy

Alimony, or maintenance as it is called here in Kentucky, is an interesting topic because how state law defines and treats alimony does not necessary mesh with the bankruptcy code. In this post, I am talking about when a non-debtor ex-spouse owes the person filing bankruptcy (the debtor) alimony or maintenance (the two terms are interchangeable and I’ll stick with alimony since it is the most recognized). The scenario is a divorced debtor filing a bankruptcy (it can be either a chapter 7 or a chapter 13) because their ex has failed to pay the alimony as ordered as is now in a world of hurt. So, the debtor has to list the alimony owed to him or her because it comes into the bankruptcy estate through 11 USC Sect. 541. There is even a “clawback” provision in 11 USC 541(a)(5)(C) that reaches 180 days beyond the filing date of the petition in cases where a divorce has not yet been finalized.

To be sure, 11 USC Sect. 522(d)(10)(D) appears to exempt alimony (“the right to receive”) so that the debtor gets to hold on to it. However, appearances can be deceiving because the bankruptcy courts do not have to accept the determination of the parties or the state court in deciding if a certain asset is alimony. The debtor may have a court order that calls what the ex owes them alimony and he or she may believe it is alimony, but the bankruptcy court can decide differently. If the bankruptcy court deems the awarded monies to actually be a property settlement, then it is not exempt beyond any available “wild card” exemption from 11 USC 522(d)(5).

The bankruptcy court makes its determination as to whether or not an award of alimony is truly alimony or if it is actually a property settlement mechanism by looking at what actually transpired. There are different aspects that the court may focus on and so it is more likely to be alimony if: 1) it ends at death or remarriage, 2) it can be modified based on need, 3) the debtor did not have property or resources to meet their basic needs, 4) it is subject to the tax treatment for alimony in the tax code (taxable to recipient; deductible by payor), and 5) the payments go directly to the debtor. If, on the other hand, the award of monies was in lieu of other property or debt, then it is unlikely to be deemed alimony. These are not necessarily exclusive factors, but will give an idea of how the courts analyze an alimony claim of exemption. The bottom line is that the court wants to be sure that the monies are actually for the support and sustenance of the recipient. This is consistent with the other items in Sect. 522(d)(10)(D) because each is a replacement for wages.

Be careful entering into a bankruptcy if you are the recipient of alimony or maintenance. When you interview your prospective attorney, but sure they understand the nuance behind the stated words of the law. They need to be able to analyze how likely the court is to see the award as alimony. If the award is sizable, then you can expect to have an objection to the exemption be filed by the trustee. If you win by convincing the court that it is indeed alimony, you will still have to show that all of it is “reasonably necessary” to live on – and that does not mean living in style or luxury.

Debt and Divorce

In Kentucky marital law there is no presumption that debt incurred by one spouse is marital debt and the recent Supreme Court of Kentucky opinion in Rice v Rice, 2009-SC-000730-DG, March 24, 2011 (to be published) reaffirms that doctrine. Sometimes you can tell when a court gets hacked off, and some of that comes through in this opinion written by Justice Noble. One clue as to the court being upset is when they use the word “egregious” and it appears in this opinion.

The husband and wife had been married for 42 years. The wife, Carolyn, worked at an $8.00 an hour job. The husband, Jackie, allowed their adult son to accumulate around $65,000.00 debt by letting him use credit cards and co-signing for loans. This went on for about four (4) years before Carolyn got wind of her husband allowing this mountain of debt to arise and when she confronted Jackie about it, he just changed the mailing address for the bills so she would not find them. Are you starting to see what lead to the divorce?

Anyway, the trial court that granted the divorce assigned each of the parties one half (1/2) of this debt even though Carolyn had not authorized it. The Court of Appeals let that decision stand, but the Supreme Court would not tolerate it. They held that a debt incurred or authorized by one spouse and which the other spouse neither authorized nor received a benefit from is not marital debt.

The reason it was important that Carolyn take her fight to the Supreme Court of Kentucky instead of filing bankruptcy is that the assignment of debt may have been deemed a “domestic support obligation” by the bankruptcy court. So, even though her legal obligation to the creditors may have been extinguished in bankruptcy, she might have remained on the hook to Jackie for around $32,500.00 because domestic support obligations are not discharged.

Discharge of Debt and Domestic Support Obligations

The changes in the bankruptcy code from the 2005 BACPA essentially eradicated a debtor’s ability to discharge their domestic support obligations. So, if you are divorced or pay child support, it is important to understand what you can do regarding debts arising from the divorce or child support. A recent decision by Judge Scott, Judge for the Eastern Distric of Kentucky Bankruptcy Court, offers a concise explanation of how domestic support obligations arise and how they are impacted by the automatic stay from collection activity of 11 U.S.C. Section 362.

Domestic support obligations (I’ll call these “DSO”s here on out) are defined liberally by the bankruptcy code at 11 U.S.C. Section 101(14A). When a DSO arises because it is “in the nature of” maintenance, alimony or child support, then the automatic stay of Section 362 does not prevent collection actions from property that is NOT part of the estate. The clearest example of this is when the divorce court ordered one party to pay his or her ex-spouse monthly payments (either alimony payments or child support) and the receiving party can still expect to receive those monthly payments from the debtor’s ongoing wages, which are not part of the estate of a Chapter 7. The receiving spouse need do nothing in the bankruptcy court to take action to enforce this order of support.

The recent decision referenced above gives a great example of a very different way that a DSO can arise. In that case, the debtor was ordered to maintain payments on the marital residence until it sold. However, he did not do so (perhaps he could not or maybe he thought he was pulling one over on his ex-wife, I have no idea) and the marital residence foreclosed. There was a deficiency of around $45,500 from the foreclosure as compared to the assessed value of the house. Presumably, the full debt on the house was covered by the sale proceeds and the $45,500 represented equity. So, the debtor had been ordered by the divorce court judge to pay 1/2 of that to his ex-wife. The debtor argued that since the house did sell and there was no net gain from said sale, that he did not owe his ex-wife one cent. Neither the divorce judge nor Judge Scott bought this argument.

The debtor went into bankruptcy with a $22,750 plus DSO as a result of the foreclosure on the marital residence. Since it was not in the nature of alimony, maintenance or child support, the automatic stay did prevent the ex-wife from pursuing collection activity, so she moved the court to lift the stay. She attempted to do so, but failed to sufficiently explain to the bankruptcy court the reason why she should be allowed to have the stay lifted.

The end result is that the debtor clearly has to repay his ex-wife the $22,750 that he theoretically could have realized if he had kept current on payments and sold the house on the open market. However, since the ex-wife did not fully carry her burden of proof, she is going to have to wait until the bankruptcy is closed to take action to collect this debt.

Several lessons come from this case. First, you really should consult with an attorney familiar with both family law and banruptcy law if you are going to allow property that was subject to a decree or court order in a divorce be repossessed or foreclosed upon. The long term cost to you may be far more than you want to incur. Second, remember that bankruptcy does not take care of every sort of debt and you need to recognize what debts will remain. This could help you decide between pursuing a work-out outside of bankruptcy, filing a Chapter 7, or filing a Chapter 13. Third, if you are owed a DSO, be sure to adequately provide evidence to the bankruptcy court of the “good cause” (the reason why you are harmed) required by 11 U.S.C. Section 362(d)(1) for the automatice stay to be lifted.

Debt, divorce and the devil.

I was sitting in state court just the other day and saw yet another example of the interplay between divorce and bankruptcy. A creditor had sued a woman for a delinquent debt. The woman came to court to defend against a motion for default judgment. Her defense was that she was not responsible for the debt because it had been assigned to her ex-husband in their divorce. Unfortunately, that is not a valid legal defense. Many divorced persons erroneously assume that the divorce decree assigning debt to their ex also absolves them of liability on that debt. It does not. This woman is now facing wage and bank account garnishements because her ex-husband failed to pay the debt. He may have even filed bankruptcy which would explain why the creditor was only coming after the woman. Her only option is to go back to family court and get the judge there to enforce their own order and make the ex re-pay her for what it cost her. If he is without resources, this may mean he spends some time in jail for contempt, but the woman’s finances are still wrecked. Ah, divorce – the curse that keeps on cursing – the devil’s own little specialty area.

Anyway, it is important for family law practitioners to know something about bankruptcy and bankruptcy lawyers to know something about family law. I find it a natural fit to practice in both the family law and the bankuptcy areas.

Domestic Support Obligation & Bankruptcy (or No Discharge for the Durango Debt)

The Kentucky Court of Appeals just issued a decision directly related to family law and bankruptcy that shows why knowledge of both fields can be so important. In Howard v Howard, 2008-CA-001059-MR (June 12, 2009)(to be published) the Court addressed two important issues regarding domestic support obligations.

A domestic support obligation has a very broad definition under the bankrucpty code (11 USC 101(14A)) encompassing any debt owed to or recoverable by “a spouse, former spouse, or child of the debtor or such child’s parent, legal guardian, or responsible relative” including a “government unit”. This includes alimony (maintenance), child support, or other obligations arising out of a divorce or separation. The debt can be established through a separation agreement, decree or other order of the court. 11 USC 523(a)(15). For Kentucky Courts, it also includes a Dodge Durango debt.

In this case, Mr. Roy Shane Howard divorced his wife, but he agreed to, and was later ordered in the decree, to pay towards a deficiency judgment arising from the repossession of their Durango. The case does not say, but that repossession may have been the final straw that broke the back of their marriage. Some folks really love their Durangos.

Anyway, after the divorce, he listed this deficiency judgment as a debt in his bankruptcy and his ex-wife did not object to its discharge so he figured he no longer owed that debt. However, little did he realize that Kentucky Courts share jurisdiction with Federal courts to determine whether an obligation is discharged and the Court of Appeals wasn’t buying the argument that she had to object in the bankruptcy case. After all, the bankruptcy code declares such debts as non-dischargeable and spells out no special action required by the creditor.

This Court determined that Roy’s obligation in the divorce to pay part of the Durango deficiency was a domestic support obligation. While the bankrutpcy discharged the debt as to the original lender, it did not disturb his responsibility for the debt to Sondra, his ex-wife. In other words, the original creditor could not come after Roy for the debt any longer, but they could go after Sondra and Sondra could bring it right back around and get Roy for contempt in the divorce court. And that is exactly what happened.

So, if debts are an issue in a divorce proceeding, it is wise to plan carefully what will happen to those debts. Often, it is best for the each person to set aside the anger and honetly assess if they can pay those debts once the one set of living expenses becomes two separate households. If not, and they otherwise qualify for bankruptcy, then a joint bankruptcy may be the best option.

I said there were two important domestic support obligation issues, but I will save the other one for the next post.

Adoption statutes require strict compliance

Adoption can be an expensive proposition and I have been asked on occasion if a person can do their adoption pro se (on their own and without a lawyer). Actually, this question tends to come up in family law matters in general far more than in other areas of law. I hear this question about self-representation even less often in bankruptcy where folks clearly are in dire straits financially. My response is typically yes, you can but . . .. Then I relate to them a show I saw on Discovery or TLC about a man who was out hiking and became trapped when a boulder rolled onto his arm. He would have died out in this ravine had he not amputated his own arm with a pocket knife (the tv show assured me this was a true story). Anyway, in this graphic and slightly grotesque story the man did what he had to do to survive, but it had to be exceedingly painful and extremely messy. Representing oneself in a family law matter can be just like that: exceedingly painful and extremely messy.

That answer seems to ring intuitively true for people in divorce situations, but many assume that since an adoption is a happy occasion and that judges love putting families together rather than tearing them apart, that one could handle it without a lawyer. The contrary is actually true. In the recent Kentucky Court of Appeals decision R.M. v. R.B., 2008-CA-001099-ME, (2009, to be published), the Court reminds us that “[b]ecause adoption is a statutory right, Kentucky Courts require strict compliance with the statutory procedures to protect the rights of natural parents.” The statutory framework for adoption contained in KRS 199 has many “if, then” kinds of provisions requiring careful navigation even by seasoned adoption attorneys. Because of this strict compliance requirment, adoption is the least likely area of family law where one should proceed pro se. At the very least, consult with an attorney that is knowledgeable in adoptions to see if there are any “boulders” in your particulare situation that need to be dealt with.

Here I am dead and my ex-wife (ex-husband) got all of my retirement!?

It is common for a Separation and Property Settlement Agreement to be reached in a divorce situation where retirement benefits are divided up. When one spouse’s retirement is split up and a portion is given to the other spouse, family law practitioner’s know that a Qualified Domestic Relations Order (“QDRO”) is required in addition to the agreement document. However, due to off-setting of funds, one spouse generally has a retirement account that remains unmolested and sometimes each spouse keep their retirement wholly as their own through negotiations. In this latter situation, a QDRO is not required and so they are rarely prepared and entered with the court and the plan administrator. A recent Supreme Court of the United States (“SCOTUS”) decsion, KENNEDY, executrix of the ESTATE OF KENNEDY, DECEASED v. PLAN ADMINISTRATOR FOR DuPONT SAVINGS AND INVESTMENT PLAN et al., Decided January 26, 2009(available here at Findlaw) points out the danger assuming the divorce’s settlement agreement wraps up loose ends regarding retirement accounts.

In the Estate of Kennedy case, Husband and Wife entered into an agreement where Wife gave up her interest in Husband’s savings and investment plan (“SIP”) that was governed by the Employee Retirement Income Security Act of 1974 (“ERISA”). The divorce was granted and the settlement was accepted by the courts. Husband’s attorney did not see the need for a QDRO and Husband assumed that was that and never changed his designation of beneficiary with the SIP administrator. When Husband died, the SIP administrator disbursed the remaining funds to ex-Wife. Everybody else got a bit peeved over this and sued in Federal District Court because it involved a question of federal law under ERISA.

Without getting too far into the analysis, SCOTUS decided to keep things simple and straightforward for plan administrators: either you do a QDRO or you change your beneficiary. The plan administrator is to look to the documents of the plan under ERISA to determine where the money goes avoiding complicated inquiries into a person’s intent. While a QDRO is an exception to this that could require the administrator to look outside of the plan documents, such an inquiry would be limited.

The lesson here is that if your are able to keep your retirement accounts intact through a divorce, you cannot rely on the divorce settlement agreement to direct those funds upon your death. You must either change your designated beneficiary, or have a QDRO entered – changing your beneficiary is by far the simplest and least costly of those options. Family lawyers need to provide their clients with follow-up directions at the end of a divorce to tie up loose ends such as changing beneficiaries for retirement accounts.

Family Law Planning & Bankruptcy

As I have suggested, I believe there is a significant intersection between family law and bankruptcy law. One example of this link comes in the form of the homestead exemption. Kentucky now allows for debtors seeking bankruptcy to use the Federal exemptions. This greatly increased the homestead exemption from the low and static Kentucky exemption to the Federal exemption that is tied to inflation. Currently, an individual can claim $20,200.00 of the equity of their residence as exempt property. For a married couple, that means they can claim $40,400.00 equity in their residence as exempt. In other words, if you are married, have a home that is valued at $200,000.00 dollars and you owe $160,000.00 on the home that is secured by a mortgage, then you can likely reaffirm the debt of $160,00.00 and still keep your home even in a Chapter 7 bankruptcy.

This knowledge is priceless if you are either contemplating divorce or in the midst of a divorce action. Saving a home in the face of a bankruptcy can benefit your family regardless of whether the divorce occurs or not (though hopefully, as I stated here, the divorce could be avoided). Knowing the exemption and interplay of bankruptcy and family law can allow for wise planning on the timing of the filing or bankruptcy, how marital assets are divided, and where monies might come from to satisfy domestic obligations.

The Debt & Divorce Correlation

Common thought has long been that severe financial stress leads to divorce. Such ideas, when repeated often enough, are accepted as truth without much scrutiny. However, research exists to refute this conclusion (here is one example from 2006 though it focuses on only one culture). I suspect the answer is, as Suzy Brown (Director of Midlife Divorce Recovery Bootcamp) suggests, difficult financial situations bring some couples to renew their efforts to make their marriage work while pushing others over the edge to divorce and I doubt a strong correlation between debt and divorce would be found in the United States population.

What does appear clear is that mounting debt and dire economic expectations leads to increased stress for many folks and finances, in turn become a source of marital strife. For those whom such strife pushes toward divorce, I find it troubling that they would think of dissolving their marriage long before contemplating eradicating their debt. Somehow, in our society, it has become more acceptable to sever the marriage ties, but it remains unthinkable to file for bankruptcy and release the weight of debt. And yet, bankruptcy very well could be the thing that relieves enough stress for those looking to divorce as a solution to back up and give their marriage another chance. Anecdotally, it often appears to be either an issue of pride where they created the debt thus they will be responsible for repaying it come hell or high water. Logically then, those same sentiments of honoring a contract should apply even more to the contract of marriage which is usually ratified before God.

To be clear, I do respect people who desire to be responsible for the debts they created, but there are circumstances when the fresh start that bankruptcy can offer is the best course to pursue. The bankrupcty code, specifically Chapter 7 and Chapter 13, is meant to provide a safety valve for individuals who, by honest mistake or life circumstances, got into debt beyond what they can reasonably manage. In essence, it is legislative grace that not only helps those individuals, but greases the gears of our economy on the larger scale. Our modern day bankruptcy code can be traced to God’s original notions of bankruptcy. That’s right, God designed a bankruptcy code long ago and it can be found in Deuteronomy (begin your review in Chapter 15). In contrast to the year of jubilee and that system of debt relief, Holy Scripture offers only narrow circumstances where divorce is condoned.

So, I urge those folks who are experiencing marital strife due to mounting debt, especially to that subset of people who are considering divorce as a result of this strife, to go talk to someone who knows bankruptcy law and see if you could qualify for relief through a Chapter 7 or 13. If so, that may give you enough surcease from the economic tension to strengthen your marriage. You can find practitioners who are versed in both family law and bankruptcy for an even fuller picture of your options and the consequences of each. I, for one, would far rather represent a couple in a bankruptcy so they can enjoy a real fresh start financially than represent that same couple in a divorce. To that end, I return to posting on this blog and intend to provide information about consumer bankruptcy as well as family law because I see the two areas of law significantly linked.

Child Support Intricacy: Tax credits

The Court of Appeals addresses the treatment of a couple of different tax credits in determining income for child support calculations in the to be published decision Brausch v. Brausch, 2007-CA-002198-ME (Sept. 12, 2008). The appellant, James Brausch, argued that the Earned Income Credit and the additional Child Tax Credit that his ex-wife, Tracy, received in 2006 should count as income for her.

One would have to have all the income figures and plug them into the Kentucky child support worksheet to know how exactly James would benefit from the inclusion of these tax credits. Adding income to either side of the equation can raise the overall support obligation, but also changes the percentage each party would be responsible to pay. So, one can assume that James percentage would be lowered enough to decrease his obligation.

The Kentucky child support definition of income in KRS 403.212 is very broad, but benefits from means-tested public assistance programs are specifically excluded as income. The Court determined that the Earned Income Tax Credit is a public assistance benefit because it is treated as a dollar for dollar payment of tax. Rather than just reducing one’s tax liability, it could actually result in a refund. They also determined it was means-tested because it is directed towards the neediest of families. For example, it is phased out for families with two or more qualifying children at just $11,600.00 earned income. So, the Court held that the Earned Income Credit should not be included as income.

The Child Tax Credit received different treatment by the Court. They point to the $110,000.00 ceiling for receiving this credit so it cannot qualify for exclusion from income as a means-tested public assistance benefit. However, the Court determined that because the Child Tax Credit is determined by and tied to the dependent child exemptions, it is not income. Basically, the Court treated the Child Tax Credit as an extension of the dependent child exemptions which have traditionally been within the discretion of the trial court to allocate between parents. In this particular matter, Tracy had already been awarded the dependent child deductions for the year in question, so she was allowed to keep the $3000.00 she recieved but not include the amount as income.

In going forward in this case and as a guide for others, the Court favors equally dividing such deductions in a simple and straightforward manner. This can be accomplished with an even number of children by assigning each parent one-half of the deductions each year or by rotating the deductions from year to year.