Family Law Attorneys Beware: Possible Exceptions to The Chapter 7 Bankruptcy Discharge

Marlene Weinstein

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (hereinafter “BAPCPA”) enacted on April 20, 2005, and generally applicable to all cases filed on or after October 17, 2005, made various revisions to Title 11 of the United States Code (hereinafter “Bankruptcy Code”) with regard to divorce-related debts.  For example, debts such as child and spousal  support were given the new classification of “domestic support obligation” and were given added protection.

Although child and spousal support obligations and other debts which were determined to be “in the nature of support” were nondischargeable pursuant to 11 U.S.C. §523(a)(5) prior to BAPCPA, regardless of whether a Debtor filed for protection under Chapter 7[1],  11[2], 12[3] or 13[4] of the Bankruptcy Code, the same was not true of other types of divorce-related debts such as a hold harmless obligation, an equalizing payment and/or a debt based upon the Debtor’s breach of a fiduciary duty, fraudulent representation and/or willful and intentional conduct (hereinafter “Non-Support Debt”).

Prior to BAPCPA, a Non-Support Debt was dischargeable if a Debtor filed for protection under Chapters 13 and received a Chapter 13 discharge.  However, if the Debtor filed a Chapter 7, 11 or 12 bankruptcy case, the Non-Support Debt was discharged UNLESS a spouse, former spouse or child of the Debtor (hereinafter collectively “Spouse”) was successful in asserting that the Debtor’s obligation to the Spouse for the Non-Support Debt should be excepted from discharge on any of the following grounds – misrepresentation or fraud [§523(a)(2)]; breach of fiduciary duty [§523(a)(4)]; willful or malicious injury [§523(a)(6)]; and/or that “the debt was incurred by the debtor in the course of a divorce or separation in connection with a separation agreement, divorce decree or other order of a court of record …” [§523(a)(15)][5].  However, unless the Spouse filed a lawsuit against the Debtor in Bankruptcy Court within sixty (60) days of the first date set for the meeting of creditors[6] and prevailed against the Debtor in the lawsuit, with the exception of §523(a)(5) debts, a Debtor’s obligations to his/her Spouse were discharged and the Spouse was forever barred from seeking collection of the debts from the Debtor.  With the enactment of BAPCPA, the rules changed.  Pursuant to the provisions of BAPCPA, a Debtor who now files a Chapter 13 case and receives a Chapter 13 discharge will still receive a discharge of a Non-Support Debt incurred in connection with a divorce or separation that might have been excepted from discharge in a Chapter 7 case prior to BAPCPA pursuant to 11 U.S.C. §523(a)(15), such as a hold harmless obligation and/or an equalizing payment.

However, if the Non-Support Debt is one that might be excepted from discharge because the debt was incurred based upon the Debtor’s misrepresentation or fraud under Section 523(a)(2), or the Debtor’s breach of fiduciary duty under Section 523(a)(4), then such a debt can be excepted from the discharge in a Chapter 13 case pursuant to post-BAPCPA 11 U.S.C. §1328(a)(2).  However, just like in the pre-BAPCPA Chapter 7 cases, the Spouse would have to file a complaint against the Debtor within sixty (60) days after the first date set for the meeting of creditors in the Chapter 13 case and prevail against the Debtor in the complaint.

Pursuant to the provisions of BAPCPA, a Debtor who now files a Chapter 7 case and receives a Chapter 7 discharge does not receive a discharge of any debts incurred in connection with a divorce or separation, etc., even those debts that might otherwise have been dischargeable prior to BAPCPA pursuant to 11 U.S.C. §523(a)(15).  There is no longer a balancing test for debts such as hold harmless obligations and equalizing payments — they are not dischargeable by the Chapter 7 discharge.  In addition, debts incurred in connection with a divorce or separation that were incurred based upon the Debtor’s misrepresentation or fraud and/or breach of fiduciary duty pursuant to Sections 523(a)(2) and/or (a)(4) that required the filing of a complaint in the Chapter 7 case to obtain an order that such debts are nondischargeable no longer require a Spouse to file a complaint in the Chapter 7 case to be nondischargeable.

HOWEVER, there may be a glitch.  Assume the following facts with respect to a Spouse’s claim against the Debtor for a breach of fiduciary duty based upon the Debtor’s unauthorized and post-separation disposition of his/her retirement account:

1. Assume the Debtor files a Chapter 7 case.  The debt is nondischargeable as a Non-Support Debt based upon the fact that it is a debt incurred in the course of a separation and/or a divorce pursuant to 11 U.S.C. §523(a)(15).
2.  Assume that the debt is also likely to be nondischargeable as Non-Support Debt that is based upon the Debtor’s breach of fiduciary duty under 11 U.S.C. §523(a)(4).  However, because the Spouse knew the debt was nondischargeable without taking any action under Section 523(a)(15), the Spouse decided not to spend any money filing a complaint against the Debtor in the Bankruptcy Court, and therefore, the Spouse never filed the complaint in the Chapter 7 case that is required to be filed within the 60-day period following the meeting of creditors in order to obtain a determination by the Bankruptcy Court that the Debtor breached his/her fiduciary duty and that the debt is nondischargeable, not only pursuant to Section 523(a)(15), but also pursuant to 11 U.S.C. §523(a)(4).
3. Several years later, the Debtor files a Chapter 13 case.  As stated above, all Non-Support Debts will be discharged in the Chapter 13 case unless it is nondischargeable based upon 11 U.SC. §§ 523(a)(2) and/or (a)(4).
4. The only Non-Support Debt that was excepted from the Chapter 7 discharge was the divorce-related debt under 11 U.S.C. §523(a)(15) since there will be discharged in the Chapter 13 case.

Based upon the foregoing facts, it is likely that the Debtor will take the position, and this writer believes that the Bankruptcy Court will agree, as follows:

1. That the Non-Support Debt that was excepted from the Chapter 7 discharge was nondischargeable pursuant to 11 U.S.C. §523(a)(15) only;
2.  That the Spouse waived his/her right to assert that the debt arising out of the Debtor’s breach of fiduciary duty is nondischargeable pursuant to 11 U.S.C. §523(a)(4) due to the fact that the time to raise that issue was sixty (60) days after the first date set for the meeting of creditors in the Chapter 7 case;
3.  That since the Spouse failed to file the complaint in the Chapter 7 case within the requisite deadline, that the only Non-Support Debt that survived the Chapter 7 case was the debt incurred in connection with a separation and/or a divorce pursuant to 11 U.S.C. §523(a)(15); and,
4.  Therefore, the debt will be discharged in the Debtor’s Chapter 13 case.

The foregoing is an attempt to bring to the attention of both family law and bankruptcy attorneys, the necessity of discussing all of the issues that arise with respect to the dischargeability of a divorce-related debt that is a Non-Support Debt, so that a Spouse can make an informed decision as to whether or not to rely on the Chapter 7 discharge to preserve his/her rights against the Debtor.

Marlene G. Weinstein is a sole practitioner whose practice is devoted exclusively to Bankruptcy Law representing debtors, creditors and Chapter 7 trustees.  She believes pre-bankruptcy planning is important and that it can sometimes be used as an effective tool in negotiations between parties involved in non-bankruptcy disputes.  She often works with her clients in conjunction with their family law, tax, litigation and other non-bankruptcy attorneys.  Her office is in Walnut Creek.  She can be reached at (510) 472-0800.

[1]    Chapter 7 discharge provided by 11 U.S.C. §727.
[2]     Chapter 11 discharge provided by 11 U.S.C. §1141.
[3]     Chapter 12 discharge provided by 11 U.S.C. §1228.
[4]     Chapter 13 discharge provided by 11 U.S.C. §1328.
[5]     Cases interpreted the provisions of Section 523(a)(15) in a variety of ways since its passage in October, 1994; however, whether a debt incurred in the course of a divorce or separation, etc. would be discharged required the court to determine either (A) that the debtor did not have the ability to pay the debt or (B) that discharging the debt would result in a benefit to the debtor that outweighed the detrimental consequences to the spouse, former spouse or child of the debtor.
[6]     See Federal Rule of Bankruptcy Procedure 4007(c).