Chapter 7: Trustee liquidates debtor’s nonexempt assets to pay creditors, most consumer cases involve no nonexempt assets and are closed within 6 months with no payments to creditors, certain debts may be excepted from the bankruptcy discharge, including spousal support and, under certain circumstances, other divorce related debts.

Chapter 13: Repayment plan available only to individuals, trustee collects payments and disburses to creditors, plan usually lasts from 3 to 5 years, debtor must pay secured and priority claims in full but need not pay unsecured claims in full as long as debtor contributes all disposable income to plan and creditor receives at least as much as creditor would receive in a chapter 7 case, certain debts are excepted from the discharge, including support claims but not other divorce related debts.


II. Conflicting Jurisdiction of Bankruptcy and Family Law Court

Jurisdiction of bankruptcy court set forth in 28 U.S.C. § 1334(a) and (b).
Bankruptcy court has exclusive jurisdiction over the bankruptcy case. 28 U.S.C. § 1334(a).
Bankruptcy court has nonexclusive jurisdiction over (1) all civil disputes based on bankruptcy law, (2) all civil disputes based on nonbankruptcy law but arising in a bankruptcy case, and (3) all civil disputes related to a bankruptcy case. A dispute is related to a bankruptcy case if its outcome could have any conceivable effect on a bankruptcy case. In re Fietz, 852 F.2d 455 (9th Cir. 1988). State court has concurrent jurisdiction to hear these issues.

Caveat: There is a very recent 9th Circuit case that holds that the state court has no jurisdiction to determine whether an action is barred by the automatic stay. Even if the issue is raised and determined in state court, the decision may be collaterally attacked in the bankruptcy court. In re Gruntz, 166
F.3d 1020 (9th Cir. 1999). (This case involved a criminal action against a debtor former spouse for failure to pay child support. The debtor was an attorney whose criminal record was preventing him from being admitted to the Bar. Therefore, after serving his sentence, he challenged the state court ruling in the bankruptcy court.) Before this decision, it was generally thought in bankruptcy circles that, if the issue of the automatic stay was litigated in state court, the state court’s decision as to whether the stay barred the action was binding, even if wrong.

Bankruptcy court has no jurisdiction to hear criminal matters.
Bankruptcy court has no jurisdiction to hear civil matters of a noncommercial nature, such as severance of the marital relationship or child custody (because such matters have no effect per se on the bankruptcy case).

Caveat: While not a matter of exclusive jurisdiction, only the bankruptcy court can hear an action to except a debt from the discharge based on 11 U.S.C. § 523(a)(2)(fraud), (a)(4)(conversion, breach of fiduciary duty), (a)(6) willful and malicious injury), and (a)(15) divorce related debts other than support debts). 11 U.S.C. § 523(c)(1). At present, these debts are only nondischargeable in a chapter 7 case. The action must be filed within 60 days of the first date set for the meeting of creditors (i.e., this meeting is set within 20 to 50 days after the bankruptcy petition is filed).

Contrast: An action to except a support debt from discharge under 11 U.S.C. § 523(a)(5) may be filed at any time in either bankruptcy court or state court.

III. AUTOMATIC STAY

When a bankruptcy petition is filed, a stay automatically goes into effect of all actions by creditors to collect pre-petition debts or to exercise control over property of the estate. 11 U.S.C. § 362(a). Any actions in violation of the automatic stay are void. In re Schwartz, 954 F.2d 569 (9th Cir. 1992). If a creditor knows that there is a bankruptcy case pending and performs an act in violation of the automatic stay, the creditor must be sanctioned even if it believed in good faith that the action would not violate the automatic stay. 11 U.S.C. § 362(h).
A creditor may ask that the stay be vacated or modified to permit the desired action to be performed. 11 U.S.C. § 362(d). In addition, certain acts are excepted from the automatic stay, e.g. (1) the commencement or continuation of a criminal action or proceeding against the debtor; 11 U.S.C. § 362(b)(1) and (2) the commencement or continuation of a proceeding to (a) establish paternity, (b) establish or modify a support award, or (c) to collect support from property that is not property of the bankruptcy estate; 11 U.S.C. § 362(b)(2).

IV. NONDISCHARGEABLE FAMILY LAW DEBTS

A. Debts for Spousal or Child Support (11 U.S.C. § 523(a)(5))

Section 523(a)(5) of the Bankruptcy Code provides that the following type of debt is not dischargeable in a chapter 7 case:

...to a spouse, former spouse, or child of the debtor, for alimony to, maintenance for, or support of such spouse or child, in connection with a separation agreement, divorce decree or other order of a court of record, determination made in accordance with state or territorial law by a governmental unit, or property settlement agreement, but not to the extent that--
(A) such debt is assigned to another entity, voluntarily, by operation of law, or otherwise (other than debts assigned pursuant to section 402(a)(26) of the Social Security Act, or any such debt which has been assigned to the Federal Government or to a State or any political subdivision of such State); or
(B) such debt includes a liability designated as alimony, maintenance, or support, unless such liability is actually in the nature of alimony, maintenance, or support[.]

Whether a debt is covered by 11 U.S.C. § 523(a)(5) may be determined at any time and in either bankruptcy court or state court. This type of debt is nondischargeable in both chapter 7 and 13. It is also a priority claim. 11 U.S.C. § 507(a)(7). In a chapter 7, it is entitled to be paid before priority tax debts and general, unsecured claims. However, as discussed above, since most chapter 7 cases are “no asset” cases, this priority usually has little value. In a chapter 13 case, however, priority claims must be paid in full through the plan.


Note: For a recent case containing an exhaustive discussion of the dischargeability of assigned support debts, see In re Cervantes, 229 B.R. 19 (Bankr. 9th Cir. 1999).

Note--New Case Relating to Debts Created by Hold Harmless Agreements: The bankruptcy court is not bound by labels placed on various obligations by the parties or the state court. It must look behind those labels to determine if an obligation was intended to be in the nature of support. In a recent case, In re Dewey, 223 B.R. 559 (Bankr. 10th Cir. 1998), the bankrupty appellate panel for the Tenth Circuit held that a hold harmless agreement was intended as support. As a result, a chapter 13 plan was required to provide for its payment in full.

Note--Debt May Be For Support Even Though Not Payable Directly to Spouse or Child: In a recent case, the Ninth Circuit Court of Appeals held that, if a debt is intended as support for a spouse, former spouse or child, it does not matter whether the debt is payable directly to the spouse, former spouse or child. In re Chang, 163 F.3d 1138 (9th Cir. 1998). In Chang, the natural father of a child and the child’s guardian ad litem were awarded fees incurred in a custody action. The mother then filed a bankruptcy case and attempted to discharge these obligations. The Court held that the debts were nondischargeable under 11 U.S.C. § 523(a)(5).

B. Other Family Law Debts

Until the law was amended in 1994, nonsupport family law debts, including debts arising from property division, could be discharged in bankruptcy. In 1994, a new exception to the discharge--11 U.S.C. § 523(a)(15)--was adopted for a debt:

...not of the kind described in paragraph (5)[suppport debts] 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 governmental 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[.]

Contrast with debt excepted from discharge under § 523(a)(5): A debt of the type described by section 523(a)(15) is only nondischargeable in a chapter 7 case, not in a chapter 13 case. The action to determine that the debt is nondischargeable may only be filed in bankruptcy court and must be filed within 60 days of the first date set for the meeting of creditors. Moreover, this type of debt is not a priority debt and thus need not be paid in full in chapter 13.

Note the broad language describing the type of debt covered: This exception to discharge appears to cover any type of debt incurred by the debtor in the course of a family law proceeding. For example, it arguably covers a debtor’s debt to his or her own family law attorney.

Also note shifting burden of proof: Most courts have held that the creditor has the burden to prove that the debt is covered by the initial broad language of section 523(a)(15). Then the burden shifts to the debtor to prove that he or she is either unable to pay or that failing to discharge the debt would be more harmful to him that discharging it would be to his or her spouse. See In re Gamble, 143 F.3d 223 (5th Cir. 1998); In re Crosswhite, 148 F.3d 879 (7th Cir. 1998).

V. PROPERTY OF THE ESTATE

When a bankruptcy case is filed, an estate is created. Property of the estate is protected by the automatic stay. In a chapter 7 case, the trustee sells or otherwise liquidates the nonexempt property of the estate and distributes the proceeds to creditors. Most transactions dealing with property of the estate require court approval. See 11 U.S.C. § 363 (use, sale or lease of property). The automatic stay does not bar post-petition enforcement of support awards against property that is not property of the estate. 11 U.S.C. § 362(b)(2). Section 541 of the Bankruptcy Code defines what constitutes property of the estate.

A. Community Property

Property of the estate includes:

All interests of the debtor and the debtor’s spouse in community property as of the commencement of the case that is--
(A) under the sole, equal, or joint management and control of the debtor; or
(B) liable for an allowable claim against the debtor, or for both an allowable claim against the debtor and an allowable claim against the debtor’s spouse, to the extent that such interest is so liable.

11 U.S.C. § 541(a)(2). This means that, even if only one spouse files a bankruptcy estate, in most instances, the entire community property of the couple will be property of the bankruptcy estate. The corollary to this provision is that all creditors entitled to be paid from community property may file a claim against the bankruptcy estate even if the debtor spouse is not personally liable for the debt. In the latter instance, however, the claim is only entitled to be paid from the community property, not from the debtor’s separate property.

Note: The entire community comes into the bankruptcy estate even if one spouse files after marital status has been severed as long as the community property has not yet been divided. See In re Mantle, 153 F.3d 1082, 1085 (9th Cir. 1998), citing with approval In re Miller, 167 B.R. 202 (Bankr. C.D.Cal. 1994).

B. Pensions

Section 541(c) of the Bankruptcy Code provides:

(1) Except as provided in paragraph (2) of this subsection, an interest of the debtor in property becomes property of the estate under subsection (a)(1), (a)(2), or (a)(5) of this section notwithstanding any provision in an agreement, transfer instrument, or applicable nonbankruptcy law--
(A) that restricts or conditions transfer of such interest by the debtor or
(B) that is conditioned on the insolvency or financial condition of the debtor, on the commencement of a case under this title, or on the appointment of or taking possession by a trustee in a case under this title or a custodian before such commencement and that affects or gives an option to effect a forfeiture, modification, or termination of the debtor’s interest in property.

(2) A restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable nonbankruptcy law is enforceable in a case under this title.

Paragraph 541(c)(2) means that a pension plan that contains a transfer restriction that is enforceable under applicable nonbankruptcy law is not property of the bankruptcy estate. The debtor may retain it free from the claims of creditors.

Note: Even if the pension plan does come into the bankruptcy estate, the debtor may be able to claim it as exempt. In most states, including California, state law controls the extent of the exemption to which the debtor is entitled. See Cal.Civ.Proc.Code §§ 703.140(b)(10)(E), 704.110, 704.115.

1. Plans subject to ERISA

To be subject to ERISA, a pension plan must contain a provision prohibiting any voluntary or involuntary transfers of the plan assets. These provisions are enforceable under ERISA.
In Patterson v. Shumate, 504 U.S. 753 (1992), the Supreme Court held that ERISA constituted “applicable nonbankruptcy law” within the meaning of section 541(c)(2) of the Bankruptcy Code. Thus, if a plan is subject to ERISA, it is not property of the estate. The debtor may retain the plan free from creditors’ claims.

2. Keogh plans

Whether a Keogh plan--i.e., a retirement plan established for the benefit of a self-employed person--is property of the debtor’s bankruptcy estate--depends on whether it contains an anti-alienation provision that would be enforceable under state law. Under California law, a private retirement plan is protected from creditors’ claims as long as the debtor does not exercise excessive control over it. For example, in In re Moses, 1999 WL 27488 (9th Cir.), the Ninth Circuit Court of Appeals held that a Keogh plan was excluded from a debtor-doctor’s bankruptcy estate where it was established by a medical partnership with 2,400 physicians members, including the debtor. The debtor’s contributions to the plan were mandatory. Moreover, the debtor could not withdraw from the plan as long as he remained a partner. The panel concluded that, given these facts, state law would enforce the anti-alienation provision, and thus the plan was not property of the bankruptcy estate.

3. Spendthrift trusts

Sometimes a trust will be established for a debtor’s benefit, either by the debtor or by some third party, independent of the debtor’s occupation or employment. The provisions of the trust document may purport to prohibit any voluntary or involuntary transfer of the trust assets. Under California law, such provisions are only enforceable if a third party establishes the trust and there is an independent trustee. See In re Moses, 215 B.R. at 34, discussing Cal.Prob.Code § 15304(a). If the debtor established the trust himself or is free to gain access to the funds, the trust assets are property of the estate.

4. IRAs

Several courts of appeal have held that a debtor’s interest in an IRA is not property of the bankruptcy estate. See In re Yuhas, 104 F.3d 612 (3d Cir. 1997); In re Meehan, 102 F.3d 1209 (11th Cir. 1997). The Ninth Circuit does not appear to have addressed this issue. However, in In re Rawlinson, 209 B.R. 501, 503 (Bankr. 9th Cir. 1997), in which the issue presented was whether an IRA could be exempted from the estate, a Ninth Circuit bankruptcy appellate panel assumed without deciding that an IRA would be property of the estate, noting the following Supreme Court dicta:

[I]ndividual retirement accounts...are specifically excepted from ERISA’s antialienation requirement. Although a debtor’s interest in these plans could not be excluded under § 541(c)(2) because the plans lack transfer restrictions enforceable under “applicable nonbankruptcy law,” that interest nevertheless could be exempted under § 522(d)(10)(E).

Patterson v. Shumate, 504 U.S. 753, 763 (emphasis added)(citations and footnotes omitted.)

However, the panel then held that the IRA could be claimed as exempt under Cal.Civ.Proc.Code § 703.140(b)(1)(E) to the extent necessary for the support of the debtor and the debtor’s dependents.

5. 403(b) Retirement Plans

In In re MacIntyre, 74 F.3d 186 (9th Cir. 1996), the debtors, both physicians employed by a nonprofit hospital, had substantial funds in a 403(b) retirement plan. As in Rawlinson, no one apparently contended that these funds were not property of the estate. However, the debtors successfully claimed them as fully exempt under Cal.Civ.Proc.Code § 704.115(b). The Court held that section 704.115(e), which limited the debtor’s exemption in retirement plans to what was necessary for the debtor’s and the debtor’s dependents’ support, applied only to self-employed retirement plans and IRAs.

VI. AVOIDANCE OF LIENS SECURING DEBTS INCURRED IN DIVORCE PROCEEDING

Section 522(f)(1) of the Bankruptcy Code provides as follows:

(1) Notwithstanding any waiver of exemptions but subject to paragraph (3), the debtor may avoid the fixing of a lien on an interest of the debtor in property to the extent that such lien impairs an exemption to which the debtor would have been entitled under subsection (b) of this section, if such lien is--
(A) a judicial lien, other than a judicial lien that secures a debt--
(i) to a spouse, former spouse, or child of the debtor, for alimony to, maintenance for, or support of such spouse or child, in connection with a separation agreement, divorce decree or other order of a court of record, determination made in accordance with State or territorial law by a governmental unit, or property settlement agreement; and
(ii) to the extent that such debt--
(I) is not assigned to another entity, voluntarily, by operation of law, or otherwise; and
(II) includes a liability designated as alimony, maintenance, or support, unless such liability is actually in the nature of alimony, maintenance or support....

1. Judgment Liens Securing Support Awards

The substance of section 522(f)(1)(A), qualifying the phrase “a judicial lien” was added by the Bankruptcy Reform Act of 1994. As a result of this provision, a judicial lien securing a support obligation may never be avoided under section 522(f)(1)(A). As discussed above, courts tend to interpret the term “support” quite broadly. However, the bankruptcy court is required to look behind a label placed on an obligation to determine the true nature of the debt based on the intent of the parties at the time the obligation was created.

2. Judgment Liens Securing Nonsupport Family Law Obligations

If a judgment lien on the debtor’s homestead secures a nonsupport obligation--e.g., a property settlement obligation, whether the lien may be avoided under section 522(f)(1)(A) is controlled by the rationale of Farrey v. Sanderfoot, 500 U.S. 291 (1991). In that case, the Supreme Court held that a judgment lien could not be avoided under this provision unless the debtor owned the property interest before the lien attached. In that case, the parties had stipulated that, as a result of the divorce decree, the parties’ old interests in the homestead were extinguished and the debtor’s interest in the homestead represented a new interest. Therefore, the lien could not be avoided.
Several courts in the Ninth Circuit have held that the law of the relevant state results in the same extinguishment of old interests and creation of new ones. See In re Catli, 999 F.2d 1405 (9th Cir. 1993)(Washington law); In re Barnes, 198 B.R. 779 (Bankr. 9th Cir. 1996)(California law); In re Yerrington, 144 B.R. 96 (Bankr. 9th Cir. 1992), aff’d, 19 F.3d 32 (9th Cir. 1994)(Alaska law).
This issue took an unexpected twist in In re Stoneking, 225 B.R. 690 (Bankr. 9th Cir. 1998). In that case, the debtor’s former spouse’s attorney had obtained a judicial lien securing his fees on the couple’s hometead while it was still community property. The community was later divided, and the home, still subject to the attorney’s lien, was awarded to the debtor as his separate property. When the debtor filed a bankruptcy petition and moved to avoid the attorney’s judgment lien under section 522(f)(1), the attorney argued the motion should be denied because the debtor’s current interest in the homestead did not exist before the creation of the lien. The bankruptcy appellate panel rejected the argument, distinguishing it from the lien in Farrey v. Sanderfoot because the “lien nevertheless was not created simultaneously with the termination of Debtor’s interests in Residence.” Stoneking, 225 B.R. at 693. The lesson taught by Stoneking is that, to preserve a family law attorney’s lien, the lien should be specifically re-created as part of the judgment creating the new property interest.

3. Family Law Obligations Secured By Consensual Liens

Before Farrey v. Sanderfoot gave protection from avoidance to most family law judgment liens, some family law practitioners may have obtained deeds of trust to secure their clients’ obligations to prevent them from being avoided under section 522(f)(1)(A). A recent Ninth Circuit bankruptcy appellate panel decision, however, should alert practitioners to the fact that this practice is not without its own risks. In re DiSalvo, 221 B.R. 769 (Bankr. 9th Cir. 1997). In DiSalvo, the spouse ignored the deed of trust and executed her family law judgment on other property of the debtor spouse. The bankruptcy court held that the creditor spouse had violated the one form of action rule; Cal.Civ.Proc.Code § 726(a); and had not only waived her security but also extinguished her entire claim. The bankruptcy appellate panel affirmed the lower court’s decision that the one form of action rule applied to this type of deed of trust and that the creditor spouse had violated the rule and had thereby lost her security. However, the panel reversed the ruling that the creditor spouse had extinguished her claim, concluding that this sanction was too harsh.


CANB DocumentsNorthern District of California