Family Law: Trickery in Property Settlements
Family Law: Trickery in Property Settlements
February 28, 2024
Please note that this article is purely for educational purposes and is not intended to constitute or be construed as legal advice.
When family lawyers set out to help their clients pursue a divorce or separation agreement, the question often arises whether debts incurred as the result of the divorce settlement qualify for discharge by filing a bankruptcy case. The type of debt a client may commonly seek to discharge could range from alimony to child support, a property settlement, or many things seemingly in between. An unwitting family lawyer might tell their client there is nothing that can be done to ease the burden of their alimony payments because domestic support obligations (DSOs) cannot be discharged in bankruptcy. Likewise, an attorney representing an obligee may attempt to comfort a client by assuring them there is no way an obligor could possibly escape a debt incurred pursuant to a divorce settlement. However, there are times when obligations that are perceived to be in place to provide support for a former spouse are able to be discharged in bankruptcy.
Oftentimes support obligations and property settlement debts are treated analogously by both courts and parties alike. Where a spouse is given more property, they usually receive less support, and vice-versa. Because of this seemingly indifferent approach to classifying settlement obligations, parties and courts often seek to frame obligations with other factors in mind. For example, settlements may be motivated by a party’s sentimental desire to keep the marital home or concerns with tax burdens incurred from the settlement’s obligations. Regardless of why a debt is designated as a support obligation or a property settlement, failure to consider the practical effects these designations as they relate to bankruptcy proceedings can be detrimental to clients.
It is crucial that ethical and proactive attorneys account for any loopholes that opposing parties could used to trick clients. This article exposes and discusses an often-overlooked trick that a cunning family law attorney could use to help clients avoid paying their debts to former spouses.
Discussion
Bankruptcy courts seek to provide a "fresh start" to protect "honest but unfortunate" debtors. Bosiger v. US Airways, Inc., 510 F.3d 442, 448 (4th Cir. 2007). In light of this purpose, there is a presumption that all debts owed by a debtor are dischargeable unless a party contending otherwise proves nondischargeability. 11 U.S.C. § 727(b). In the Fourth Circuit, courts have been advised to narrowly construe exceptions to discharge against the creditor and in favor of the debtor. Kubota Tractor Corp. v. Strack, 524 F.3d 493, 497 (4th Cir. 2008) (quoting Foley & Lardner v. Biondo, 180 F.3d 126, 130 (4th Cir. 1999)). The burden is on the creditor to prove the exception to discharge by a preponderance of the evidence. Grogan v. Garner, 498 U.S. 279, 287-88, 111 S. Ct. 654, 112 L. Ed. 2d 755 (1991); Kubota Tractor Corp., 524 F.3d at 497.
However, 11 U.S.C. § 523(a)(5) says DSOs are nondischargeable. Furthermore, section 523(a)(15) builds on 523(a)(5) and adds obligations "incurred by the debtor in the course of a divorce or separation or in connection with a separation agreement" to the list of nondischargeable debts. Rosenblum v. Hardesty (In re Hardesty), 553 B.R. 86, 90-91 (E.D. Va. 2016). At face value, this seems to defeat any prospect of discharging any debt incurred as a result of a divorce order or agreement. But, one key difference between sections 523(a)(5) and 523(a)(15) is that section 523(a)(15) does not apply in Chapter 13 cases. Id.; 11 U.S.C. § 1328(a)(2). This means a Chapter 13 debtor, simply by filing under Chapter 13, escapes the broad obligatory language of 523(a)(15). It is thus incumbent upon a former spouse in a Chapter 13 case to prove the subject debt is a DSO under section 523(a)(5), as opposed to a property settlement obligation under section 523(a)(15). Clark v. Clark (In re Clark), 574 B.R. 598, 603 (Bankr. S.D. W.Va. 2017).
The Bankruptcy Code states that a debt qualifies as a DSO if it is (1) owed to a spouse or child of a spouse, (2) "in the nature of alimony, maintenance, or support," (3) established by a divorce decree before a debtor spouse petitioned for relief under Chapter 13, and (4) "not assigned to a nongovernmental entity, unless that obligation is assigned voluntarily by the spouse, [or] child of the debtor..." 11 U.S.C. § 101(14A); In re Hardesty, 553 B.R. at 90. The existence of the first, third, and fourth elements is easily determined. But the second element is often the subject of greater analysis. The issue in these cases is determining what qualifies as a debt in the nature of alimony, maintenance, or support.
I. The Four Factor Analysis
To determine whether a debt is in the nature of alimony, maintenance, or support, courts look at the mutual intent of the parties at the time the agreement was entered. Pagels v. Pagels (In re Pagels), 2011 Bankr. LEXIS 560, *27. If an obligation is found to be non-dischargeable under 11 U.S.C. § 523(a)(5) and 1328(a)(2), the debtor must list the obligation as a priority claim in his Chapter 13 plan and repay it in full. 11 U.S.C. § 507(a)(1)(A); In re Deberry, 429 B.R. 532, 537 (Bankr. M.D.N.C. 2010). If, however, the court concludes that both parties intended the obligation to be a property settlement obligation, the debt is subject to discharge upon plan completion and discharge under 11 U.S.C. § 1328(a). 11 U.S.C. § 523(a)(15), 1328(a)(2). The question of whether the parties intended to create an obligation in the nature of alimony, maintenance, or support at the time of their divorce is a factual issue governed by bankruptcy law. See In re Hardesty, 553 B.R. at 91 (citing In re Long, 794 F.2d 928, 930 (4th Cir. 1986)). The inquiry is guided by four non-exclusive factors aimed at divining the parties' intentions: (1) the actual substance and language of the agreement, (2) the financial situation of the parties at the time of the agreement, (3) the function served by the obligation at the time of the agreement, and (4) any evidence of overbearing at the time of the agreement. In re Leviner, 2017 Bankr. LEXIS 2584, 2017 WL 3986500, at *5 (Bankr. W.D.N.C. Sept. 8, 2017); In re Hardesty, 553 B.R. at 91 (citing Catron v. Catron (In re Catron), 164 B.R. 912, 918-20 (E.D. Va. 1994)). see also Catron v. Catron, No. 94-1279, 1994 U.S. App. LEXIS 36061, 1994 WL 707966 (4th Cir. Dec. 21, 1994).
i. Actual Substance and Language of the Agreement
The Court is not bound by the labels used in a settlement agreement or order, but must look behind them to determine the true nature of an obligation based on the details of the entire settlement agreement. In re Clark, 574 B.R. at 604. If an obligation is listed in a segment of the agreement that is separate and distinct from those discussing support obligations, then the opposing party must overcome a "substantial obstacle" to show that the obligation is created in the nature of alimony, maintenance, or support. Tilley v. Jessee, 789 F.2d 1074, 1078 (4th Cir. May 5, 1986). Courts also consider the number and frequency of payments due pursuant to the agreement, as well as whether the obligation terminates upon the death or remarriage of the recipient. In re Leviner, No. 16-31885, 2017 Bankr. LEXIS 2584, 2017 WL 3986500, at *5 (Bankr. W.D.N.C. Sept. 8, 2017). A long-term obligation to make regular monthly payments is more likely to be considered support. Id. An obligation that terminates on the death or remarriage of the obligee is likely to have been intended for support. Id.
ii. The Parties’ Financial Situations
Courts are more likely to consider an obligation a DSO if (1) there is a considerable income disparity between the parties, and (2) without Debtor paying the obligation, the party with lower income is unable to support him or herself and any minor children. In re Crosby, 229 B.R. 679, 682 (Bankr. E.D. Va. 1998); see also In re Catron, 164 B.R. at 919. An obligation that is essential to enable a party to maintain basic necessities or to protect a residence has been ruled a nondischargeable support obligation on numerous occasions in bankruptcy courts across the country. See, e.g., Tatge v. Tatge (In re Tatge), 212 B.R. 604, 608 (8th Cir. October 8, 1997) (agreement to make mortgage payments was intended to serve most basic of support functions, to provide a home that plaintiff otherwise would not have been able to afford); Bristow v. Bristow (In re Bristow), No. 04-50235, 2005 Bankr. LEXIS 1117, slip op. at 5-6 (agreement to pay an equity line debt in equitable distribution judgment was obligation necessary for support, as evidence supported finding that ex-wife was unable to meet basic household needs if debtor did not pay); Batzek v. Batzek (In re Batzek), 314 B.R. 464, 468 (Bankr. M.D. Fla 2004) (debtor's obligation to pay second mortgage was nondischargeable as being in nature of support); Linet v. Azia (In re Azia), 159 B.R. 71, 74 (Bankr. D. Mass. 1993) (obligation to pay second mortgage on marital residence, which was conveyed to ex-wife, and to hold ex-wife harmless, constituted a nondischargeable DSO because it was one which enabled debtor's ex-wife and their children to maintain shelter); In re Cacolici, 108 B.R. 578, 584 (Bankr. N.D. Ohio 1989) (debtor's divorce decree obligation was nondischargeable support even when termed "property settlement" because the assets awarded to former spouse were necessary for her support); but see In re Lepley, No.07-20344, 2007 Bankr. LEXIS 2983, slip op. at 5-6 (court found that obligation to pay ex-wife $150 per week after termination of child support was not a DSO by looking at the terms and purpose of the agreement and found instead that it was a property settlement).
The court in Smith v. Smith (In re Smith) placed greater weight on the parties’ financial situation than any of the other three factors in analyzing a debtor’s attempt to discharge an obligation imposed by a settlement agreement. 2018 Bankr. LEXIS 2596 (Bankr. W.D.N.C. Aug. 24, 2018), aff’d 2019 U.S. Dist. LEXIS 1047 (W.D.N.C., Jan. 3, 2019). The court noted,
[The obligee] was clearly the breadwinner during the marriage by a significant margin. In fact, the State Court found that [the debtor’s] annual employment income only rivaled [the obligee’s] monthly income from employment during one 12-month period of the marriage. [The debtor] owned and operated a daycare business out of her home, but the State Court paints a dismal picture of the financial status of the business, as it was never profitable and had no value. [The obligee] also appeared to have better prospects for the future, as his employment and significant income appeared to be stable and he had retirement accounts on which to rely. [The debtor], by contrast, had no retirement or investment accounts, and the State Court did not expect her to earn more than the minimum wage.
In re Smith, 2018 Bankr. LEXIS 2596, at *17 (emphasis added). Thus, where the court found a significant gap in income and minimal earning capacity for the debtor, the court ruled in favor of the debtor and discharged the debt.
iii. Intended Function of the Obligation
Courts consider the circumstances surrounding Parties' divorce to determine parties' mutual intent to create the obligation. In re Hardesty, 553 B.R. at 95 (citing Tilley, 789 F.2d at 1077). Relevant factors include "whether the obligation allocates debt or divides property… and whether the obligation was intended to provide for basic necessities." In re Hardesty, 553 B.R. at 95 (citing Lawrence v. Combs (In re Combs), 543 B.R. 780, 799 (Bankr. E.D. Va. 2016)). Where family courts retain jurisdiction to modify the terms of an obligation, bankruptcy courts may take that fact as an indication that the obligation is intended as support. Rutkin, Family Law and Practice § 52.01[2][b] (1991).
iv. Evidence of Overbearing
The four factor analysis ends with the Court scrutinizing the circumstances during the divorce proceedings to surface any gross unfairness or lack of representation. In re Hardesty, 553 B.R. at 95. In determining whether a spouse's will has been overborne, the court should consider whether both parties were represented by an attorney, whether the terms of the agreement grossly favor one spouse over the other or leave one spouse with virtually no income, the statements of the spouses in court, the age, health, intelligence and experience of the spouses, the bargaining positions of the parties, whether there were any misrepresentations, and whether the creditor spouse had knowledge of the debtor spouse's weakness or inability to fulfill the terms of the agreement. Kettner v. Kettner, Civil Action No. 91-587-N, 1991 U.S. Dist. LEXIS 21130, at *5-6 (E.D. Va. Nov. 19, 1991).
Conclusion
While bankruptcy is often a foreign field of law for many family lawyers, giving consideration to the practical effects of a divorce settlement is nothing new. Obligations that are classified by the court as property settlements are subject to discharge, while domestic support obligations are not. However, not every divorce agreement that classifies an obligation as a property settlement will escape discharge, particularly when the property settlement is found to be in the nature of alimony, support, or maintenance. The four factor test serves as a practical guidance consideration for family lawyers in negotiating divorce settlements.
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