Whenever a potential client tells me they have a “simple” bankruptcy, I force myself not to laugh out loud. Bankruptcy is a minefield and time and time again I’ve discovered that there isn’t any such thing as a simple bankruptcy.
I’ll tell you why. In bankruptcy, context matters. Transactions that wouldn’t have the smallest negative consequence outside of bankruptcy can have a significant consequence once someone files bankruptcy. Deciphering my clients’ financial lives and making sure, in the context of bankruptcy, there isn’t anything that will blow up in their face and have unintended or unexpected consequences is one of my primary responsibilities.
Here’s my favorite example: imagine I borrow $2,000 from my brother to put new tires on my car. Keep in mind that my car must have new tires. I use the car to go to work. I need my job to put food on my table and clothes on my children’s’ backs. I also use the car to go to school to make sure they get the education the law says I am required to make sure they get.
Now imagine I repay my brother $2,000 and file bankruptcy a few weeks later. I mean, repaying my brother is the right thing to do, right? Of course, it is. I don’t things to be weird at Thanksgiving, avoiding my brother because I haven’t repaid him the $2,000 that he couldn’t afford to loan me.
There’s only one person in the world that would have a problem with me repaying my brother: the bankruptcy trustee. In the case of characters that you’ll encounter if you enter the world of bankruptcy, the trustee’s job is to see if there is anything she can take or recover to repay your creditors.
That payment I made to my brother? That’s a problem. First, I can’t hide that repayment from the trustee or the court. I’m required to disclose any repayments to friends or relatives that I made in the 12 months before I filed bankruptcy. Second, any repayments to friends or relatives made in those 12 months can be considered “preferences”. A preference is, essentially, a payment made to one creditor to the detriment of my other creditors. So, if I repaid my brother but didn’t pay my creditors, my brother has been treated preferentially.
Here’s the bad news: the trustee can “clawback” that payment I made. He can get an order to force my brother to turn over $2,000. The one silver lining is that I can pay that $2,000 to avoid my brother getting mixed up in my bankruptcy and keep being able to talk to him at Thanksgiving.
The above is just one example of how important context can be when someone files bankruptcy, but there are more. Colorado bankruptcy court Judge Elizabeth Brown recently issued an opinion that also highlights how important context can be. In In re Haddad, the court was asked to determine whether or not the debtor’s obligation to turnover proceeds from the sale of a marital home to his ex-wife was a dischargeable property settlement or instead a payment in the nature of a non-dischargeable support obligation.
A divorce agreement can include two types of obligations: one is a support obligation (such as child support or spousal maintenance – also known as alimony); the other is the obligation to divide marital property, also known as a property settlement. The obligation to divide marital property can take the form of many things. It may include paying the other spouse’s debts, or, as in the Haddad case, it can involve dividing marital assets, such as the residence the couple lived in during the marriage.
You cannot eliminate a support obligation in bankruptcy, either chapter 7 or chapter 13. However, you can eliminate a property settlement in chapter 13 bankruptcy, but not in a chapter 7. This is one of a few reasons why someone who is otherwise eligible for a chapter 7 bankruptcy might want to file a chapter 13 instead.
The dispute in this case turns on whether Mr. Haddad’s obligation to turnover proceeds from the sale of the marital residence was, in fact, a support obligation. At first blush, and outside the bankruptcy context, Mr. Haddad’s obligation to turnover half of the home proceeds would seem like a simple property settlement. The fact that the divorce settlement includes a separate support obligation is also persuasive that the requirement to turn over the home proceeds is just a property settlement.
But, in bankruptcy, context is everything.
In addition to looking at the terms of the divorce settlement, Judge Brown looks at the financial positions of Mr. Haddad and his ex-wife at the time of the divorce. Prior to the divorce, his ex-wife was a fulltime homemaker. While Mr. Haddad was employed, earning a good income, traveling, enjoying nice meals out, his ex-wife was barely getting by.
Looking beyond the divorce agreement, Judge Brown found that that the division of the home proceeds was intended to provide the ex-wife the support she needed. Judge Brown found the debt to be a non-dischargeable support obligation. Judge Brown also found that the ex-wife was entitled to attorney fees related to the fight about the dischargeability of the debt.
Divorce issues are some of the most complex issues I’ve dealt with in bankruptcy. First, it involves very emotional wounds that are usually still fresh when my clients come to me. Second, it usually involves divorce counsel who is unfamiliar with the bankruptcy laws and procedure. That unfamiliarity can cost time (and increased bankruptcy fees) for my client as they try to move forward and get a fresh start after their divorce. But I relish these cases. Sometimes, bankruptcy is the best way to end a contentious divorce proceeding. In one case, I was able to keep my client from going to jail after being held in contempt of trying to comply with an order from a divorce court that was starkly unfair.
If you’re considering bankruptcy to address divorce-related obligations, I’d be happy to talk with you. I offer a free initial consultation. The easiest was to schedule an appointment is by clicking here.