February 2015 • Volume 103 • Number 2 • Page 50
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Best of Discussions
Can Debtors Discharge Divorce-Based Attorneys’ Fees in Bankruptcy?
In a Chapter 7 proceeding, no; in Chapter 13, maybe yes, depending on how the court classifies the debt.
ISBA discussion groups let you pose questions to and share information with lawyers from Chicago to Cairo. Join at www.isba.org/discussions. A question and answer from the Family Law Discussion Group is below.
Attorney fees and bankruptcy
Modupe Sobo, Chicago. Has anyone filed an objection to a Chapter 7 bankruptcy where the movant is trying to discharge attorneys' fees incurred in pursuing college expenses? What is the process and how long does it take? I'm trying to determine if it is worth it to pursue it, for fees less than $2,000. [Editor's note: another list member was in "a similar situation, except my fees were incurred during a divorce."]
An ISBA lawyer responds
Rebecca Reinhardt, Mt. Vernon. I drafted a brief article on this a while back [for my firm newsletter]. The real distinction lies in the type of bankruptcy the debtor files. [In short, under Chapter 7] attorneys' fees [incurred] in pursuit of college expenses [in connection with a domestic support obligation] would be nondischargeable…. If the debtor requested a discharge and has failed to list it as a priority nondischarged domestic support obligation, [there's a danger of] the trustee overlooking it and it getting discharged…. My [updated] article on the topic is as follows.
Chapter 7. In In re Johnson, 2012 WL 2835462 (Bankr. C.D. Ill. 2012), the marital settlement agreement obligated the husband to pay the fees to the wife's divorce attorney, but the husband filed a Chapter 7 bankruptcy before doing so. Seeking to avoid the bankruptcy discharge, the wife's attorney argued to the bankruptcy court that the fees, though payable to him, were in the nature of a domestic support obligation and thus nondischargeable under 11 U.S.C. § 523(a). The bankruptcy court agreed that the fees were nondischargeable.
The Bankruptcy Code actually has two provisions relevant to the treatment of marital obligations in bankruptcy: § 523(a)(5), excepting from discharge debts "for a domestic support allegation," and 11 U.S.C. § 523(a)(15), covering debts "to a spouse, former spouse, or child of the debtor and not of the kind described in section 523(a)(5) 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 or governmental unit.
In Johnson, the court said that after the Bankruptcy Abuse Prevention & Consumer Protection Act of 2005 (119 Stat. 186) ("BAPCPA"), the distinction between domestic support obligations (§ 523(a)(5)) and other types of obligations arising out of the ending of a marital relationship (§ 523(a)(15)) is of no practical consequence in a Chapter 7 bankruptcy: neither is dischargeable in Chapter 7. The court went on to state that it was of no consequence that the obligation was owed to the wife's attorney and not to the wife directly.
While 11 U.S.C. § 101(14A) defines "domestic support obligation" as used in § 523(a)(5) as a debt "owed to or recoverable by" the spouse or child, courts have not interpreted the statute literally, looking instead to the nature of the debt and not to whom the debt is owed. Johnson followed that trend. The Johnson court also noted that there was nothing in the underlying dissolution case that indicated that wife would no longer be liable for the amount of attorneys' fees husband was obligated to pay or that her liability would be absolved if he failed to meet his obligation.
Chapter 13. While it was ultimately irrelevant in the Johnson case how the court defined the attorney fee obligation from husband to wife, there is a significant distinction between the dischargeability of debts arising from a divorce or separation in a Chapter 13 bankruptcy proceeding. How the court classifies the debt can be determinative.
In Chapter 13, to obtain confirmation, plans must provide for payment in full of claims entitled to priority under 11 U.S.C. § 507. 11 U.S.C. § 1322(a)(2). "[D]omestic support obligations" are entitled to such priority. § 507(a)(1)(A). Further, "domestic support obligations" are excepted from the general discharge granted to debtors upon completion of Chapter 13 plan payments. 11 U.S.C. § § 523(a)(5), 1328(a)(2). If the debtor's obligation is "domestic support," the debtor must propose to pay it in full through a repayment plan, and the obligation will not be discharged unless it is paid in full.
However, in Chapter 13, debts arising under § 523(a)(15) are dischargeable if the debtor receives a full-compliance discharge. In re McCreary, 2009 WL 5215587 (Bankr. C.D. Ill. 2009). Thus, if the obligation is not a support obligation but arises from a divorce or separation agreement or order relating to property division, the debtor is only required to pay a pro rata share of the funds available in the Chapter 13 plan. The creditor spouse is treated as a general unsecured creditor and, upon successful completion of the plan, any remaining balance is discharged. In re Rabideau, 2011 WL 165179 (Bankr. C.D. Ill. 2011).
Thus, the distinction between support obligations and property division is significant in Chapter 13 cases. "Whether a debt is nondischargeable as being in the nature of alimony, maintenance or support...is a matter of federal, not state, law." In re Marriage of Lytle, 105 Ill.App. 3d 1095 (1982).
11 U.S.C. § 101(14A) defines a domestic support obligation as a debt: (1) owed to or recoverable by a spouse, former spouse or child; (2) that is in the nature of alimony, maintenance, or support; (3) that is established by a court order; and (4) that has not been assigned to a governmental entity. State law is used to ascertain the incidents or nature of the debt to determine whether it fits within the federal exception. Marriage of Lytle. The label attached and the language of the decree or underlying agreement are not controlling in determining dischargeability; rather, one must look to the substance of the decree or agreement to determine the essential nature of the obligation. Marriage of Lytle.
What is a 'domestic support obligation'? The court in In re Daulton, 139 B.R. 708 (Bankr. C.D. Ill. 1992), set forth factors to be considered in determining whether an obligation is a domestic support obligation. (Note that § 523(a)(15) was markedly changed by BAPCPA; previously, courts applied a balancing approach to determine whether the debtor could reasonably afford to pay such debts and the resulting harm posed to the creditor spouse in the event of a discharge, and this approach no longer applies.)
The factors include the age and health of the parties, whether there are children to be provided for, the employment status and future earning capacity of the parties, where the obligations are located and how they are labeled in the underlying domestic court order, the adequacy of support absent debt assumption, the existence of a hold harmless clause, and whether there was any indication that the provisions at issue were intended to balance the relative income of the parties. The actual intent of the parties if they entered into an agreement must be considered as well.
In filing an objection to discharge or proof of claim in the bankruptcy proceeding it is important to provide the bankruptcy court with sufficient evidence to make a determination about the nature of the underlying obligation and the specific dollar amount that is nondischargeable. In In re Blasko, 2013 WL 6074102 (Bankr. C.D. Ill. 2013), the bankruptcy court found that the debtor's obligation pursuant to a dissolution judgment to pay his former spouse's credit card bills was a nondischargeable domestic support obligation because the debtor "presented no evidence on any of the Daulton factors to support his position that the [credit card] obligation was property settlement" and he thus did not meet his burden of proof. Ultimately, the full amount claimed by the creditor spouse was deemed a domestic support obligation.
In In re Mitchell, 2013 WL 2422694 (Bankr. N.D. Ill. 2013), while the bankruptcy court allowed relief from the automatic stay to the creditor spouse in a Chapter 7 proceeding, the court found that debt was nondischargeable pursuant to § 523(a)(15) due to lack of evidence to support a finding that it was a domestic support obligation. Had the husband's bankruptcy been a Chapter 13 proceeding, this could have been fatal to the creditor spouse's ability to obtain the full judgment amount.
Thus in a Chapter 13 proceeding, debts under § 523(a)(15) are potentially dischargeable, while in Chapter 7 debts arising in the course of a divorce or separation are unqualifiedly nondischargeable. In re Harn, 2008 WL 130914 (Bankr. C.D. Ill. 2008).
Practice tips. An individual and his or her attorney involved in settlement of a dissolution action should clearly set forth the intent of the parties and ensure that it meets the federal definition for the type of obligation the agreement is attempting to achieve. Furthermore, the parties should be made aware that particular obligations set forth in the agreement may ultimately be nondischargeable in a bankruptcy proceeding. Hold-harmless agreements have been held nondischargeable in Chapter 7 proceedings per § 523(a)(15), as have agreements to pay mortgage obligations. See In re Walden, 312 B.R. 187 (Bankr. C.D. Ill. 2004).
Debtors with significant marital debt must consider the benefits of Chapter 13 when deciding under which chapter to file. In McCreary, discussed above, the bankruptcy court held that a former husband's filing of a Chapter 13 bankruptcy instead of a Chapter 7 to avoid, among other things, paying the full amount due his former wife under a property settlement was legitimate and not in bad faith.