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Attorney Dave Falvey Norwich Bankruptcy

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Brief Background

Bankruptcy Issues Related To Domestic Support Obligations

Bankruptcy courts have long held that debts that are in the “nature of support” are not dischargeable. Support debts often arise during divorce proceedings and may be contrasted with the division of marital property. For instance, a family court order directing a husband to pay alimony or maintenance to a wife is usually “in the nature of support,” an order to pay a joint credit card bill is usually not “support.”

In bankruptcy law, a “Domestic Support Obligation,” or “DSO,” is any debt incurred before or after a bankruptcy filing that is owed to or recoverable by a spouse, former spouse, child or governmental unit; in the nature of alimony, maintenance or support; and established pursuant to the terms of a divorce decree, separation agreement, property settlement agreement, court order or administrative determination. A creditor holding a DSO has expanded rights under the Bankruptcy Code.

Debtor’s Exempt Property

Property exempted by a debtor in bankruptcy may still be used to pay a DSO creditor. In other words, exempt property is not exempt when it comes to a DSO. See 11 U.S.C. § 522(c)(1). Unfortunately, Section 522(c)(1), while well intended, has caused a great deal of confusion when trying to enforce this law in a Chapter 7 bankruptcy case.

Several bankruptcy courts have ruled that Section 522(c)(1) does not allow a trustee to liquidate exempt property to satisfy a domestic support obligation. See In re Duggan, 2007 Bankr. LEXIS 2750 (Bankr. M.D. Fl. 2007). However, at least one court has held that a domestic support creditor could do so. See In re Quezada, 368 B.R. 44 (Bankr. S.D. Fl. 2007).

To date the process for such an action remains in question, and courts that have addressed the issue have agreed that there is no process within a bankruptcy case for a DSO creditor to attach or collect exempt assets. See In re Hibbard, Case No. 08-36322 (Bankr. S.D.Ohio, 2010) (“For better or worse, Title 11 provides only one method for the distribution of funs to creditors in a Chapter 7 case – through a Chapter 7 trustee”).

Nevertheless, Section 522(c)(1) allows DSO creditors to collect from assets that the bankruptcy debtor claimed as exempt in a non-bankruptcy forum, and effectively removes an exemption claimed in the bankruptcy case as a defense to such collection.

Liens Against the Debtor’s Property

The Bankruptcy Code also protects a prepetition lien that secures a Domestic Support Obligation. A judicial lien securing a support claim cannot be avoided on the grounds it impairs an exemption. See 11 U.S.C. § 522(f)(1)(A). Additionally, the Supreme Court case of Farrey v. Sanderfoot extends lien avoidance protection for non-debtors seeking to defend lien avoidance actions in bankruptcy. Farrey v. Sanderfoot, 500 U.S. 291 (1991).

In Sanderfoot, a couple divorced and the family court divided assets. The jointly owned home was awarded to husband, and he was ordered to make equalization payments to the wife. The family court gave wife a lien against the home to ensure payment. Husband filed bankruptcy and sought to avoid wife’s lien as impairing an exemption in the home under Section 511(f).

The Supreme Court pointed out that lien avoidance under Section 511(f) requires a debtor to have an interest in property before any lien attached (statute expressly permits avoidance of “the fixing of a lien on an interest of the debtor”). When the family court terminated the couple’s joint tenancy, it created a new ownership interest in the property subject to a simultaneous lien.

After Sanderfoot, a lien incorporated in the judgment of dissolution cannot be avoided. See In re Thompson, 240 B.R. 776 (B.A.P. 10 Cir. 1999); Naqvi v. Fisher, 192 B.R. 591 (D. N.H. 1995). However, a lien that fixes itself to the property through a divorce decree that incorporates the couple’s settlement agreement is more appropriately defined as a judicial lien and may be avoided. See In re Huskey, 183 B.R. 218 (Bankr. S.D. Cal. 1995); In re Wells, 139 B.R. 255 (Bankr. D. N.M. 1992).

This “loophole” in the Bankruptcy Code has been used by creditors to defeat a debtor’s motion to avoid judicial lien. In the case of In re White, 450 B.R. 866 (Bankr. E.D. Ark. 2011), a couple owned property jointly encumbered by a judicial lien. The couple divorced, divided property, and executed quitclaims evidencing individual ownership. They each filed separate bankruptcy cases and attempted to avoid the creditor’s judicial lien.

The Arkansas Bankruptcy Court pointed out that, while married, “the debtors enjoyed a collective homestead exemption under Arkansas law” and the creditor’s judicial lien was subject to avoidance. However, the debtors altered their ownership interest after the “fixing” of the judicial lien.

In the end, the debtors could not avoid the judicial lien. The lessons here are clear: if you are contemplating divorce and have debt, seek the advice of a bankruptcy attorney.