We recently interviewed Christopher Holmes and Jess M. Smith, III, the senior partners at Tom Scott & Associates, P.C. Below is Part 1 of that interview, which focuses on a few aspects of how a divorce can impact bankruptcy.
Q: We know that divorce is one of the major unfortunate events that cause people to file for bankruptcy. For someone who is considering a divorce or who is already divorced and is considering whether or not to file for bankruptcy, what circumstances might they encounter and how can those be handled to their advantage?
CH: We had a client from Avon, which is in Hendricks County, in his thirties, who was divorced not so long ago. In the divorce decree, his ex-spouse was awarded a property settlement of over $46,000. He had some other financial woes, but this property settlement was the biggest, so he wanted to file bankruptcy.
I told him that under Chapter 7 of the bankruptcy code that the divorce settle was a non-dischargeable debt, so he would be wise to file under Chapter 13 of the bankruptcy code, because we could discharge the vast majority of that settlement.
Q: What was the nature of the debt that would make it different under the those two chapters of the bankruptcy code?
CH: Because it was a property settlement, the bankruptcy code states that it is a non-dischargeable debt under Chapter 7. He was going to keep the properties and she was going to get money in exchange for her equitable interest in those properties. So this settlement was a debt that, according to Chapter 7, you cannot get rid of, but the United States Congress made it a dischargeable debt in Chapter 13.
JS: Congress created the legislation on the theory that if you do the best you can and pay what you have to pay, and the ex-spouse gets in line with the other debtors and receives a portion of what you owe, that’s fine under Chapter 13. But you just can’t file under Chapter 7 and walk away from the property settlement debt completely.
CH: So as long as the settlement debt is not deemed to be in the nature of alimony, maintenance, or child support, he pays back a few pennies on the dollar. Then, upon the discharge of his bankruptcy, the rest of the debt is wiped out, rendered null and void. So, the ex-wife thought after the divorce was finalized that she was was going to be receiving money in exchange for the physical properties he kept as part of the divorce settlement. But that money owed to her went into the Chapter 13 and she had no recourse but to accept those pennies on the dollar.
JS: The other time where property settlement comes into play is when you have one credit card that both divorced spouses used while they were married. One spouse is ordered to pay that credit card debt and says, “I didn’t incur that credit card debt,” but the divorce judge say, “I don’t care. You’re paying it.” That is a debt in Chapter 13 in which they can list the bank or financial institution that issued the credit card and the ex-spouse as creditors, so they pay pennies on the dollar to the original creditor and the ex-spouse – and then the credit card company goes after the ex-spouse for the difference.
CH: In that situation, she can’t go back to the divorce court and ask the judge to hold her ex-husband in contempt for not paying the debt as he was originally ordered to do in the divorce decree. In addition to that debt, to further this gentleman’s problems, he has a child support obligation that he has been unable to pay in full, so he has what is called a child support arrearage. so, in a Chapter 7, he is pretty much at her mercy with a non-dischargeable debt. The benefit of a Chapter 13 would be that he can force the woman to accept the cure of that child support arrearage over the life of the Chapter 13 plan. Meanwhile, she can’t go back to divorce court to ask that judge to hold in in contempt for not paying all of the child support. So, he has a very powerful remedy to keep his ex-spouse at bay on both the back child support and the non-payment of the property settlement.
Q: If alimony was a part of the divorce settlement, would it be covered in this situation as well?
CH: Alimony is non-dischargeable, but if he is behind in paying the alimony, he could use a Chapter 13 to, as we say, cure, or catch-up on that situation. It also forces the ex-spouse to accept that cure or re-payment over a 3 to 5 year period, as opposed to being forced to come up with it in a much shorter period of time.
Q: Does this individual’s employment status affect the case?
CH: He is a self-employed home remodeler with two children, so unfortunately his income is variable, which prevents him from paying his child support in a timely manner, because his income goes up and down. What we are hoping to do in his plan is to buy him more time to resolve that problem.
Q: What is the process you would go through to make his case or a similar case to the divorce court judge?
CH: Luckily, the bankruptcy code has provisions that make it pretty clear-cut that if we propose this plan, unless there is some legitimate objection, whether the ex-spouse likes it or not, she is compelled to comply with the terms of it,or at least accept the terms of the plan.
Q: Were there any legitimate exceptions that you feared might come into play when proposing the plan on his behalf?
CH: My fear was that her divorce court lawyer might try to assert that this property settlement was in fact in the nature of maintenance. I’ve had that happen in the past where even though it clearly stated “property settlement” in the divorce decree, they convinced the state court judge to say, “Oh no, what I really meant was that this is in the nature of maintenance, which makes it a non-dischargeable debt,” and therefore the client couldn’t get rid of it in the Chapter 13 bankruptcy.
JS: I’ll give you an example of an experience our associate Andrew DeYoung had. The bankruptcy code says that an above median debtor can contribute to the retirement accounts during the bankruptcy – basically shielding money from their creditors. Andrew had a case recently in which the debtor, his client who is a divorced woman, proposed to still contribute big chunks of money into her retirement account. Her ex-husband’s attorney said, “This plan is not being proposed in good faith, because she could stop these contributions to put more money into the plan.” The judge agreed the contributions were in contravention of the code and basically said, “I don’t think you should fully fund your retirement account and I’m going to make you offer some more money to the bankruptcy plan.” The judge didn’t state what that amount would be, but it forced them to eventually reach a deal that both sides could live with.
I think had Andrew’s client had the money to go up to the Court of Appeals, he might have won the case for her, but she didn’t have the money to pay for an appeal. That particular judge did not like the – quote, exorbitant, unquote – amount, about $800 per month, being put into her IRA, which her employer would then match on top of that, so she had great incentive to contribute to her protected retirement fund. Her ex-spouse objected and the judge agreed that she could not soak all of that money away from the settlement and just pay three cents on the dollar, so she had to do something else. As I stated, they eventually worked it out and agreed upon an amount she could put into her IRA.