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January 01, 2018 Bankruptcy

The Bankruptcy Stay as a Roadblock, and How to Overcome It

By: Mary Bower Sheats

Your opponent calls to say that her client has filed a bankruptcy petition. You call your client. She wants to know whether she can change her mind and resurrect the settlement offer which she had rejected before the bankruptcy. You make a call to your friend the bankruptcy lawyer. Your friend says that you are probably entitled to relief from stay, that any settlement must be approved by the bankruptcy judge, and that the retirement funds and other assets your client owes to the bankrupt spouse might be distributed to his creditors instead of to him.

The filing of a bankruptcy petition operates as a stay, applicable to all entities, of the commencement or continuation of any judicial, administrative, or other action or proceeding against the debtor to recover any claim against the debtor that arose prior to the commencement of the bankruptcy case. If a divorce action is pending at the time of the bankruptcy filing, the bankruptcy will stay the divorce to the extent that the divorce proceeding seeks to determine the division of property that is property of the bankruptcy estate. The bankruptcy process could cause the distribution of the debtor’s interest in the marital assets to creditors of the bankruptcy debtor.

There are exceptions to the stay. The bankruptcy does not stay civil actions or proceedings to establish paternity, establish or modify a domestic support obligation, decide matters relating to child custody or visitation, address domestic violence, or dissolve a marriage when the divorce does not affect property of the estate.

The bankruptcy estate is comprised of all legal or equitable interests of the debtor in property as of the commencement of the case, including any interest the debtor acquires or becomes entitled to acquire within 180 days after the date of the bankruptcy filing as the result of a property settlement agreement with the debtor’s spouse, or of an interlocutory or final divorce decree. See 11 U.S.C. § 541.

Most bankruptcy debtors will try to immunize the property they expect to receive in their divorce action by claiming that the property is exempt from the bankruptcy estate. The U.S. Bankruptcy Code allows the debtor to prevent the distribution of certain property by claiming it as exempt. Section 522(b) of the Code allows the bankruptcy debtor to choose the exemptions afforded by state law or the federal exemptions listed in section 522(d). Section 522(l) states the procedure for claiming exemptions and objecting to claimed exemptions: “The debtor shall file a list of property that the debtor claims as exempt under subsection (b) of this section. … Unless a party in interest objects, the property claimed as exempt on such list is exempt.” The Federal Rules of Bankruptcy Procedure allow creditors and the bankruptcy trustee thirty days to object to claimed exemptions unless the court extends the time for objecting to the debtor’s claimed exemptions. Taylor v. Freeland & Kronz, 503 U.S. 638, 639 (1992).

If the divorcing spouses have not divided their retirement assets or other marital assets between them prior to the bankruptcy filing, then the debtor’s right to receive retirement assets or any other nonexempt marital assets from the non-debtor spouse will be included in property of the bankruptcy estate to the extent that the debtor has not exempted the marital assets from property of the estate. The nonexempt assets could then be subject to distribution to the creditors of the debtor in the course of the bankruptcy proceeding.

The Bankruptcy Code provides the non-debtor spouse a right to request relief from the automatic stay in order to return to the state court to complete the distribution of the marital assets.

Where equitable distribution is not determined prior to the commencement of a bankruptcy case, the non-debtor spouse may have only an unsecured claim against  the bankruptcy estate. If economic terms are decided by a domestic relations court  or agreed to by the parties prior to the commencement  of  the  bankruptcy case, the non-debtor spouse would have an in rem interest and not merely an unsecured claim. See, e.g., Verner v. Verner (In re Verner), 318 B.R. 778, 787–90 (Bankr. W.D. Pa. 2005); Roshan v. Nouri (In re Nouri), 304 B.R. 155, 160–05 (Bankr. M.D. Pa. 2003). See also Gendreau v. Gendreau (In re Gendreau), 122 F.3d 815, 818 (9th Cir. 1997); Lowenschuss v. Selnick (In re Lowenschuss), 170 F.3d 923, 930 (9th Cir. 1999).

The bankruptcy court will usually grant relief from stay to the parties to proceed with the division of marital assets in the state court divorce proceeding. However, the bankruptcy trustee stands in the shoes of the debtor, and the trustee may be substituted for the debtor in the divorce proceedings in order to collect the debtor’s nonexempt share of the marital property for the benefit of the bankruptcy estate. Any settlement between the bankruptcy trustee and the non-debtor spouse must be approved by the bankruptcy court. See In re Martin, 91 F.3d 389 (3d. Cir. 1996).

If your client violates the automatic stay, any individual injured by any willful violation of the stay  will  be  entitled  to  recover  actual  damages,  including  costs  and  attorney fees, and, in  appropriate  circumstances,   punitive   damages.  If  you  are  unsure,  it is in your best interest and the best interest of your  client to obtain a court order granting relief from stay before taking any action against the bankruptcy debtor to enforce your client’s claims against  the  debtor.  See 11 U.S.C. § 362 (k)(1).

Bankruptcy Discharge by the Numbers

Usually at the end of the bankruptcy case, the debtor receives a discharge. The bankruptcy discharge order does not discharge the debtor from liability for any domestic support obligation, such as child support or alimony. See 11 U.S.C. § 523(a)(5). There are various types of discharges, depending upon the Bankruptcy Code chapter the bankruptcy was filed under, but there is no discharge that relieves the debtor of liability for a domestic support obligation.

The discharge is an injunction that discharges the debtor from personal liability for all of his or her dischargeable debts and permanently prohibits the creditors from enforcing their claims against the debtor. The discharge is personal and is only granted to individuals.

Chapter 7. The chapter 7 debtor remains liable for all obligations incurred in the course of the divorce or separation because the chapter 7 discharge does not discharge the chapter 7 debtor from personal liability for any debt to a spouse, former spouse, or child of the debtor incurred by the debtor in the course of a divorce or separation or in connection with a separation agreement or divorce decree.

Chapter 13. A chapter 13 discharge is different. The difference between a chapter 7 and a chapter 13 bankruptcy is that, in chapter 13, the debtor repays certain debts over a repayment plan period that can last up to sixty months. In a chapter 7 bankruptcy, by contrast, there is no repayment plan.

A chapter 13 bankruptcy is a wage earner reorganization, which can last for as long as sixty months. At the end of that period, the bankruptcy court grants the debtor a different kind of discharge than the discharge the chapter 7 debtor receives. The chapter 13 discharge is often referred to as the “super” discharge because, among other things, it discharges the debtor permanently from all personal liability for any debt to a spouse, former spouse, or child of the debtor that was incurred by the debtor in the course of a divorce or separation or in connection with a separation agreement or divorce decree. See 11 U.S. C. § 523 (a)(15), § 1328 (a)(2).

Chapter 11. A chapter 11 bankruptcy is also a repayment plan, but, in contrast to chapter 13 provisions, if the chapter 11 debtor is an individual, all obligations incurred in the course of a divorce or separation survive the chapter 11 bankruptcy discharge, as do any domestic support obligations.

Chapter 12. Chapter 12 is a bankruptcy involving a family farmer or fisherman. All  obligations incurred in the course of a divorce or separation also survive the chapter 12 bankruptcy discharge. It is only the chapter 13 discharge that, with the exception of domestic support obligations, discharges the debtor from obligations incurred in the course of a divorce or separation proceeding. fa

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Mary Bower Sheats

Mary Bower Sheats ([email protected]), of counsel with Frank, Gale, Bails, Murcko & Pocrass, P.C., in Pittsburgh, Pennsylvania, focuses her practice on bankruptcy,  commercial  law,  and  family law. She is active with the Inns of Court and is a member of the Allegheny County Bar Association.