The Interplay Between Bankruptcy and Divorce Law in Virginia

How to file bankruptcy in Virginia after filing for divorce:

It may be advantageous to file bankruptcy in Virginia after filing for divorce, depending on the particular circumstances and timing of your cases, and the relief you seek.  The actual mechanics of filing the bankruptcy itself are fairly straight forward.  You can file yourself, use a bankruptcy petition preparer, or use a lawyer who has been admitted to practice in the U.S. Bankruptcy Court.  The official forms required for filing bankruptcy are posted on the website for the U.S. Bankruptcy Court for the Eastern District of Virginia.  Before filing bankruptcy you must complete a required credit counseling course from a provider approved by the U.S. Trustee’s office, or request an exception for certain grounds.  You must pay the filing fee in whole when you file, or you may ask the court for permission to pay in installments.  About a month after filing bankruptcy, you will be required to attend a scheduled meeting of creditors, where the trustee appointed in your case will ask you certain questions.  Creditors have a right to attend this meeting, but rarely show up.  In order to receive a discharge in a chapter 7 case, you must also complete a required debtor education course from an approved provider no later than sixty days after your meeting of creditors and file a certification with the court.  In a chapter 13 case, you must complete the required debtor education before completing your plan payments and receiving a discharge.  In the event you elect to reaffirm a debt in your chapter 7 case, you may have to attend a hearing concerning whether the court will approve the proposed reaffirmation agreement.

After filing for divorce, you should consider several issues before filing a bankruptcy case in Virginia.  First, should you file a joint bankruptcy case with your spouse after filing for divorce?  You and your spouse are eligible to file a joint case while you are still married.  A joint bankruptcy case may save you both in fees and costs and will discharge your dischargeable marital debts (along with your dischargeable separate debts), which are often a point of contention in divorce cases.  By getting rid of your marital debts in bankruptcy, you have eliminated an area to litigate in equitable distribution in your divorce case, or an area that may prevent you from negotiating a separation agreement or property settlement agreement.  You should consider whether there is actual conflict of interest with your spouse before filing a joint case.  While a joint chapter 7 case for estranged spouses may make sense, it is much more difficult to justify a joint chapter 13 case after filing for divorce because of the ongoing responsibilities and payments required in chapter 13, and the potential for one spouse to discharge a debt to the other spouse.  You should also consider whether your spouse might have engaged in some conduct which could jeopardize your prospects for obtaining bankruptcy relief, such as transferring or concealing assets to defraud creditors, submitting false or fraudulent loan applications, or withdrawing large amounts of cash or buying luxury items with no intention of repaying the debt.

Second, what kind of bankruptcy case should you file after you have filed for divorce in Virginia?  The answer to this question will depend on the relief you seek and the nature of your debts.  Some folks need bankruptcy protection to preserve valuable property, such as the marital residence, so it will be available for equitable distribution in Virginia.  Other filers primarily need a discharge of credit card debt, or protection from a garnishment of wages or a bank account.  Chapter 13 bankruptcy discharges a broader range of family law debts than chapter 7 bankruptcy will.    Domestic support obligations, such as alimony, child support, or spousal support are not dischargeable in either chapter 7 bankruptcy or chapter 13 bankruptcy.  Other debts owed to a spouse, former spouse or child of the debtor which are not domestic support obligations and that were incurred in a divorce or separation, or in a separation agreement or property settlement agreement, or from a divorce decree or court order of a court of record, may be dischargeable in a chapter 13 bankruptcy case, but are not dischargeable in a chapter 7 bankruptcy case.

Third, what is best time to file for bankruptcy after filing a divorce in Virginia?  The timing of a bankruptcy case filing can be critically important, and has been addressed in detail in a separate page in this blawg:  “Should I file for bankruptcy before divorce, or divorce before bankruptcy?”.  Certainly, if you wish to discharge family law debts that are not domestic support obligations in a chapter 13 case, it is important that those claims have come into existence, and are not merely potential claims.  All other factors being equal, you may wish to wait until the conclusion of equitable distribution or the execution of a separation agreement or property settlement agreement, or the entry of a divorce decree or other court order, before filing for chapter 13 bankruptcy relief.  The downside to waiting is the possibility that the nonpayment of a particular obligation required by the court may potentially subject the debtor to a contempt of court charge.

Fourth, will you need relief from the automatic stay in bankruptcy to continue or conclude your divorce case?  The automatic stay in bankruptcy allows a spouse to seek the dissolution of a marriage, as long as the spouse does not seek equitable distribution of property of the bankruptcy estate.  The safest course is to file a motion for relief from the automatic stay in a chapter 13 bankruptcy case or in a lengthy chapter 7 case, before proceeding with equitable distribution in your divorce case, or entering into a separation agreement or property settlement agreement if you intend to affect marital property or debts, or even post-petition earnings of the debtor, which are property of the estate in a chapter 13 case.  Actions taken in violation of the automatic stay are void.  The cost of seeking relief from stay may be small compared to the consequences of a void separation agreement or void equitable distribution decree.

You should consult with your Virginia bankruptcy and divorce lawyer, or Richmond divorce lawyer James H. Wilson, Jr., to discuss the advantages and disadvantages of filing bankruptcy after divorce.

Can the chapter 7 bankruptcy trustee recover property transferred from the debtor divorced wife to her parents on fraudulent transfer grounds where the property transferred would have been exempt under state law?

In the case of Sullivan v. Welsch, 457 B.R. 748 (B.A.P. 8^th Circuit, 2011), (In re: Mary Lumbar, Case No: 11-6018), the bankruptcy appellate panel for the Eighth Circuit Court of Appeals rejected the “no harm, no foul” rule and held that the debtor ex-wife might have fraudulently transferred property to her parents, even though the property would have been exempt under state law.

The wife’s parents entered into an installment sales contract or contract for deed for the purchase of certain real property, the title to which would remain with the parents until the contract payments were paid in full, at which time title would be conveyed to the married couple.  Under the contract, the husband and wife were to make installment payments and two balloon payments to the wife’s parents over the course of seven years, with the final balloon payment paying off the contract in full.  The contract for deed was recorded in land records after it was fully ratified.  The husband and wife failed to make the first balloon payment.  The parents continued to accept installment payments from the couple and subsequently transferred the contract to themselves as trustees of their living trust.  The husband and wife failed to make the second and final balloon payment.  Nevertheless, the wife’s parents continued to accept monthly payments from the couple.  Five years later, the husband filed for divorce from his wife.  The parents then declared a default in contract for deed.  As the property had appreciated in the interim from the contract sales price of approximately $150,000 to more than $560,000, with a balance due of only $188,000, the husband took legal action against his wife, her parents, and their family living trust to enforce the contract for deed and realize the appreciation in value.  The state court legal actions were settled with a cash payment from the wife’s parents to the husband in return for a release of his rights in the real property and his rights to other marital property.  In accordance with the comprehensive settlement, the husband and wife quit claimed their equitable interests in the real property to the wife’s parents.  The wife’s quit claim deed to her parents was not recorded.  A year later, the wife filed a chapter 7 bankruptcy case without listing any interest in the real property or claiming any exemption in it.

The chapter 7 trustee filed an adversary proceeding to set aside the transfer and recover the real property as an unperfected, voluntary and fraudulent transfer under Bankruptcy Code Sections 544(a), 548(a) and 550 and certain Minnesota state statutes.

The bankruptcy court first recognized that state law determines property rights in bankruptcy.  The bankruptcy court judge next recognized that Minnesota state law provided that one could not fraudulently transfer exempt homestead property, as creditors could not claim they were prejudiced by a transfer or claim that it was a fraud when there would be no recovery of value.  The bankruptcy court judge further held that that Minnesota protection extended to bankruptcy fraudulent transfers under 11 U.S.C. 548 and denied the trustee’s avoidance actions.

On appeal, the bankruptcy appellate panel (“BAP”) held that the bankruptcy court judge erred by failing to analyze the alleged fraudulent transfer under Bankruptcy Code Section 548.  The BAP recognized two bases for the chapter 7 bankruptcy trustee’s avoidance powers:  (1) the avoidance powers of an unsecured creditor using state or federal law under Bankruptcy Code Section 544(b), and (2) the power to avoid a voluntary or involuntarily transfer within two years of filing found to be constructive fraud for lack of full, fair-market consideration while the Debtor was insolvent under Bankruptcy Code Section 548(a)(1)(B).  The BAP agreed with the chapter 7 trustee’s assertion that Minnesota law did not extend to avoidable fraudulent transfers in bankruptcy under 11 U.S.C. 548.  The BAP recognized five elements to the trustee’s fraudulent conveyance avoidance powers under 11 U.S.C. 548, and only the first one – the interest of the Debtor in property – depended upon an interpretation of state law.  The other four elements – (2) a voluntary or involuntary transfer, (3) within two years of filing bankruptcy, (4) for less than reasonably equivalent value, and (5) while the debtor was insolvent – all depended upon an interpretation of federal bankruptcy law.  The BAP ruled that the debtor, by entering into a settlement agreement and transferring the property, did have an interest in property under state law.  It also ruled that the transfer took place within two years of the wife filing her chapter 7 bankruptcy case.  As the other three elements were disputed, the BAP reversed and remanded the case for further findings by the bankruptcy court judge.

In reaching its decision, the BAP reasoned that the debtor could not claim the property as exempt because she voluntarily transferred the property before filing bankruptcy and her parents could not claim the exemption she might otherwise have.  By so doing, the BAP rejected the “no harm, no foul” rule that a minority of the courts have used to restrict the trustee’s avoidance power to those transfers involving nonexempt property.  The Fourth Circuit Court of Appeals, which includes the U.S. Bankruptcy Court for the Eastern District of Virginia, similarly rejected the “no harm, no foul” rule in a non-family law case in Tavenner v. Smoot, 257 F.3d 401 (4^th Cir., 2001).

You should consult with your Virginia bankruptcy and divorce lawyer, or Richmond divorce lawyer James H. Wilson, Jr., to discuss how you or your spouse’s your divorce transactions might affect a Virginia bankruptcy case.

How to file divorce in Virginia after one’s spouse files bankruptcy

You may be able to file for divorce in Virginia after your spouse files bankruptcy, depending on the type and timing of the bankruptcy proceeding, but you should not attempt to divide your property or allocate your debts through the equitable distribution process or by a separation agreement or property settlement agreement without first obtaining relief from the automatic stay in a pending case such as a chapter 13 bankruptcy case.  The automatic stay that goes into effect as soon as a bankruptcy case is filed protects property of the bankruptcy estate and the debtor from collection efforts of his or her creditors holding prepetition claims.  Those creditors may include the spouse of the debtor.  A spouse may have a claim against a spouse in bankruptcy due to the existence of joint debts, a right to contribution, and rights incidental to the marital relationship, including a right to support and the rights to a division of marital property and allocation of marital debts through the equitable distribution under Virginia Code Section 20-107.3.

 The automatic stay in bankruptcy found in Bankruptcy Code Section 362 does include exceptions for certain family law cases such as the establishment of paternity, the establishment or modification of  a domestic support obligation (as defined in 11 U.S.C. 101(14A), a proceeding to collect a domestic support obligation from property that is not property of the estate, a proceeding concerning child custody or visitation, a proceeding regarding domestic violence (such as a protective order), or a proceeding for divorce or the dissolution of the marriage provided the case does not seek a determination of the division of property that is property of the estate.  Nevertheless, settling one’s marital obligations with a separation agreement or property settlement agreement, or litigating the typical contested divorce case usually involves actions that could be considered a violation of the automatic stay.  Any action taken in violation of the automatic stay is void or of no effect.  Consequently, the prudent course of action is to first seek relief from the automatic stay in order to ensure that your separation agreement or property settlement agreement is valid or your equitable distribution award will not be disturbed.

While most chapter 7 cases are pending for only a short period of time, usually four to five months, a chapter 13 case may last three to five years.  Thus, while a spouse may choose to simply wait for the conclusion of a chapter 7 case (or 180 days if advisable under 11 U.S.C. 541(a)(5)(B)) before signing a separation agreement or proceeding with equitable distribution in Virginia, a spouse of a debtor in a chapter 13 case faces a potentially much greater delay. In addition, under Bankruptcy Code Section 1306, property of the estate in a chapter 13 case includes property that the debtor acquires and earnings from service performed during the case.   In all cases, the spouse of the debtor spouse should consult with a lawyer to protect that spouse’s rights in the bankruptcy case.

 Relief from the automatic stay may be obtained in the U.S. Bankruptcy Court for the Eastern District of Virginia (EDVA) by filing a Motion for Relief from the Automatic Stay along with a Notice of Motion and Notice of Hearing.  The website for the EDVA has a court calendar for each of the two judges that lists regular hearing dates for Motions, including Motions for Relief from Stay.  The EDVA website also includes a number of bankruptcy forms for use in a Virginia bankruptcy, including a model Notice of Motion form.  After obtaining the appropriate hearing date, a movant would file the motion and notice, along with a proposed written order, and pay the filing fee to the clerk of court.  The motion, notice and proposed order should be mailed to the debtor spouse, the trustee appointed in the case, all creditors, and all parties in interest. 

 On the hearing date, the U.S. Bankruptcy Court for the Eastern District of Virginia will use a pre-call docket system in which all cases on the docket are first called by a clerk to determine if the matter requires a judicial determination.  Most cases are continued by agreement or resolved by agreement on the pre-call docket.  The few cases for the judge to hear, including your Motion for Relief from Stay, will be called in sequence after the judge takes the bench.  Usually, no one files an objection to the motion or shows up in opposition to the motion on the hearing date, which gives the non-filing spouse the opportunity to persuade the judge to grant his or her motion for relief unopposed.

 After the judge grants relief from the automatic stay in court, the successful moving party must then submit a written order reflecting the judge’s decision for the judge’s signature (hopefully your proposed order).  With the issuance of the court’s written order, the non-filing spouse can then safely proceed with equitable distribution or the negotiation and execution of a separation agreement or property settlement agreement.

 You should consult with your Virginia bankruptcy law and divorce law attorney or Richmond divorce lawyer James H. Wilson, Jr., to discuss whether you should seek relief from the automatic stay in your spouse’s bankruptcy case in order to execute a separation agreement or property settlement agreement or pursue equitable distribution in your Virginia divorce case.

What is the definition of “income” and what is the definition of “debt” in bankruptcy and divorce in Virginia?

Sometimes, the difference in the meaning of one word can determine the outcome of a case.  We often assume we know the meanings of some of the most frequently used words in bankruptcy and divorce, words like “income” and “debt”.  Yet, a closer examination of the legal definition of some of these frequently used words reveals how the legal definition may differ from the meaning of the word in common parlance.

 Debt and income are important terms in bankruptcy and divorce in Virginia.  The legal definition of income in family law and divorce matters may affect child support, spousal support or maintenance, and the classification of marital property and separate property in equitable distribution in Virginia.  The legal definition of debt may affect the nature of a claim in bankruptcy and whether the claim represents an obligation owed or an interest in property.  In Virginia, it is not surprising that family law has stronger legal definitions of “income” and bankruptcy law has stronger legal definitions of “debt”, as divorce and family law are often concerned with establishing legal obligations based on income, while bankruptcy is concerned with the extinguishment of legal obligations based on debt.

 We can first turn to Black’s Law Dictionary for common legal definitions of debt and income.  According to Black’s Law Dictionary, “debt” is “[a] fixed and certain obligation to pay money or some other valuable thing…, either in the present or future.”  Black’s Law Dictionary (Abridged 6^th Ed., 1991).  The legal definition of “income” is “the return in money from one’s business, labor, or capital invested; gains, profits, salary, wages, etc.” Black’s Law Dictionary (Abridged 6^th Ed., 1991).

 The bankruptcy code leads us to a broad twofold definition of a “debt” in bankruptcy:  “The term “debt” means liability on a claim.”  11 U.S.C. § 101(12).  “The term “claim” means – (A) right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured; and (B) right to an equitable remedy for breach of performance if such breach gives rise to a right to payment, whether or not such right to an equitable remedy is reduced to judgment, fixed, contingent, matured, unmatured, disputed, undisputed, secured or unsecured.”  11 U.S.C. § 101(5).   Thus, while a debt in common parlance usually means a present obligation on the part of the debtor and a present right to a certain amount of money on the part of the creditor, a debt in bankruptcy is not limited by time, conditions, or amount.  Of course, a debtor in bankruptcy may not discharge a debt that had not come into existence at the time of the filing of the bankruptcy case.

 While the bankruptcy code does not define “income”, it does include a definition of “current monthly income” in 11 U.S.C. 101(10A) for means testing purposes under 11 U.S.C. 707(b)(2)(A)(i), as follows: “The term “current monthly income” – (A) means the average monthly income from all sources that the debtor receives (or in a joint case that the debtor and the debtor’s spouse receive) without regard to whether such income is taxable income…”  Thus income in bankruptcy may include nontaxable receipts, such as gifts or inheritances, which would not be considered income in the ordinary sense.

 “Income” enjoys a broad and comprehensive definition in Section 20-108.2(C) of the Code of Virginia, where “gross income” means all income from all sources, and shall include, but not be limited to, income from salaries, wages, commissions, royalties, bonuses, dividends, severance pay, pensions, interest, trust income, annuities, capital gains, social security benefits except as listed below [not Federal supplemental security income benefits], unemployment insurance benefits, disability insurance benefits, veterans’ benefits, spousal support, rental income, gifts, prizes or awards.”    Excluded from “gross income” under the Virginia child support law definition are the following:  “1.  Benefits from public assistance and social services programs as defined in §63.2-100; 2.  Federal supplemental security income benefits; 3.  Child support received; or 4.  Income received by the payor from secondary employment income not previously included in “gross income” where the payor obtained the income to discharge a child support arrearage…”  Va. Code § 20-108.2(C)(1) – (3). 

 While Section 20-107.3 of the Code of Virginia, Virginia’s equitable distribution statute, provides definitions of “separate debt” and “marital debt”, “debt” itself is not defined.  “Debtor” is defined in Virginia’s Uniform Commercial Code (Va. Code § 8.9A(102)(a)(28)), but not “debt”.  While Virginia has a Division of Debt Collection (Va. Code § 2.2-518), and a Virginia Debt Collection Act (Va. Code § 2.2-4800, et seq.), the legal definition of a “debt” remains elusive.  Virginia does define a “Debt Collector” in Virginia Code § 6.2-2000 with reference to the Federal Fair Debt Collection Practices Act, which does include a definition of debt as follows: “(5) The term “debt” means any obligation or alleged obligation of a consumer to pay money arising out of a transaction in which the money, property, insurance, or services which are the subject of the transaction are primarily for personal, family, or household purposes, whether or not such obligation has been reduced to judgment.”  15 U.S.C. 1692(a)(5).   Finally,  the Virginia Taxes Title, Section 58.1-301 incorporates the definitions used in the Internal Revenue Service, which includes a definition of debt as follows:  “A debt is any amount owed to you, including stated principal, stated interest, fees, penalties, administrative costs, and fines. The amount of debt canceled may be all or only part of the total amount owed. However, for a lending transaction, you are required to report only the stated principal.”

 You should consult with your Virginia bankruptcy and divorce attorney or Richmond Bankruptcy and Divorce Lawyer James H. Wilson, Jr., to discuss how the legal definitions of “debt” and “income” may affect your case.

Would an adult child’s obligation to support a parent be dischargeable in a Virginia bankruptcy?

Parents and spouses are not the only parties who may have a legal duty to support another person.  Adult children may have not only a moral obligation, but also a legal obligation to support their parents.  Many states, including Virginia, have enacted filial responsibility statutes that make adult children responsible for supporting their parents in certain instances.  While approximately thirty states have such filial responsibility statutes, very few of those states actually enforce the law so there is very little case law on the issue.  Neglect of Older Persons: An Introduction to Legal Issues Related to Caregiver Duty and Liability, by Lori Stiegel, Ellen Klem and Jenette Turner (American Bar Association on Law and Aging, 2007). 

Virginia Code Section 20-88 provides that “[i]t shall be the joint and several duty of all persons eighteen years of age or over, of sufficient earning capacity or income, after reasonably providing for his or her own immediate family, to assist in providing for the support and maintenance of his or her mother or father, he or she being then and there in necessitous circumstances…”  The Virginia Juvenile and Domestic Relations District Court has exclusive original jurisdiction of all cases arising under Virginia Code Section 20-88, presumably because the judges of that court have jurisdiction over family law matters (other than divorce) and extensive experience in understanding family finances, income, expenses and support.  In Virginia, “necessitous” is defined as “living in or characterized by poverty; needy,” and as “narrow, destitute, pinching, pinched.”  Mitchell-Powers Hdwe. Co. v. Eaton, 171 Va. 255, 198 S.E. 496 (1938). 

The adult child is only responsible for his or her parent after reasonably providing for his own family.  Bagwell v. Doyle, 187 Va. 844, 48 S.E.2d 229 (1948).   Although the triggering condition required is “necessitous circumstances”, the level of support required of the adult children is actually closer to that of permanent spousal support (which recognizes a right to continue the standard of living established during the marriage) consisting of “…such support and maintenance as comport with the health, comfort and welfare of normal individuals according to their standards of living considering his or her own means, earning capacity and station in life…”  Mitchell-Powers at 262 (1938).  This compares with a spouse’s contract or tort liability to a third party for a spouse’s necessaries codified in Virginia Code Section 55-37 and for emergency medical treatment of a spouse codified in Virginia Code Section 8.01-220.2, in addition to possible criminal prosecution for desertion or nonsupport of a spouse or child under Virginia Code Section 20-61. 

There are two exclusions to the statutory duty to support one’s parent: (1) the desertion, neglect, abuse or willful failure to support the child by the parent; and (2) the receipt by the parent of public assistance or services under a federal or state program, with the exception that the Commonwealth of Virginia or one of its departments, including the Department of Medical Assistance Services or the Behavioral Health and Developmental Services, might seek reimbursement for a portion of the costs of such assistance or services from the adult children in the place of the necessitous parent.  Va. Code §20-88 .  The reason for the dearth of cases involving filial responsibilities statutes is probably this second exclusion.  Many elderly people in Virginia who might otherwise be in necessitous circumstances are taken care of in nursing homes under Medicaid coverage.   In Virginia, the Department of Medical Assistance Services administers the Medicaid program through the localities, which helps pay for nursing home care not otherwise eligible for Medicare coverage, for persons 65 years and older, who have limited income and resources.

Would such a filial support obligation to the parent or the Commonwealth of Virginia be dischargeable in bankruptcy by the adult child?  Bankruptcy Code Section 523(a)(5) creates an exception to discharge for a domestic support obligation.  “Domestic Support Obligation” is defined in Bankruptcy Code Section 101(14A) as follows:

“(14A) The term “domestic support obligation” means a debt that accrues before, on, or after the date of the order for relief in a case under this title, including interest that accrues on that debt as provided under applicable nonbankruptcy law notwithstanding any other provision of this title, that is—

(A) owed to or recoverable by—

(i) a spouse, former spouse, or child of the debtor or such child’s parent, legal guardian, or responsible relative; or

(ii) a governmental unit;

(B) in the nature of alimony, maintenance, or support (including assistance provided by a governmental unit) of such spouse, former spouse, or child of the debtor or such child’s parent, without regard to whether such debt is expressly so designated;

(C) established or subject to establishment before, on, or after the date of the order for relief in a case under this title, by reason of applicable provisions of—

(i) a separation agreement, divorce decree, or property settlement agreement;

(ii) an order of a court of record; or

(iii) a determination made in accordance with applicable nonbankruptcy law by a governmental unit; and

(D) not assigned to a nongovernmental entity, unless that obligation is assigned voluntarily by the spouse, former spouse, child of the debtor, or such child’s parent, legal guardian, or responsible relative for the purpose of collecting the debt.”

In order to be considered a Domestic Support Obligation not dischargeable in bankruptcy, the support obligation must meet the four requirements found in (A), (B), (C), and (D) above.  A filial support obligation may meet the first and fourth elements of a Domestic Support Obligation in that it is “(A) owed to or recoverable by…(ii) a governmental unit, and is “(D) not assigned to a nongovernmental entity…” , but it would fail to meet the second element in that it is not support to a “spouse, former spouse, or child of the debtor or such child’s parent…” and it may not meet the third element because if the obligation was established in the Juvenile and Domestic Relations District Court, because that court is not “(C)(ii)…a court of record;”, although the argument could be made that the third element is satisfied because the Debtor’s filial support obligation is  “(C)…subject to establishment…by reason of applicable provisions of – …(iii) a determination made in accordance with applicable nonbankruptcy law by a governmental unit…”

Although it appears that a filial support obligation would be a dischargeable debt in bankruptcy, you should first consult with your Virginia bankruptcy and family law lawyer, or Richmond bankruptcy and family law lawyer James H. Wilson, Jr., to discuss whether your particular family law obligation may be dischargeable in bankruptcy.

Can a chapter 7 bankruptcy trustee sell the debtor’s right to a portion of her former spouse’s 401(k) plan?

Not in the case of In re Carlton, Case No: 300-40223, an unpublished case from U.S. Bankruptcy Court for the District of Oregon, where the judge held that the Debtor has no claim against her former husband, but instead has a right in his 401(k) plan and a right to obtain a Qualified Domestic Relations Order (“QDRO”).

In Carlton, the Debtor wife was divorced from her husband before filing chapter 7 bankruptcy.  In the divorce decree, the state court judge awarded the Debtor wife fifty percent (50%) of her husband’s 401 (k) plan and an equalizing judgment for a sum to compensate her for her share of the husband’s IRAs that he would retain.  The state divorce court retained jurisdiction to enter a QDROs transferring wife’s share of her husband’s retirement plan.  The wife did not obtain a QDRO before filing for chapter 7 bankruptcy to discharge her debts.  In her bankruptcy filing, the wife listed her interest in the 401(k) plan as a contingent, unliquidated claim against her ex-husband on her schedule of personal property (Bankruptcy Schedule B), but did not list it as exempt on her schedule of exempt property ( Bankruptcy Schedule C). The chapter 7 trustee appointed in the Debtor’s bankruptcy case negotiated with the Debtor’s ex-husband to sell her interest in his 401(k) plan back to him for the sum of $5,000.  The Debtor wife objected to the trustee’s notice of intent to sell filed in the case to obtain the bankruptcy court judge’s approval of the sale.

The chapter 7 trustee in Carlton argued that the Debtor wife had no interest in her husband’s retirement plan until she obtained a QDRO, but instead had a claim against her ex-husband.  The Debtor wife argued that the divorce decree created an interest in her former husband’s 401(k) plan, which interest was not property of the estate due to the anti-alienation provisions of the Employee Retirement Income Security Act (“ERISA”), 29 U.S. Code Section 1056(d)(1).   ERISA is a federal law that regulates the creation of pension and retirement plans for employees and their beneficiaries, including spouses and children.  In general, interests in an ERISA plan may not be alienated, sold or transferred. This restriction on the alienation of ERISA benefits ensures that these plan are created exclusively to provide retirement benefits to participating employees and their beneficiaries.  Boggs v. Boggs, 520 U.S. 833, 845 (1997) .  One exception to this general rule against alienation was created for former spouses, who can obtain an interest in their spouse’s retirement plan from a divorce by a special order known as a Qualified Domestic Relations Order or QDRO,  29 U.S. Code Section 1056(d)(3)  .  (Spouses may also use a regular Domestic Relations Order in a divorce case to preserve the tax treatment of a transfer of a non-ERISA retirement plan, such as an Individual Retirement Plan or IRA.)

The bankruptcy court judge recognized that the state divorce decree awarding an interest in the husband’s 401(k) plan created the wife’s interest in the plan and limited the husband’s interest in the whole plan, citing Trustees of the Directors Guild of America-Producer Pension Benefits

Plans v. Tise, 234 F.3d 415 (9th Cir. 2000).  Instead of having a claim against her husband, the Debtor had a claim against the 401(k) plan.  The divorce decree gave the wife a right to obtain a QDRO in order to enforce her claim.  The bankruptcy judge ruled that the right was personal to the Debtor wife and could not be exercised by a chapter 7 trustee, who was not within the definition of alternate payee under ERISA, limited to a spouse, former spouse, child or other dependent of the employee participant.  29 U.S.C. 1056(d)(3)(K).  Since the chapter 7 trustee could not obtain a QDRO, he could not sell the interest in the retirement plan.

If you have any questions about a chapter 7 bankruptcy trustee’s rights in your or your former spouse’s retirement plan, call your Virginia bankruptcy and divorce law lawyer or Richmond Divorce Lawyer James H. Wilson, Jr.

Is a wife’s interest in her former husband’s government pension arising from a divorce decree an interest in property or a debt dischargeable in bankruptcy?

The Sixth Circuit Court of Appeals held in the case of In re: McCafferty, 96 F.3d 192 (6^th Cir., 1996), that the wife’s interest in her husband’s pension was not a dischargeable debt, but was instead an interest in property excluded from property of the estate under 11 U.S.C. 541(d).  In McCafferty, the appellate court recognized a constructive trust in the government pension under which the former husband held bare legal title for the benefit of his former wife.  While the McCafferty court noted that the wife might have benefitted from the addition of 11 U.S.C. 523(a)(15) shortly after the case was filed, which addition creates an exception to discharge for debts arising from divorce, separation, a separation agreement, a divorce decree, or other court order, the case was really decided on the distinction between an interest in property and a debt.

The husband and wife had been married for approximately twenty-three years before the husband filed for a divorce in the state of Ohio.  Ohio, just like Virginia, has equitable distribution, which allows the divorce court judge to divide up the parties marital property and marital debt.  Just as in Virginia, equitable distribution allows the divorce court judge to award a spouse an interest in the marital share of the other spouse’s retirement plan or pension. Specifically, in Virginia, Virginia Code Section 20-107.3(G), allows the divorce court judge to direct payment of a certain percentage, up to 50%, of the marital share of a pension, profit-sharing or deferred compensation plan, or retirement benefits, vested or unvested.  In McCafferty, the judge awarded to the wife, one-half of the value of the pension on the date of the divorce.  The judge entered a money judgment in favor of the wife for $100,250.21, and ordered the husband to satisfy the judgment by paying to his wife the sum of $1,500 a month starting six years after the divorce decree was entered. 

 Seven months after he was divorced, the husband filed a chapter 7 bankruptcy case, and an adversary proceeding in the case to declare the debt to his former wife to be nondischargeable.  The wife’s first argument was that the interest in the husband’s retirement plan was nondischargeable as being in the nature of support.  Upon the wife’s request, the bankruptcy judge granted relief from the automatic stay to allow the state court divorce judge to clarify the nature of the judgment.  The state court judge ruled that the judgment was not support, but was instead a distribution of property.  The wife than argued that the court should impress a constructive trust upon her interest in husband’s pension, such that it would not be property of the estate and was nondischargeable in the husband’s bankruptcy.  The bankruptcy court judge ruled that the interest in the pension plan was a dischargeable debt.  The U.S. District Court affirmed the bankruptcy judge’s decision and the wife appealed to the Court of Appeals.  Both the bankruptcy court and the district court held that the wife’s constructive trust theory was foreclosed by the decision in In re: Calhoun, 715 F.2d 1103 (6^th Cir., 1983), which recognized that the first step in determining whether the assumption of joint obligations payable to third party creditors in a separation agreement with a hold harmless provision was nondischargeable support was a determination of whether the court or the parties intended to create an obligation to provide support by assuming the debts.  As the state court judge in McCafferty held that the wife’s interest in husband’s retirement plan was a distribution of property and not support, the debt could not be nondischargeable support.

In the Court of Appeals, the husband relied on the broad definition of a debt in the bankruptcy code (now 11 U.S.C. 101(12) “debt” and 101(5) “claim”) and the case of In re Omegas Group, 16 F.3d 1443 (6^th Cir., 1994), where the appellate court upheld the bankruptcy court’s refusal to apply a constructive trust in property at the expense of the creditors in bankruptcy without an underlying judgment or decision from a separate prepetition proceeding.  The appellate court in McCafferty distinguished the Omegas case, finding that the divorce decree satisfied the separate prepetition proceeding requirement to imposing a constructive trust in a bankruptcy case.  While the Court of Appeals agreed with the U.S. District court that the wife’s interest was not a nondischargeable support debt under 11 U.S.C. 523(a)(5), the Court of Appeals ruled that the support issue was irrelevant if wife’s interest in her husband’s retirement plan was not property of the bankruptcy estate under 11 U.S.C. 541(d).  As the divorce decree awarded the wife a separate interest in her husband’s pension, the husband retained only bare legal title, regardless of the fact that the decree did not specifically refer to a “constructive trust”.  As wife’s equitable ownership interest was outside the bankruptcy estate, the bankruptcy court was without jurisdiction over her separate interest.  A discharge of husband’s obligation to pay wife directly could not affect her separate interest in the pension itself.  Consequently, the wife’s award of pension benefits was not a dischargeable debt in bankruptcy.

You should consult with your Virginia divorce and bankruptcy attorney, or Richmond Bankruptcy and Divorce Lawyer James H. Wilson, Jr., concerning whether obligations arising from your Virginia divorce case may be discharged in bankruptcy.

When do stock options become marital property subject to equitable distribution in a Virginia divorce case?

According the Supreme Court of Virginia in the case of Schuman v. Schuman, stock options become marital property when they are earned during the marriage and before the date of last separation, regardless of whether the options are vested or nonvested.  Although Schuman does not directly concern bankruptcy, it does concern how intangible property rights, options in stock arising from employment, are treated as deferred compensation under Virginia’s equitable distribution statute, §20-107.3, and how a spouse who is not on the legal title to such property, nevertheless gains an interest through marriage and divorce in Virginia.  In a bankruptcy case, normally title to property controls, and the spouse who is not a title owner of such options would not have an interest in them that could be considered property of the bankruptcy estate under 11 U.S.C. 541 by virtue of the marriage, unless that spouse acquires or becomes entitle to acquire those rights in the marital property before filing bankruptcy, or as a result of a property settlement agreement, or interlocutory or final divorce decree within 180 days after filing bankruptcy under 11 U.S.C. 541(a)(5)(B).

In the Schuman case, the parties were married for only about four years and had entered into a premarital agreement or antenuptial agreement prior to their marriage, as permitted under the Virginia Premarital Agreement Act, Sections 20-147 to 20-155 of the Code of Virginia.  The Wife worked as a Vice President and then a President for SAIC, a large government contractor in Virginia.  As part of her employment package, she received what were called “stock options”, but what were in fact vesting stock, according to footnote 2 of the Supreme Court’s opinion.  A stock option is a right to buy a particular stock at a particular price, known as the strike price, on a predetermined date in the future when the option can be exercised.  The option purchaser pays a premium for the right to purchase under those conditions, but is not obligated to buy the stock.  If the stock option is exercised, then the option holder would ordinarily have to pay the price to buy the stock.  The option itself, the right to buy the stock at the strike price, may become a valuable property right if the strike price is lower than the current trading value or price of the stock, because the purchaser could buy the stock and sell it at its higher fair market value for a profit.  The value of the option increases or decreases disproportionately greater than the differences in the value of the underlying stock.  With a true option, the option itself can be sold without ever buying the stock.  By giving the controlling officers options in the company’s stock, a company can create a strong incentive for the controlling officers to increase the values of the shares of stock.

In Schuman, the option was not a true option because the stock would simply become part of the highly compensated employee’s portfolio when vested, provided the employee continued to work for the company.  It was actually a grant of stock subject to a vesting schedule, what the Supreme Court of Virginia referred to as “vesting stock”.  Unlike a true stock option, such vesting stock does not have a strike price, and would not be exercised by anyone; it simply transfer’s from the company’s books to the employee’s book of stock.

The Schuman case was twice appealed, first from the Virginia Circuit Court where the divorce case was tried, to the Virginia Court of Appeals, and then from the Virginia Court of Appeals to the Supreme Court of Virginia.  At the trial court level, the judge who heard the equitable distribution portion of the divorce case decided that the entirety of the stock award were separate funds, because the wife purchased them with her separate property.  The Court of Appeals decided the stock awards were separate property for a different reason, because the vesting date was after the date of last separation of the parties, a critically important date under Virginia equitable distribution statute, particularly with respect to a married person’s interest in his or her spouse’s retirement plan, pension plan or deferred compensation plan.  The Supreme Court of Virginia reversed the Court of Appeals and remanded the case to the Court of Appeals for a further remand to the trial court for the appropriate factual determinations consistent with the appellate court’s legal decision.

In arriving at its decision, the Supreme Court of Virginia noted that the Court of Appeals had previously correctly decided, the Dietz v. Dietz case, that deferred compensation in the form of stock options were considered deferred compensation subject to equitable distribution under Virginia Code Section 20-107.3(G), which allows the divorce court judge to direct payment of a certain percentage, up to 50%, of the marital share of a pension, profit-sharing or deferred compensation plan, or retirement benefits, vested or nonvested, of an employee spouse to the nonemployee spouse. Citing Black’s Law Dictionary, the court found “deferred compensation” to be “[p]ayment for work performed, to be paid in the future or when some future event occurs.”  While the Virginia Court of Appeals implicitly held that the option was earned on the date of vesting, the Supreme Court of Virginia held that the marital share of a deferred compensation, whether vested or nonvested, should be calculated the same way as the marital share of a pension, profit-sharing or retirement plan, as illustrated in the case of Mann v. Mann, 22 Va. App. 459, 464-65, 470 S.E.2d 605, 607-08 (Va. Ct. Appeals, 1996).  Consequently, the case was remanded for further remand to the trial judge for new findings and a new decision.

You should consult with your Virginia divorce attorney or Richmond divorce lawyer James H. Wilson, Jr., concerning how to calculate the marital share of stock options in your Virginia divorce case.

What is bankruptcy?  What is divorce? What is the relationship between bankruptcy and divorce in Virginia?

A bankruptcy is a case or legal proceeding in federal court in which a debtor seeks protection from his or her creditors and an adjustment or discharge of his or her debts.  A debtor may initiate a voluntary bankruptcy case or the creditors of a debtor may initiate an involuntary bankruptcy case.  Often, a debtor initiates a bankruptcy case when he or she is insolvent, unable to pay his or her bills as they become due, or has lost control of property, through a garnishment, attachment or judgment lien, or is about to lose property to a repossession or foreclosure sale or trustee’s sale.  In a straight bankruptcy or chapter 7 proceeding, the debtor agrees to give up his or her nonexempt property for sale by an appointed trustee in return for a discharge of his or her dischargeable debts.  In a plan bankruptcy under chapter 11, chapter 12, or chapter 13, the debtor pays part or all of his or her debts through a plan confirmed by the bankruptcy court.  The most common plan bankruptcy is chapter 13, also known as a wage earner plan or the adjustment of the debts of an individual with regular income, which is available to individuals with regular income and a limited amount of unsecured debt and secured debt.  The chapter 13 plan lasts from three to five years.  After completing the plan, the chapter 13 debtor received a discharge of his or her debts.  It is often filed by a homeowner who is facing foreclosure and wishes to keep his or her home and pay back the arrearage amount over a three to five year period.

A divorce is a case or legal proceeding in state court terminating the legal relationship of marriage and resolving the legal incidents and consequences of marriage, which may include liability for spousal support, rights to inheritance, interests in marital property, and liabilities for marital debts.  A divorce may also address the custody, visitation, and support of children born or adopted of the marriage.  In Virginia, a man and a woman can enter into contracts, before marriage or during the marriage or separation, governing their legal responsibilities and liabilities arising from the marriage.  The agreements, which are variously known as premarital agreements, antenuptial agreements, marital agreements, separation agreements, property settlement agreements, or marital stipulations, can be enforceable just like any other contract if certain legal requirements are met.  Although a man and a woman can enter into a contract governing the incidents their relationship as husband and wife, the parents of a child cannot ultimately bind a court to a contract controlling the custody, visitation and support of a child, because Virginia has an interest in the well-being and best interests of children within its jurisdiction.  Virginia has two types of divorces: a divorce from bed and board and a divorce from the bond of matrimony.  A divorce from bed and board – a divorce a mensa et thoro – is literally a divorce from bed and table.  It recognizes that the parties are now legally separated, but does not allow the parties to remarry.  A divorce from the bond of matrimony – a divorce a vinculo matrimonii – is a full and final divorce from the bond of matrimony allowing the parties to remarry.  A divorce from bed and board may be granted only on fault grounds, while a divorce from the bond of matrimony may be granted for fault or no fault grounds, usually a one year separation, or a six month separation, if there are no minor children and the parties have entered into a written separation agreement.

Bankruptcy and divorce are related to each other because they are both primarily concerned with finances, assets, property, liabilities, and debts.  The marital relationship gives rise to interests in property and liabilities for support and contribution for debts.  A marriage creates certain efficiencies in financial arrangements which are disrupted or destroyed by a separation of the spouses.  Maintaining two households is usually considerably more costly than maintaining one household. In Virginia, marriage is viewed as an economic partnership in which the parties are entitled to share in their joint efforts and support.   A husband or wife may make financial sacrifices in reliance on the continued existence of that marital partnership.  Consequently, a spouse may be financially vulnerable if and when the marriage dissolves.

Bankruptcy and divorce are not strangers in Virginia.  Unfortunately, financial difficulties often lead to marital difficulties, and marital difficulties often lead to financial difficulties. A bankruptcy can result in a divorce, and a divorce can result in a bankruptcy.

You should consult with your Virginia bankruptcy and divorce lawyer, or Richmond bankruptcy and divorce lawyer James H. Wilson, Jr., to discuss the relationship between a potential or ongoing bankruptcy or divorce in Virginia.

Is a debtor’s undistributed interest in an ERISA pension plan arising from a QDRO excluded from property of the estate in a bankruptcy case?

Yes, in In re Lalchandani, 27 B.R. 880 (BAP 1^st Cir., 2002), where the Bankruptcy Appellate Panel for the 1^st Circuit Court of Appeals affirmed the Bankruptcy Court’s holding that the debtor’s interest in her former husband’s Employee Retirement Income Security Act (“ERISA”) qualified pension plan arising from a Qualified Domestic Relations Order (“QDRO”) was excluded from property of the estate.

In Lalchandani, before filing bankruptcy, the Debtor wife and her husband had entered into a separation agreement under which the husband agreed to transfer the sum of $25,000 to the Debtor wife as an alternate payee of her husband’s ERISA pension plan.  As required under ERISA, the transfer would be made by a QDRO, a special order issued in divorce cases to meet the requirements of ERISA and allow the plan administrator of the retirement plan to transfer an interest in the employee’s account.  The Debtor wife then filed a chapter 7 bankruptcy case and did not identify her interest in her husband’s retirement plan on Schedules B and C.  Five days later, the Massachusetts probate and family court granted the parties a provisional divorce, known as a divorce nisi, and issued the QDRO.

The chapter 7 bankruptcy trustee, who was appointed to administer nonexempt property in the Debtor wife’s case, filed a motion with the bankruptcy court judge to declare the wife’s interest in the pension plan to be property of the estate under 11 U.S.C. § 541(a)(5)(B) and to compel the wife to turnover such interest to him.  The Debtor wife contested the matter, arguing that her interest in the plan was excluded under 11 U.S.C. 541(c)(2), which states as follows:

A restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable nonbankruptcy law is enforceable in a case under this title.

The bankruptcy court judge denied the trustee’s motion.  Relying on the language of the separation agreement, the bankruptcy court judge found the transfer was one from one ERISA pension plan to another ERISA pension plan, both excludable from the property of the estate.  The chapter 7 trustee appealed the decision.

On appeal, the Bankruptcy Appellate Panel first recognized that an interest in an ERISA plan was excluded from the property of the bankruptcy estate under 11 U.S.C. § 541(c)(2) and the U.S. Supreme Court’s holding in the case of Patterson v. Shumate, 504 U.S. 753 (1992), due to the anti-alienation clause in the ERISA statute, 29 U.S.C. §1056(d)(1).  The Bankruptcy Appellate Panel adopted the reasoning of the 8^th Circuit Bankruptcy Appellate Panel in the case of In re Nelson, 274 B.R. 789 (2002), recognizing that the protections of ERISA extends not only to the employee, but also to the spouse, former spouse, or dependent children, who may also be beneficiaries under the retirement plan.  Finding that he Debtor wife in Lalchandani was a beneficiary of her former husband’s plan, the Bankruptcy Appellate panel held that Patterson v. Shumate was applicable, and her interest in the ERISA plan under the QDRO was properly excluded from property of the estate.

If you have questions about whether property received under equitable distribution in Virginia, a divorce decree, separation agreement, or property settlement agreement is subject to administration in you or your spouse’s bankruptcy case, contact your Virginia bankruptcy and divorce lawyer or Richmond bankruptcy and divorce lawyer James H. Wilson, Jr.