BAPCPA AND ITS IMPACT

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1 BAPCPA AND ITS IMPACT ON OUR FAMILY LAW PRACTICES NORTH CAROLINA FAMILY LAW SPECIALISTS MEETING JULY 17-18, 2009 RALEIGH, NC PREPARED AND PRESENTED BY: Robert A. Ponton, Jr. Samuel T. Wyrick, III WYRICK ROBBINS YATES & PONTON LLP 4101 Lake Boone Trail, Suite 300 P.O. Drawer Raleigh, North Carolina

2 [This article was originally authored by Robert A. Ponton, Jr., and John T. Logan (Chapter 13 Trustee, EDNC). It has been updated for this presentation by Robert A. Ponton, Jr. and Samuel T. Wyrick, III.] The "Bankruptcy Abuse Prevention and Consumer Protection Act of 2005," Public Law 109-8, hereinafter the 2005 Act, became effective on Oct. 17, The legislation, representing the largest overhaul of the Bankruptcy Code since its enactment in 1978, contains numerous amendments significant to family lawyers. The 2005 Act makes its primary purpose very clear. In response to increased bankruptcy filings and substantial creditor losses, the 2005 Act is designed to eliminate perceived loopholes in the former Bankruptcy Code which allowed "bankruptcy abuse." Many of the provisions of the 2005 Act, including means testing (which compares the debtor's income to the state's median income to determine if the debtor may file Chapter 7), are intended to encourage the repayment of debts by making it more difficult for debtors to discharge debts through Chapter 7 bankruptcy and encouraging Chapter 13 bankruptcy filings. However, some of the most positive changes effected by the 2005 Act are those dealing with Domestic Support Obligations [hereinafter DSO, a new term of art in the Bankruptcy Code, defined in 11 U.S.C. 101(14A)]. This article addresses issues impacting family lawyers: namely, the automatic stay in bankruptcy; Chapter 7 bankruptcy; Chapter 13 bankruptcy and the impact of a bankruptcy filing on domestic claims. I. Domestic Support Obligations Section 101(14A) of the 2005 Act defines a DSO as a debt owed to a spouse, a former spouse, or a child of the debtor or such child s parent, legal guardian, responsible relative, or governmental unit, which obligations are in the nature of alimony, maintenance, or support (including assistance provided by a governmental unit) and not assigned to a nongovernmental entity, unless assigned voluntarily for the purpose of 2

3 collecting a debt. The 2005 Act removed all qualifications on who is owed the spousal and child support. II. Notice Required to Holder of DSO and to State Child Support Enforcement Agency When There is a Bankruptcy Filing Under 704(a)(10) of the 2005 Act in a Chapter 7 liquidation, when there is a claim for a DSO against the debtor, the Trustee is under an affirmative obligation to provide written notice to the holder of the claim, and of the right of the holder to use the services of the applicable state child support enforcement agency for assistance in collecting child support during and after the case. The Trustee is also under an affirmative duty to provide notice of the obligation directly to the appropriate state child support enforcement agency, along with the name, address and telephone number of the holder of the claim Act, 704(c)(1). Comparable duties apply to the Trustee under a Chapter 13 filing Act 1302(b)(6) and (d). Sample DSO notices for Trustees use, provided by the U.S. Trustee Program of the U.S. Department of Justice are included within Attachment 1. III. The Automatic Stay in Bankruptcy When Does the Automatic Stay Begin, and When Does it End? Section 362 is the automatic stay provision of the Bankruptcy Code. The automatic stay is effective immediately upon the debtor's bankruptcy filing, without any additional action required by the debtor. When the creditor spouse receives notice of a bankruptcy filing (irrespective of the chapter), such notice is also notice to the creditor spouse that the automatic stay is in effect. Generally, the automatic stay is effective until the debtor achieves his discharge, an order is entered by the bankruptcy court "lifting" the automatic stay, or the bankruptcy case is dismissed. Upon discharge, the automatic stay is 3

4 replaced by a permanent injunction that prohibits any collection of discharged debts. (Note: Solely for convenience, this article uses the masculine pronoun. Bankruptcy issues are gender neutral.) What Actions of the Creditor Spouse are Prohibited by the Automatic Stay? With specific exceptions which are discussed below, the automatic stay prohibits the creditor spouse from either beginning or continuing any judicial action (lawsuit, hearing, or execution) either against the debtor spouse [ 362(a)(1) and (2)] or against property of the debtor spouse's bankruptcy estate [ 362(a)(2) and (3)]. Therefore, if your client receives notice that his spouse has filed bankruptcy, your initial advice to your client is that his domestic case must be discontinued until your client obtains stay relief from the Bankruptcy Court. Obtaining stay relief to allow your domestic case to proceed in state court is very possible and is generally not expensive. Often it may be accomplished by entry of a Consent Order with the debtor, particularly if you are clear with debtor s counsel that you want relief from the automatic stay only to liquidate your client s claim for purposes of determining the amount and nature of the claim. The process requires filing a Motion (known as an adversary proceeding, not a complaint, in bankruptcy) for Relief from the Automatic Stay. In the Eastern and Western Districts of North Carolina, a motion is not required if a consent order is being tendered; in the Middle District, the motion must be submitted to the Clerk with the consent order. There is no filing fee required if a consent order is tendered with the motion, otherwise a $ filing fee is required. The new Act, in fact, provides for special rights for child support creditors. Further, as discussed below, some actions can proceed without bankruptcy court involvement. The Automatic Stay Prohibits the Prosecution of Equitable Distribution Claims (Absent Relief from the Automatic Stay) There is no exemption within Section 362(b) for equitable distribution proceedings. The 2005 Act explicitly excludes division of property proceedings from its new exceptions to the automatic stay, at least to the extent that the marital/divisible property is property of the bankruptcy estate [ 362(b)(2)(A)(iv)] (which it will be). 4

5 Therefore, the creditor spouse must seek relief from the automatic stay in the debtor spouse s case prior to: 1. Filing any lawsuit for equitable distribution; or 2. Proceeding with a filed suit for equitable distribution; or 3. Attempting to enforce any equitable distribution judgment and/or distributive award with respect to property of the bankruptcy estate. The Following Actions by the Creditor Spouse are Allowed in Spite of the Automatic Stay The "non-stayed" proceedings, as contained within Section 362(b), are: (1) the commencement or continuation of a criminal action or proceeding against the debtor [be very careful here -- using a criminal action, such as "worthless check" charges, as a vehicle to collect a debt, is a stay violation]; (2) (A) the commencement or continuation of a civil action or proceeding: (i) for the establishment of paternity; (ii) for the establishment or modification of an order for DSOs [Note: For our purposes, DSOs are obligations to pay post-separation support, alimony, and child support (see discussion below on p. 6, Actions to Establish or Modify Support Obligations]; (iii) concerning child custody or visitation; (iv) for the dissolution of a marriage [absolute divorce], except to the extent that such proceeding seeks to determine the division of property that is property of the estate [Note: Equitable distribution proceedings are stayed]; or (v) actions regarding domestic violence; 5

6 (B) the collection of a DSO from property that is not property of the estate (see discussion below in Contempt Motions Are They Stayed or Not? p. 7); (C) with respect to the withholding of income that is property of the estate or property of the debtor for payment of a DSO under a judicial or administrative order or a statute; (D) for withholding, suspension, or restriction of a driver's license, a professional or occupational license, or a recreational license, under State law, as specified in Section 466(a)(16) of the Social Security Act; (E) for reporting of overdue support owed by a parent to any consumer reporting agency as specified in Section 466(a)(7) of the Social Security Act; (F) for interception of a tax refund, as specified in Sections 464 and 466(a)(3) of the Social Security Act or under an analogous State law; or (G) for enforcement of a medical obligation, as specified under Title IV of the Social Security Act. Easily Understood Non-Stayed Domestic Claims Claims for absolute divorce, paternity, custody, visitation, domestic violence, license termination and restriction, and tax refund interception can proceed in State Domestic Court without bankruptcy court involvement. Actions to Establish or Modify DSO s Are They Stayed or Not? As observed in Norton Bankruptcy Law and Practice 3d, 175:6, under pre (b)(2)(A)(ii), a spouse was required to make a motion for relief from stay and at least a minimal showing of good cause to secure the right to pursue support relief in a domestic relations case in a state court. There is no longer the need for formal relief from the stay for most actions involving DSO s. 6

7 In In Re: Sunny Pamaswamy De Wakar 2007 WL (Bkrtcy.E.D. Va. 2007), the question before the court was whether a Chapter 11 debtor in possession who was separated from his spouse, but not subject to any court or agency order, or separation or property settlement agreement, for the payment of spousal or child support was required to give his spouse the special notices mandated by the Bankruptcy Code for holders of domestic support obligations. (See Discussion above on p. 2, regarding the notice required of the bankruptcy Trustee to the holder of a DSO and to the appropriate State Child Support Enforcement Agency.) The Court held that under the facts of this case, when no order had yet been entered in a state court determining an amount of child or spousal support, so as to be a DSO, the motion to require the debtor to give his wife and the state child support agency the notices required under 1106 (1)(A) and (B) would be denied. The Court, however, observed that: The debtor s wife is of course free, without encumbrance from the automatic stay, to bring a proceeding in state court to establish the appropriate amount of child or spousal support. 362(b)(2)(A)(ii), Bankruptcy Code. Id., (Emphasis added). We believe that even though there is no North Carolina case on point, the observation of the Court in the Eastern District of Virginia, quoted above, mirrors the meaning and intent of the provisions of the 2005 Act, and can be considered reliable authority (along with the 2005 Act itself) for bringing and maintaining a state court action for child or spousal support without first having to secure relief from the automatic stay. Contempt Motions Are They Stayed or Not? Debtor's Earnings. Section 362(b)(2)(C) provides that income that is "property of the bankruptcy estate or property of the debtor" may be withheld for payment of a court ordered DSO. Therefore, as we read the new Act, if the debtor spouse is in arrears (for example, on his post-separation support obligation) and files bankruptcy, the automatic stay does not 7

8 prohibit a civil contempt proceeding for so long as the civil contempt purge is limited to withholding [the debtor's] income for payment of a domestic support obligation under a judicial or administrative order or a statute. Notably, in In Re: Taylor, 2007 WL (Bkrtcy. E.D. Va. 2007) the debtor filed a motion with the court to extend the applicable automatic stay so as to block a motion by the debtor s wife to allow the continuation of a state court proceeding to monitor the debtor s compliance of a domestic support obligation of the debtor to her and to allow the court to take any action deemed necessary (in contempt ) to enforce the court s prior domestic support order. The reviewing court in the Eastern District of Virginia held that Ms. Taylor (the debtor s spouse) would be granted relief from the automatic stay so that the state court could in fact monitor the debtor s compliance with that court s order and take any action deemed necessary by that court to enforce its prior order. This rationale seems persuasive, in allowing state court oversight of the debtor s proper payment of his income towards a DSO, although there is as yet no North Carolina law on this issue. Debtor's Assets. Section 362(b)(2)(B) provides that DSOs may also be collected from property "that is not property of the estate," without seeking relief from the stay. Property of the bankruptcy estate, in a broad sense, includes everything in which the debtor has an ownership interest when he files bankruptcy. Sections 541 (applicable in Chapters 7, 11, 12, and 13), 1115 (in Chapter 11 cases) (added by the 2005 Act), and 1306 (in Chapter 13 cases) define property of the estate. If in doubt, it is safest to presume that property is property of the estate. Under Section 522(c)(1) of the Bankruptcy Code, property exempted [by the debtor] is not liable during or after the case for any debt of the debtor that arose before commencement of the case, except a debt for a domestic support obligation. (See, N.C.G.S. 1(C)-1601, et seq., for North Carolina's statute designating exempt property) (Attachment 2). In our opinion, if within the debtor's bankruptcy petition the debtor has claimed an equity interest in an asset as "exempt property," then the exempt equity interest is not property of the estate and is available to purge the 8

9 debtor's contempt for failure to comply with a court ordered support obligation without bankruptcy court involvement. For example, if a debtor claims a $1,500 equity exemption in his automobile, then that exempt equity is available to purge a debtor's contempt for non-payment of his post-separation support obligation. (Note well: Exempt property is generally not available to satisfy pre-bankruptcy filing obligations. However, it is available to satisfy DSOs pursuant to N.C.G.S. Section1C-1601(e)(9)). Although a holder of a DSO may be entitled to pursue exempt property for satisfaction of DSOs (to reach the equity portion of such property) the property is still property of the estate. It is risky to proceed against such property without relief from the automatic stay unless it is crystal clear that it is not property of the estate and that the automatic stay does not apply. 1 The consequences of violating the automatic stay can be serious and can include actual damages (including costs and attorneys fees), and, in appropriate circumstances, punitive damages, under Section 362(k)(1). Until you have case law guidance in your district on this issue, before proceeding with a contempt motion, we advise that you seek stay relief or consider filing a motion under Section 362(j) requesting entry of an order under Section 362(c) confirming that the automatic stay has been terminated. Check your local court rules. The filing of such a motion requires a filing fee of $ in the U.S. District Court for the Eastern District of North Carolina in conjunction with a motion to lift the automatic stay. IV. Tenancy by the Entirety Property 2 1 Case law to date related to state court contempt proceedings has dealt only with pre-filing obligations of the debtor that involve application of the debtor s income stream towards an obligation that has been determined to be a DSO. Best practice at this time with regard to the pursuit of property of the debtor believed to be available to satisfy a DSO but not being the debtor s income stream itself would be to first seek relief from the automatic stay. Even if you are seeking state court contempt action related to a debtor s failure to apply his or her income towards a DSO, the degree of comfort that you feel in bringing that contempt motion in state court without having sought relief from the automated stay should be governed by the extent to which you feel that the obligation underlying the motion would be viewed by a Federal Bankruptcy Court as clearly characterizable as a support obligation. As the reasoning of the court shows in In re Travis Benton Johnson (see discussion below in Protecting the Creditor Spouse in Chapter 13, on p. 22) there can be significant issues surrounding whether an economic obligation undertaken by a spouse during separation is or is not in fact a support obligation, and Federal law, not state law, will be applied in seeking the intent of the parties.) 2 See generally the article Asset Protection and Tenancy by the Entirety, by Fred Franke, appearing in the Spring 2009 Issue of the ACTEC (American Council of Trust and Estate Counsel) Journal 34 ACTECJ 210, which also contains a compendium of states treatments of entirety property; 9

10 Under 522(a)(3)(B) of the 2005 Act, there is an exemption for any interest in entireties property... to the extent that such interest as a tenant by the entirety... is exempt from process under applicable non-bankruptcy law (i.e. applicable state law). In what are referred to as full bar states (North Carolina is one) there is a complete bar against a judgment secured by a creditor of only one spouse attaching to the real property interest, of property owned by the judgment debtor/spouse as a tenant by the entirety. If only one judgment spouse is a debtor, and that debtor owns entireties property fully immune from judgment execution, the property is fully exempt. It is also true, that if both spouses file for bankruptcy, claiming their entireties property as exempt, it will not be exempt as to claims of judgment creditors that hold pre-petition judgments against the debtors jointly.) To the extent that entireties property in a bankruptcy estate is not exempt (e.g. if there are joint pre-filing judgment debts of the spouses) the Trustee can sell the entireties property (even if only one spouse is in bankruptcy) if the Trustee can demonstrate that the criteria of 363(h) of the 2005 Act are satisfied, e.g. if:. (1) partition in kind of such property among the estate and such co-owners is impracticable; (2) sale of the estate s undivided interest in such property would realize significantly less for the estate than sale of such property free of the interests of such co-owners; (3) the benefit to the estate of a sale of such property free of the interests of coowners outweighs the detriment, if any, to such co-owners; and (4) such property is not used in the production, transmission, or distribution, for sale, of electric energy or of natural or synthetic gas for heat, light, or power. If the value of the entireties property exceeds the joint debt value, the remaining equity is exempt. Fraudulent Transfer By definition an exempt property is removed from the bankruptcy estate. As noted by Mr. Franke in his article, and discussed in In Re: Swiontek, 376 B.R. 851,

11 865 (N.D. Ill., E.D. 2007), however, if a debtor should be found to have engaged in a fraudulent pre-petition transfer of his or her interest in entirety property, that interest, if recaptured by the Trustee, does not revert to its character as being a tenancy by the entirety, and is not exempt from the bankruptcy estate. In In Re: Swiontek, the Court determined that the Debtor/husband s pre-petition transfer of his entirety interest in the family home to his non-debtor wife was fraudulent, and, after the Trustee satisfied the criteria set out in 363(h) of the 2005 Act, the Court allowed the Trustee to sell what it determined to now be joint tenancy property to satisfy the claims of creditors. 180 Day Problem Divorce Within 180 Days of Filing Bankruptcy One final caution, 541(a)(5)(B) of the 2005 Act provides that the bankruptcy estate includes any interest in the property of the debtor... that the debtor acquires or becomes entitled to acquire within 180 days after such date... as a result of a...final divorce decree. This means, of course, that if a final divorce decree is entered as to a debtor-spouse within 180 days of filing a bankruptcy petition, any real property interest of the debtor-spouse in an otherwise-exempt status because it is entireties property will, upon the effective date of the divorce decree, by law be transformed from tenancy by the entireties to joint tenancy. The debtor s interest in the subject property will then no longer be exempt, and will be subject to the claims of bankruptcy creditors. (See discussion in In Re: Cordova, 73 F.3d 38, 41 (4 th Cir. 1996) in which the Court held that upon entry of a divorce decree within 180 days of the filing of debtor s bankruptcy petition, the entireties exemption became inapplicable.) 11

12 V. The Impact of the 2005 Act on Chapter 7 Discharge (no substantial change) The reason the debtor has filed Chapter 7 bankruptcy is to obtain a bankruptcy discharge. A discharge, granted by the Bankruptcy Court s entry of an order at the conclusion of a case, relieves the debtor from personal liability to repay his dischargeable debts (important concept, read on). Under Chapter 7, a debtor will receive a discharge when his non-exempt property (if any) has been liquidated and the proceeds of that nonexempt property have been used, to the extent available, to satisfy his debts. Therefore, following the first meeting of creditors (the 341 meeting), discharge of Chapter 7 debtors generally occurs within months. Your job, as the family lawyer representing the creditor spouse, is to protect your client's entitlement to payment from the debtor spouse and to protect your client s distributive award. New Filing Requirements in Chapter 7 (Dramatic Changes) The debtor must now file additional documents regarding his financial condition at the same time he files his bankruptcy petition. Revised Section 521 requires a debtor to file (1) a certificate of an attorney indicating that the debtor has received a notice from the clerk explaining the sections of the Bankruptcy Code under which he may file, (2) evidence of any payments he has received from his employer within 60 days before the filing of the petition (under Local Rule which became effective in the Eastern District of North Carolina on October 17, 2005, the debtor is not required to file this evidence but must provide it to the trustee at the Section 341 meeting of creditors), (3) a statement of his monthly net income, and (4) a statement disclosing any reasonably anticipated increase in income or expenses over the 12-month period following the filing date. Additionally, the debtor must provide to the trustee, and any creditor (including your client) making a timely request, a copy of his most recent tax returns. If the debtor fails to produce all of the required documents within 45 days of filing his petition, the 2005 Act requires the automatic dismissal of the case [ 521(i)(1)]. There are, however, time frames within which requests for such information must be made, as set forth in Rule 4002 of the Federal Rules of Bankruptcy Procedure. For example, in Rule 4002(b)(4), a creditor 12

13 must request a copy of the tax return required to be provided to the trustee at least 15 days before the first date set for the meeting of creditors under 341 (this may be different than the actual meeting date if the initial meeting is continued to a later date). In addition you should always consult the applicable local rules, on our Federal Courts websites: and You may also request, under Section521(f), that the debtor file and provide you with copies of each Federal tax return (and any amendment thereof) which the debtor must file for each tax year ending during the time the debtor s case is pending. It is important to note as well that the debtor s obligation to provide tax returns under Interim Local Rule 4002(b)(4) is subject to procedures for safeguarding the confidentiality of tax information established by the Director of the Administrative Office of the United States Courts. Why are we, as family lawyers, concerned about these new filing requirements? Because these additional documents create a "treasure trove" of discoverable information useful in any future support modification and/or contempt hearings. Also remember, when using information contained in a debtor s Petition, Schedules, or Statement of Financial Affairs in domestic litigation, the debtor's representations in these documents are made "under penalty of perjury." Likewise, a debtor s testimony at his Section 341 meeting before the trustee (or at any court hearing) is recorded and given under oath. A bankruptcy discharge can also be a substantial change in circumstances justifying a modification of prior orders, of support, etc. entered prior to the debtor s discharge. See, Sloan v. Sloan, 151 N.C. App. 399; 566 S.E.2d 97 (2002). Priority of Claims (some changes) and Exempt Property Section 507 relating to the priority of distributions (made by the Chapter 7 trustee from the proceeds of a debtor s non-exempt, liquidated assets) was amended by the 2005 Act. Amended Section 507 elevates domestic support obligations to first priority among unsecured claims. The 2005 Act requires that support obligations be paid in full before other creditors, except administrative expenses incurred by the trustee in administering assets of the bankruptcy estate. The reprioritization of DSOs in Chapter 7 cases will 13

14 likely be of minimal help to creditor spouses because there will seldom be non-exempt assets for the Chapter 7 trustee to liquidate and distribute to creditors. As discussed above, North Carolina has "opted out" of the federal exemptions otherwise allowed by Section 522(a). Our exempt property statute is contained within N.C.G.S. Chapter 1C (Section 1C-1601, et seq.). If you have not read this statute recently, do so. It has been amended, and the amendments took effect January 1, (See Attachment 2) The creditor spouse will generally have more knowledge of assets and their values than any other creditor. His knowledge may result in the discovery of additional value or assets. In the majority of Chapter 7 bankruptcies, most or all of the debtor's assets are claimed by the debtor as "exempt" in the debtor s Petition and Schedules, which results in few assets for the trustee to liquidate and little or no proceeds available for distribution to creditors, including spousal creditors, irrespective of the priority of the claim, after a trustee s administrative expenses are paid. For this reason, if you are aware of improperly claimed exemptions, any objection to exemptions claimed must be filed and served within 30 days of conclusion of the debtor s Section 341 meeting. Additionally, if your client is aware that the debtor has materially under-valued assets (this includes over-statement of lien amounts) in his Schedules, it is important to bring this to the trustee s attention as soon as possible, preferably before the debtor s Section 341 meeting. Be aware, however, that the time periods for establishing the debtor s domicile for purposes of claiming exemptions have changed, so the debtor may now be able to claim the exemptions available in States other than North Carolina (often more generous), even if the debtor would have been required to claim North Carolina exemptions prior to the effective date of the Act. Under Section522(b)(3)(A) of the Code, if the debtor has not lived in a single State for 730 days pre-petition, exemptions must now be claimed in the place where the debtor s domicile for 180 days prior to the 730 day period (or the greater of such 180 days than any other place), rather than just the 180 days pre-petition. 14

15 Claims for Alimony, Child Support, Post-separation Support (DSOs) Non- Dischargeable DSOs are non-dischargeable. The creditor spouse is not required to file a complaint (adversary proceeding) objecting to the debtor s discharge to preserve the validity of his alimony, post-separation, and child support claims. Therefore, even if the debtor spouse has received his Chapter 7 discharge before you are engaged by the creditor spouse, as the creditor spouse's attorney may help your client collect child support, post-separation support, or alimony from the debtor spouse. Attorneys Fees Non-Dischargeable Attorneys' fees awarded for representing the debtor spouse in child support, alimony, and post-separation support cases are non-dischargeable. The Fourth Circuit Court of Appeals has classified an award of attorneys' fees obtained in prosecuting these claims as a non-dischargeable debt in the nature of alimony, maintenance, and support under Section 523(a)(5). In re Silansky, 897 Fed.2d 743, 744 (4 th Cir. 1990); and see, In re Bristow, 2005 Lexus 1117, Middle District of North Carolina (decided April 22, 2005). Equitable Distribution Claims Non-Dischargeable Under pre-amendment law, Section 523(a)(15) allowed the debtor spouse to discharge equitable distribution obligations including distributive awards, whether by court judgment or agreement, by demonstrating either that he did not have the ability to pay the debt or that discharging the debt would result in a benefit to him which outweighed the detrimental consequences to the creditor spouse. Under pre-amendment law, the creditor spouse was required to file a timely adversary proceeding in the debtor s case objecting to discharge in order to prevent discharge of his equitable distribution claim. The 2005 Act amends Section 523(a)(15) so that all debts incurred by the debtor "in the course of divorce or separation" or in connection with a separation agreement which are not domestic support obligations are also non-dischargeable under Section 523(a)(5). A debtor may no longer obtain a discharge of an equitable distribution 15

16 judgment/award by showing that he is unable to pay the debt. Nor may discharge be obtained upon a showing that benefits of discharge to the debtor outweigh the detrimental effects to the debtor s spouse or former spouse. By eliminating these affirmative defenses, the 2005 Act effectively renders all equitable distribution awards pursuant to court judgments and/or separation and property settlement agreements non-dischargeable in Chapter 7. [Note well: The creditor spouse is no longer required to file a complaint (adversary proceeding) objecting to the dischargeability of equitable distribution awards.] Strategies for Protecting the Creditor Spouse If you are confronted with a Chapter 7 bankruptcy representing the creditor spouse: Step 1 Obtain the debtor spouse s Bankruptcy Petition, Schedules and Statement of Financial Affairs. All petitions and most pleadings are available electronically through the appropriate bankruptcy Court Clerk's office (Eastern, Middle, Western Districts). Each Clerk's office has an easily accessible website, though access requires registration through the Web site and payment for certain information provided. Most petitions and pleadings may be retrieved by accessing them through a docket search of the appropriate bankruptcy court. Access is through the PACER service of the Administrative Office of the U.S. Courts. Go to Then go to the Frequently Asked Questions for guidance on registration, access, and payment for PACER service. Step 2 File and Serve a Notice of Appearance. Unless you, as counsel for the creditor spouse are already properly listed in the debtors schedules as a party to whom notices should be sent, you should file and serve upon the debtor, debtor s counsel, the trustee, and the Bankruptcy Administrator a notice of appearance giving notice that you are entering an appearance in the case on behalf of your named client and providing the address where all notices should be sent. This will ensure that you receive a copy of all notices in the case (such as a notice that the case has been dismissed or a discharge has been granted or denied). 16

17 Step 3 Review the Petition, Schedules and Statement of Financial Affairs. Upon obtaining the Petition, Schedules, and Statement of Financial Affairs, review them to be certain your client is listed as a creditor and that his claims are appropriately denominated either as DSOs or property distribution claims. Also review the assets listed; values and exempt property. If you are aware of any false statements or omissions, these should be brought to the trustee s attention in writing as soon as possible and preferably prior to the 341 meeting. Any documentation supporting your allegations should also be provided. This will assist the trustee in determining whether any omissions or false oaths are material and actionable (enabling the Trustee to move the court to dismiss the bankruptcy). Step 4 Determine the status of the debtor's case. Has the case been completed (discharge order entered) or is the case pending? If the creditor spouse reaches your office before a discharge is entered, you should first obtain the domestic court orders/agreements establishing the debtor spouse's obligation to your client and determine the type of obligation (i.e., child support, equitable distribution, alimony). Determine if the first meeting of creditors (the Section 341 meeting) has been held. If the meeting has not been held, you should communicate with the Chapter 7 trustee (in writing) advising him of your client's domestic support and/or equitable distribution claims. Generally, proofs of claim are not filed in Chapter 7 bankruptcies absent a notice from the court or the trustee that the case has been classified as an asset case, meaning there will be assets available to pay creditors claims (as opposed to a noasset case). Step 5 The Section 341 Meeting. This meeting is presided over by the Chapter 7 trustee. Questioning is generally brief; however, it is an opportunity for you to advise the Chapter 7 trustee of the existence of your claims and the fact that they are, in fact, non-dischargeable DSOs, as well as to inquire concerning "exempt property" claims made by the debtor spouse. Obviously, attendance at the 341 meeting will depend on whether or not you are engaged before the 341 meeting; the amount involved, and the location of the 341 meeting. If you 17

18 wish to question the debtor at greater length than is permitted at the 341 meeting, you may file a motion for entry of an order allowing an examination of the debtor under Bankruptcy Rule The Lis Pendens Question Pursuant to N.C.G.S. Section 50-20(h), if either party claims that any real property is marital or divisible property, that party may cause a Notice of Lis Pendens to be recorded, pursuant to Article 11 of Chapter 1 of the General Statutes. N.C.G.S. Section 50-20(k) provides that "the rights of the parties to an equitable distribution of marital and divisible property are species of common ownership vesting at the time of the parties' separation." It is important to advise your client that his equitable distribution claim is just that a claim. Your client's claim to equitable distribution is not a property right, nor does the equitable distribution statute (as interpreted by both state and federal courts) provide your client with a right to receive any particular item of marital/divisible property. See, In Re Halverson, 151 BR 358 (M.D.N.C. 1993); see also, Justice v. Justice, 123 N.C.App. 733, 475 S.E.2d 225 (1996), affirmed, 346 N.C. 176, 484 S.E.2d 551 (1997). In the Eastern District of North Carolina, the filing of a Notice of Lis Pendens will not create a security interest in specific property for the creditor spouse. In the case of Watts v. Slough (In Re Slough), E.D.N.C., March 2005, Chief Judge Leonard concluded that "the filing of Notices of Lis Pendens did not create security interests in the underlying properties but served as constructive notice of pending litigation. (Citations omitted)." Not published. [See, Eastern Bankruptcy Institute manuscript, June 3 and 4, 2005, page 66, for a complete case summary of this case.] VI. The Impact of the 2005 Act on Chapter 13 Introduction Chapter 13 is commonly referred to as a wage-earner bankruptcy. Historically, in North Carolina, more Chapter 13 bankruptcies are filed than Chapter 7 bankruptcies. As with Chapter 7, when the debtor files a Chapter 13 bankruptcy, he must file a petition, 18

19 schedules listing all of his assets, debts, income, and expenses, claiming certain assets as exempt and listing all creditors, and a Statement of Financial Affairs, answering questions concerning the debtor s financial affairs prior to the petition filing. In addition to his schedules and petition, the Chapter 13 debtor must file a proposed repayment plan. To be confirmed, the plan must pay priority claims (which include pre-petition alimony, post-separation support, and child support claims) in full. The debtor must pay all post filing DSOs in full and, if the trustee or an unsecured creditor (such as your client) objects to confirmation the debtor must use 100% of his "disposable income" to be received during the plan period to pay unsecured claims (including equitable distribution judgments) ( 1322 and 1325). If the debtor s plan provides for all disposable income to be committed to the plan, such an objection would not be needed to ensure that disposable income is paid for the applicable commitment period. The debtor makes monthly payments to the Chapter 13 trustee, and the trustee distributes payments on allowed claims to creditors over a period of 36 to 60 months. After all payments are made under the debtor s confirmed plan, the debtor receives his discharge. The 2005 Act requires payment plans to be made over the applicable commitment period [as defined in 1325(b)(4)], either 36 or 60 months, unless all unsecured claims are paid in full over a shorter period. What is Disposable Income and Why is it Important? "Disposable income" is all of the debtor's income not reasonably necessary for the maintenance or support of the debtor or a dependent of the debtor or for a DSO that first becomes payable after the date the bankruptcy is filed. [ 1325(b)(2)]. Therefore, income necessary for prospective DSOs is deducted by the debtor from his income prior to a determination of "disposable income." Our primary interest in disposable income relates to equitable distribution. Equitable distribution claims and judgments are unsecured claims and the debtor's obligation to pay these claims will be discharged upon completion of the plan. Therefore, if the debtor's confirmed plan pays unsecured creditors only twenty percent (20%) of their claims, your creditor spouses' equitable distribution judgment will only be paid 19

20 twenty percent (20%). Making sure that all of the debtor's disposable income is discovered and paid into the plan is your client's best protection for these claims. Protecting the Creditor Spouse in Chapter 13 In order to protect the creditor spouse's claims in Chapter 13, the following steps should be taken: File and Serve a Notice of Appearance. As in a chapter 7 case, and for the same reasons, you should file and serve a notice of appearance giving notice that you are entering an appearance on behalf of your client. Review the Petition, Schedules and Statement of Financial Affairs. As in a Chapter 7 case, obtain and review copies of the Petition, Schedules, and Statement of Financial Affairs for completeness and accuracy. If your client is not listed as a creditor, or his claims are not appropriately denominated either as DSOs or property distribution claims, immediately file a claim making this clear (see below), or if the claims' bar date has passed, write to the trustee making him aware of the amount, nature, and payment status (both pre-petition and post-petition) of any DSO within the meaning of Section 101(14A). Additionally, you should make the trustee aware, if not accurately stated in the schedules, what State has jurisdiction over enforcement of the debtor s DSOs. If you are aware of any material false oaths or omissions, bring these to the trustee s attention in writing with any available supporting documentation. File the proof of claim. The first important action item for the creditor spouse is to complete and file a "Proof of Claim" form. Supporting documentation, such as a judgment or order, should be attached. Only claims filed with Chapter 13 trustee (in the Eastern District) or the Clerk of the Bankruptcy Court (in the Middle and Western Districts) are recognized as allowed or valid claims to be paid through the Chapter 13 plan. A proof of claim form will be provided with the notice of the bankruptcy filing. The notice of bankruptcy filing will identify the Chapter 20

21 13 trustee in the notice and will provide both the address where claims should be filed and the bar date by which any claim must be filed. The bar date for filing claims is 90 days from the first date set for the meeting of creditors (note that the first date set for the meeting may be different than the date the meeting is actually held). All claims must be received by the trustee or Clerk, as appropriate, by the bar date. Any claims filed after the bar date will not be allowed and, therefore, will not be paid any distribution. Be sure to note on the face of the proof of claim form if the claim is for alimony, post-separation support, or child support (a domestic support obligation), and note on the proof of claim that the claim is a priority claim. If the claim is an equitable distribution claim, a general unsecured proof of claim must be filed. You will always want to receive a filed copy of your proof of claim. Send an extra copy of the claim with a self-addressed, postage-paid, return envelope. Section 341 Meeting. Review the debtor's Petition, Schedules, Statement of Affairs, and proposed plan, and attend the Section 341 meeting. The Section 341 meeting in Chapter 13 is presided over by the Chapter 13 trustee; the debtor is placed under oath. No judge is present. The trustee will ask questions, and creditors are allowed to ask questions of the debtor concerning his proposed plan, obligations, and repayment of debts. You will also be able to ask questions of the trustee. As in a Chapter 7 case, the time available for questioning may be limited during the meeting. If extensive questioning is necessary, a Rule 2004 examination (deposition) (requiring a motion and order) may be required. The creditor spouse (or his attorney) should attend the Section 341 meeting to confirm that all established support claims will be paid directly to the creditor spouse as priority claims, and to confirm whether the debtor is current in the payment of all post-petition DSOs. If such payments are not current, the debtor s plan may not be confirmed, and the case may be dismissed. Further, the creditor spouse should advise the trustee if there are support issues which are pending and not yet finalized and whether, 21

22 and to what extent, determination of such issues may impact a determination of the debtor's disposable income. Plan Confirmation, the Debtors Certification Concerning DSOs, and Discharge. The Chapter 13 debtor receives a discharge (of dischargeable debts) when he completes all payments required to be made under his confirmed Chapter 13 plan. One of the advantages of a debtor seeking relief under Chapter 13 in the past was that the debtor could obtain what was commonly referred to as a super-discharge. After the 2005 Act, a debtor s discharge, while broader than that available in Chapter 7, is no longer as super as it once was. There is a limited hardship discharge exception, and alimony, post-separation support, and child support debts are non-dischargeable in Chapter 13. [ 1328(a)(2)]. Additionally, a claim for willful and malicious injury, under 1328(a)(4), based on claims of alienation of affection or criminal conversation arising from a state court judgment - is possible. Therefore, when the debtor completes his plan and receives his discharge, these support and/or payment obligations remain. [Note well: Equitable distribution judgments/obligations pursuant to court order or property settlement/separation agreements are general unsecured claims that can be discharged and "crammed down" in Chapter 13. Equitable distribution claims will be paid along with other unsecured claims only to the extent of the debtor's disposable income.] Although 1328 requires a debtor seeking final discharge to certify that DSOs have been satisfied, the conservative and prudent practice is to continue to monitor the completion of those payment obligations through the powers of the state court that originally established the obligation. If the obligations were set only by contract, and they remain unmet after a discharge has occurred, there may be a need to apply to the Bankruptcy Court for an examination of the debtor and a review of the discharge of the debtor has falsely represented to the Bankruptcy Court that all DSOs, pre-petition and post petition, have been satisfied. Should you become aware within 180 days post plan confirmation that the debtor made a false statement that all post-petition, pre-confirmation domestic support 22

23 obligations were paid, and if such false statement constitutes fraud, you may seek revocation of confirmation under Section 1330(a) in addition to dismissal (or conversion to a case under Chapter 7, with the debtor s consent) under Section1307(c)(11) (failure to pay a DSO which first becomes due after the petition date). The addition of Sections 362(c)(3) and (4) by the 2005 Act, limiting the availability or extent of protection of the automatic stay in second and subsequent serially filed cases, makes dismissal of a case filed (under any chapter of the Bankruptcy Code) after Oct. 17, 2005, a much more consequential event than in the past. Accordingly, if you become aware that the debtor is two months or more delinquent in the payment of a DSO during the pendency of a case, you will have significant bargaining leverage with debtor s counsel to ensure that arrearages are promptly cured and maintained as current. Also consider providing the trustee with an affidavit concerning the delinquency with a request that a motion to dismiss be filed. Most Chapter 13 trustees will be willing to file such a motion, particularly since payment of all domestic support obligations is now a pre-condition of discharge. A Word to the Wise Regarding Characterization of Obligations in Separation and Property Settlement Agreements, to Maximize Protection in Chapter 13. The ways in which obligations regarding marital assets are described by the parties in their Separation Agreements and Property Settlements become crucial indicia for reviewing Bankruptcy Courts in later determinations as to whether a given obligation fits under the category of a DSO. In In re Travis Benton Johnson, 397 B.R. 289 Bkrtcy. (M.D.N.C. 2008) the Court grappled with the issue in the context of a Chapter 13 bankruptcy. The principal issue was whether the debtor-husband s obligation to his exwife to pay the indebtedness secured by a second deed of trust on the parties former marital residence was in the nature of support and therefore constituted a domestic support obligation (DSO) that had to be paid in full under the debtor s Chapter 13 plan. The court noted that Federal bankruptcy law, not state law determined whether a debt is in the nature of support. Id., at 296. The court went on to examine all the circumstances that would illuminate the intent of the parties at the time the obligation was undertaken by the debtor, and noted that the Separation Agreement did not designate 23

24 the obligation to pay off the second deed of trust on the marital home as support. The court in this case found that the debt was indeed a DSO, but the message of the case is clear. To maximize the probability of a paying spouse s economic obligation being characterized as a DSO, so as to insure it is paid in full out of a Chapter 13 plan, make sure the obligation is discussed and labeled as support in the documents memorializing the obligation. VII. Alienation of Affection and Criminal Conversation Are State Law Judgments Awarding Damages for These Torts Exempt from Discharge Under the 2005 Act? The short answers follow; then there is a more detailed discussion concerning both Chapter 7 (Liquidation) and Chapter 13 (The Wage Earner Plan). 1. Chapter 7 Answer. In a Chapter 7 Bankruptcy, you have a good chance at having a state law judgment award for alienation of affections or criminal conversation declared non-dischargeable by the Debtor under Section 523(a)(6) of the 2005 Act (provided that you establish a careful evidentiary record as will be discussed). 2. Chapter 13 Answer. In a Chapter 13 Bankruptcy, you have a much more remote chance at having a state law judgment award for alienation of affections or criminal conversation declared non-dischargeable by the Debtor under the applicable Code section, Section 1328(a)(4) of the 2005 Act (there is no case law extant at the time of writing of this article recognizing an adversary claim for non-dischargeability on this basis). Still there are arguments to be made that might be persuasive see below. 24

25 1a. Chapter 7 Discussion The beginning point for an analysis of a claim in a Chapter 7 case is Section 523(a)(6) of the 2005 Act, (a debt is not dischargeable if it arises from a willful and malicious injury by the debtor to another entity or to the property of another ). (An entity under the 2005 Act includes a person. See 101(15) Definition of entity. The U.S. Supreme Court has further complicated the burden of proof for a plaintiff seeking non-dischargeability by holding that 523(a)(6) applies only to acts done with the actual intent to cause injury. Kawaauhou v. Geiger, 523 U.S. 57, 61 (1998). This means that to qualify for the exception, the Plaintiff must show more than negligent, grossly negligent or reckless conduct or a deliberate act resulting in serious injury it takes a deliberate or intentional injury. There is a very thoughtful and educative discussion of these issues in the recent case of In Re Gallagher, 388 B.R. 694 (W.D.N.C. 2008). In Gallagher, the debtor had filed a Chapter 7 petition. At that time, Gallagher had been a defendant in a state court action in which Susan Keever had alleged alienation of affections and criminal conversation by Gallagher with Keever s husband. Keever filed an adversary proceeding in the Bankruptcy Court, asserting the same tort claims as those raised in state court. Keever requested that the Bankruptcy Court declare the resulting liability non-dischargeable as a willful and malicious injury under 11 U.S.C. 523(a)(6). The jury in state court had awarded Keever a verdict finding Gallagher liable for both alienation of affections and criminal conversation. The judgment included punitive damages. In Bankruptcy Court, Keever moved for summary judgment, arguing that in the state court action she had established that Gallagher had injured her in a willful and malicious manner so as to make the debt established by the state court judgment non-dischargeable under 11 U.S.C. 523(a). The Bankruptcy Court found that the doctrine of collateral estoppel barred relitigation of the issue of whether Gallagher s actions caused a willful and malicious injury, and granted Summary Judgment (meaning that the jury award was nondischargeable in bankruptcy). Gallagher appealed to the U.S. District Court for the Western District of North Carolina, and argued that the doctrine of collateral estoppel did 25