Planning for the Inevitable: Divorce and Bankruptcy By: Barbara May Marriage is about love, but divorce is about money. According to an August, 2013, survey of Certified Divorce Financial Analysts, the main causes of divorce are incompatibility (43%), infidelity (38%) and money issues (22%). Attorneys who have served time in the trenches of the bankruptcy/divorce war zone would argue that those numbers are inverted, and that most marital problems arose in one way or another from financial problems. The odds are good that your divorce client is going to end up in bankruptcy. According to a 2014 Utah State study, one in five women will fall into poverty as a result of divorce. The average divorcee needs to increase his or her income by 30% just to maintain their standard of living. Divorce clients often go into divorce broke, and they come out of it broker. You need to presume that your divorce client will end up in bankruptcy. Certain markers in a divorce should put the attorney on notice that a bankruptcy is in the offing. For example, has your client been paying interest only on his debts? Has your client had a job loss? Has your client had a car repossessed? Does your client have large medical expenses? Does your client have more than one mortgage? More than two mortgages? Is your client going through a divorce? Any one of those indicators sends a signal to a bankruptcy attorney. In a divorce case, an attorney is often seeing all of the markers at once. So, why are divorce lawyers stunned when their clients file bankruptcy as soon as the divorce is done? More than anyone, divorce lawyers should know that a bankruptcy is a reasonable likelihood at the end of a blistering divorce. Divorce lawyers unfortunately often believe "But my client liked me" and "I did a really good job" will save them from being on the receiving end of a bankruptcy. While your client may love you and you may have done a tremendous job, if your client is broke and scared and facing a bleak future, your concerns come last. A smart divorce lawyer must plan for the likelihood of bankruptcy from the minute they meet their client. There are certain things a divorce lawyer must know to protect his client or to protect himself. Property Settlements A bankruptcy lawyer can discharge the property settlement that you have taken months to craft. The 2005 bankruptcy law, BAPCPA, protects property settlements in a Chapter 7 bankruptcy, but it allows property settlements to be discharged in a chapter 13. And about 17.59% of all Minnesota bankruptcy cases are Chapter 13 filings. (District of Minnesota official statistics through September 30, 2015). Nationally, Chapter 13 cases account for 30% of all filings. (See Bankruptcy By the Numbers, Executive Office for United States Trustees, updated May 7, 2015). 1
Chapter 7 discharges most debts, except for such things as fraud, newer taxes, domestic support, marital debt, willful and malicious injury and student loans, but it leaves divorce judgments intact. A chapter 7 bankruptcy is done in 90 days and, in most cases, the debtor will keep all of his assets. A Chapter 7 can be a wonderful tool for a divorcing couple that is drowning in debt. A Chapter 13 bankruptcy requires a debtor and his bankruptcy attorney to propose a plan to repay a portion of debt. A debtor does not have to pay back all of his debt in a Chapter 13. A "composition" plan can propose monthly payments to the court as little as $100.00 a month for 36 months. (The length of the plan and the amount of the payment is determined by the debtor s income and other factors). For as little as $3600.00 in a Chapter 13 plan, a debtor can wipe out unsecured debt load as great as $383,175.00. In other words, the divorce litigant who agreed to pay a $383,175.00 property settlement can discharge that debt for as little as $3600.00. It is important to remember that bankruptcy judges don't want divorce cases showing up in their courtrooms. They are wary of being used as a court of appeals. It will be fatal to a Chapter 13 plan if a judge believes that that the debtor made a "mad dash" to bankruptcy court simply to avoid provisions of a divorce decree. Make sure all property settlements are secured A family court attorney needs to plan for the race to bankruptcy court, and put obstacles in the way. Remember that bankruptcy does not touch secured debt. If a property settlement is fully secured by being attached to an asset with equity, that debt will pass through bankruptcy unscathed. Try to secure property settlement obligations to a home with equity, if at all possible. Or leave the retirement provisions of a divorce decree open until a property settlement has been completely paid. A debtor who hopes to wipe out a property settlement in bankruptcy may think twice if he knows it will cost him his 401K. Label it as a "DSO" Domestic support orders, or "DSO" in bankruptcy jargon, are not dischargeable in any type of bankruptcy. A domestic support order can be child support, alimony, guardian ad litem fees, foster care fees, court service fees and, on occasion, attorney fees. 11 USC 523(a)(5); Adams v. Zentz, 963 F.2d 197 (1992). If a property settlement is couched in a divorce decree as a domestic support order, it will likely survive any type of bankruptcy. The definition of "domestic support order" is determined by bankruptcy law, rather than state law, so if an attorney wants a property settlement to survive as a "domestic support order", then it must look like one to a bankruptcy judge. Bankruptcy courts are influenced by how a debt is handled in a divorce decree. When a bankruptcy court is determining whether a debt is a DSO, or whether it is a property settlement, they will look to see what function the award was intended to serve. For example, if you label a property settlement as support and maintenance, a bankruptcy judge will likely call it a domestic support order. Bankruptcy judges look to where and how a domestic support order is placed in a divorce decree. If the parties intend a property settlement to provide for the support and well-being of a 2
family, the divorce decree should say so. Detail in the divorce decree what the anticipated impact of nonpayment of a property settlement would be. Will the wife be unable to provide a home for the children without the payment? Will the husband be unable to return to school and complete his education without the payment? The divorce decree should detail that a parties ability to support himself or herself depends entirely on the other party paying the court ordered debts or the property settlement. Always provide that maintenance was waived expressly in exchange for payment of these obligations, and that these obligations are intended to be in the nature of support. (Even better, use the language of the bankruptcy code and say that the obligations are intended to be in the nature of a domestic support order). Language that details the parties intentions can paralyze a bankruptcy lawyer, and it can force a judge s hand. Why is it so important to call it a DSO? Marital Debt. 1 ) DSO claims can be collected even in the middle of a bankruptcy. 2) DSO claims cannot be discharged in any bankruptcy. 3) A bankruptcy trustee can never sue to "claw back" a DSO payment. If your client has just received a large payment in the 90 days prior to the debtor filing, the bankruptcy court can may force your client to pay it over to the bankruptcy estate, unless your client can prove that it is a DSO. 4) DSO claims can be enforced against exempt property. If a debtor files bankruptcy with money in the bank or equity in a house or car, those amounts are traditionally exempt. If the debtor owes a DSO, however, the court can order the otherwise exempt property sold to pay the DSO. A person with a large child support arrearage may think twice about filing Chapter 7 if it will cost him his new sports car. 5) A debtor can have never have a judgment lien removed from his exempt property if the lien is for a DSO. Marital debt cannot be discharged in Chapter 7, but it can be discharged in a Chapter 13. 11 USC 523 (a)(15), 11 USC 1328. But that, alone, may not help your client. A debtor who files bankruptcy on a VISA bill can still get rid of VISA. They just can't get rid of their obligation to protect their spouse from that VISA bill. The outcome is often that the debtor discharges his court-ordered credit card debt and the other party finds herself being harassed and sued and garnished over the debt that got shifted to her. By the time the injured spouse finishes suing the debtor over his noncompliance with the divorce court order, she will find herself in bankruptcy. It is wiser to either secure the obligation to pay debt in the divorce decree, or to wipe out the debt prior to finalizing the divorce. Fighting over who will pay a debt that no one can afford is a fool's errand. Have the parties file joint bankruptcy If the parties have large dischargeable debt, consider filing bankruptcy for both parties before the divorce decree is entered. It takes the argument over who incurred what debt out of 3
the property division equation. In the alternative, make sure that the divorce decree details that each party consents to the other party discharging all debts in bankruptcy. The parties can then each file bankruptcy after the divorce is entered without running into the nondischargeability provisions of 11 USC 523(a)(15). Attorney fees - Getting paid You have no guarantee of getting paid if your client files bankruptcy. Divorce lawyers do not get special treatment in bankruptcy. In fact, because no one knows your client's financial situation like you, you will be treated with suspicion by the court as an "insider", and you may be the last person paid. If your client files bankruptcy on his debt to you, your debt will be discharged. Don't even contemplate suing your client in bankruptcy to collect your debt. You will not win. If a divorce decree orders the other party to pay you, especially if the debt is labeled a DSO, the debt will likely be nondischargeable in bankruptcy. (Do not just presume your fees passed through unscathed. You must file an adversary lawsuit to have the court determine that the debt is nondischargeable. Be forewarned that debtors will go to remarkable lengths to discharge their obligation to pay the other party s attorney fees.) Getting your client's attorney fees paid If your client is awarded attorney fees in a divorce decree, label the fees as a Domestic Support Order. If the fees are not labeled, your client may find himself in bankruptcy court, spending thousands of dollars in an adversary lawsuit, trying to keep the fees from being discharged. If you have made it clear in a divorce decree that the attorney fees were actually domestic support, the fight will be over before it starts. If the attorney fees are properly labeled, they will be treated as a priority debt and they will have to be paid 100% during a Chapter 13 plan. According to the Department of Justice, over 82% of all Minnesota chapter 13 plans fail right now. Sometimes, when a debtor files a Chapter 13 bankruptcy, the best thing to do is to sit back and wait for it to fail. Bankruptcy By the Numbers, Executive Office for United States Trustees, updated May 7, 2015. Attorney fees- How to avoid a "claw back" Divorce lawyers are famous for waiting until a case is done to get paid in a large lump sum. It is a mistake. Under 11 USC 548(b), if your client files bankruptcy within 90 days of the day you got paid, you will have to turn your fees over to the court to be shared with all of the other creditors. Your fees are a "preference". This provision is non-negotiable and is not affected by concepts of fairness or equity. The court will appoint a bankruptcy trustee who MUST sue you to collect any payment you received in excess of $600.00 in the last 90 days prior to bankruptcy filing. Further, because you are an "insider", the court may be able to sue you for payments you got a whole year ago. There is only way for you to dodge the trustee in the case of a preference. You must demonstrate that after you got paid you continued working on the case. If you got a lump sum of $50,000, but then put in another $10,000 in work, you will be allowed to keep the $10,000.00. But, that is rarely the case. Most often, a lawyer gets a lump sum (and often a discounted lump 4
sum), and then they close their file. The attorney who waits to get paid after a case is done is an easy victim for a claim of "preference". The only way to protect yourself from this harsh result is to get paid early and often. Look for the clues of an upcoming bankruptcy. If you see a bankruptcy on the horizon, have mom or dad pay you. Or try to convince your client not to file for at least 90 days after you got paid. Protect your retainer Remember that, if your client has posted a retainer with you, you may have to surrender any unearned retainer when your client files bankruptcy. Protect yourself. Bill regularly. Bill generously. Keep close track of your time. You can always discount or forgive a bill later. But if a trustee demands turnover of your retainer, you want to prove that it is already earned and is not subject to return. Remember also that if mom or dad posted the retainer, you can argue that it is not an asset of the debtor. (On that note, if mom or dad are posting your retainer fee and if there is some chance of bankruptcy, make sure that your written agreement with your client makes the fees refundable to the parents.) Attorney liens Consider filing an attorney lien. If you have recorded your lien more than 90 days prior to the bankruptcy filing, and if you have complied with all of the requirements of Minn.Stat. 481.13, subd. 1(a), your lien will survive bankruptcy. 11 USC 522(f)(1). Caution, however: if both parties own the property you are trying to lien, and only one of those parties is your client, then both parties must consent to the attorney lien. Kipp v. Sweno, 683 N.W.2d 259 (Minn. 2004) And good luck with that. If you view every divorce as a bankruptcy in the making, you can make the changes in your practice to protect yourself and your client. Get advice early and often in your case from a bankruptcy lawyer. Bankruptcy is a valuable tool in divorce, and it is one that you should learn to use to your client's benefit. ---------- Barbara J. May is a solo practitioner in Roseville, Minnesota. She has practiced law in Minnesota and Wisconsin State and Federal Courts for 34 years. Ms. May is a former longtime board member of the National Association of Consumer Bankruptcy Attorneys. She was certified as a Consumer Bankruptcy Specialist in July, 2000. She is a litigator in both bankruptcy and family courts, although her first love is difficult bankruptcy litigation. She is a frequent speaker on bankruptcy and family court matters, and has published articles in the Bench and Bar and the MSBA Family Law Forum. She can be reached at Barbara@BarbaraMayLawOffice.com. 5