Last month, I posted an article entitled Inheritances and Bankruptcy – Strange “Bedfellows” outlining the odd intersection between inheritances and bankruptcy. This month I want to discuss the how bankruptcy and divorce can interrelate. Most people know that financial stress is one of the leading causes of divorce. Less widely known, however, is how the subsequent bankruptcy filing by one of the spouses can be problematic. A recent case from the Ninth Circuit Bankruptcy Appellate Panel illustrates one of the problems that can arise.
In that case, Husband and Wife divorced in May 2009. The divorce decree provided that Husband was “awarded” certain credit card debts, and also provided that he would pay those debts, and “hold Wife harmless” from those debts. At some point following the entry of the decree, Husband stopped paying on those debts. Wife then filed suit in state court to enforce the judgment.
Shortly after the filing of the state court suit, Husband filed a Chapter 7 Bankruptcy Petition. He then sought a determination by the Bankruptcy Court that his obligations to pay the credit cards and hold Wife harmless from those obligations could be discharged in bankruptcy.
The problem with Husband’s argument, however, was that Section 523(a)(15) of the Bankruptcy Code specifically states that such obligations are not dischargeable in a Chapter 7 case. That section provides that a debt to
“a spouse, former spouse, or child of the debtor and not [involving support] that is incurred by the debtor in the course of a divorce or separation or in connection with a separation agreement, divorce decree or other order of a court of record, or a determination made in accordance with State or territorial law by a governmental unit”
is not dischargeable.
Notwithstanding the clear language of both the divorce decree and the Bankruptcy Code, Husband argued that §523(a)(15) did not apply because there was no explicit obligation to “indemnify” her for purposes of applicable law. (“Indemnification” is a legal principle where one party agrees to satisfy the debts of another person. Health insurance is a good example of indemnification: in return for payment of a premium, the insurance company agrees to indemnify the policyholder for certain medical debts pursuant to the policy.)
Both the Bankruptcy Court and the Bankruptcy Appellate Panel found little difficulty in rejecting Husband’s “dubious” arguments, and held that Wife held an implied indemnification claim against Husband that could not be discharged in Chapter 7 as it was a debt incurred in the course of the divorce proceeding.
This case raises a few interesting points in the interconnection between bankruptcy and divorce:
1. If a couple is going to be divorcing, it could be advantageous for them to jointly file for bankruptcy prior to getting divorced. By doing that, both spouses can discharge all debts, and the allocation of debts between them may not be an issue in the divorce decree.
2. A divorce decree “awarding” debts to a spouse is not binding on creditors. If the debt is a joint debt and it is awarded to one spouse, if that spouse does not pay it, the creditor is free to pursue the other spouse. Depending on the terms of the divorce decree, the spouse who paid it may have the right to pursue the other spouse for a reimbursement of the amounts paid.
3. If the debt involved is not considered in the nature of support, that type of debt can be discharged in Chapter 13, whereas it is not dischargeable in Chapter 7. Why the Husband in the case discussed above did not elect a Chapter 13 is a mystery to me. His argument seemed rather nonsensical!
This post is intended to be purely informational in nature, and cannot be considered legal advice. If you have questions related to bankruptcy audits, please call our office at (503) 545-1061 (Oregon cases) or (360) 836-4238 (Washington cases) to schedule a free initial consultation.