With increasing frequency, many divorce related battles over money and property are being fought in Bankruptcy Court. Bankruptcy attorneys representing a Louisiana client with unresolved community property issues must recognize the effects and consequences that a bankruptcy filing will have on any state court proceeding to partition the community. Family law attorneys must be aware of basic bankruptcy law and concepts because a Chapter 7 or Chapter 13 filing by either spouse will severely impact any state court partition proceeding.  While by no means exhaustive, several important factors to consider are discussed below. 

1. Property of the Estate, Community Property, and the Automatic Stay

The definition of property of the estate contained in §541 of the Bankruptcy Code (the “Code”) is extremely broad, generally consisting of “all legal or equitable interests of the debtor in property” at the time of filing “wherever located and by whomever held.” 11 U.S.C. §541(a). Whereas in a divorce proceeding, a spouse is entitled to half of the community and debts are allocated, in bankruptcy, all community property becomes property of the bankruptcy estate. The Fifth Circuit has held that “community property” as that term is used to define property of the estate in §541(a)(2) “includes community property and former community property that has not been partitioned as of the [bankruptcy] petition date but does not include former community property which has been divided and reclassified as separate property by state law before that date.”  In re Robertson, 203 F.3d 855, 861 (5th Cir. 2000).[1]

It is also important to remember that as of the commencement of the bankruptcy case, the state court divorce proceeding is stayed by virtue of §362 as to all property and debt issues  because those issues are now under the jurisdiction of the Bankruptcy Court.  However, issues regarding alimony, custody, and visitation may generally continue in the domestic court with some limited restrictions.

II. Payment of Community Claims and the Community Property Discharge

Because all community property is “property of the estate,” a creditor of either spouse that has the right under state law to collect its debt from community property has a “community claim” under §101(7) of the Code, which allows that creditor file a claim in the bankruptcy case. Thus, even the creditors of a non-filing or ex-spouse can participate in the bankruptcy case. In Louisiana, (i) “a separate or community obligation may be satisfied during the community property regime from community property and from the separate property of the spouse who incurred the obligation”, La. C.C. art. 2345, while (ii) “an obligation incurred by a spouse before or during the community property regime may be satisfied after termination of the regime from the property of the former community and from the separate property of the spouse who incurred the obligation.” La. C.C. art. 2357.

Section 544(a)(3) of the Code has a special discharge provision that affects community property, providing that upon discharge, all community property, including after acquired community property, is thereafter protected from recovery for community claims.

III. Exemptions

A debtor’s ability to remove property from the bankruptcy estate through exemptions is another factor that should be considered. Congress, in the Code, left to the States the choice of allowing debtors to elect the federal exemption scheme under §522(d) of the Code or to substitute the States’ exemptions. See 11 U.S.C. §522(b). The State of Louisiana has elected to “opt-out” of the federal exemption scheme, so the exemptions provided in §522(d) are not available. La. R.S. §13:3881(B)(1).

With very limited exceptions, exemptions claimed in a debtor’s schedules become final 30 days after the conclusion of the first meeting of creditors. An allowed exemption simply removes the asset from what is considered property of the bankruptcy estate, and nothing in the Code operates to determine the division of exempt property between spouses or ex-spouses. If the property claimed as exempt was community property, it retains this community characterization and must be dealt with in the state court divorce proceeding. Examples of exempt assets in Louisiana and most other states are qualifying homestead exemptions, IRA’s, 401(k)’s, and annuities.

IV. Pre-Petition Transfers

Another factor to consider is the Chapter 7 trustee’s ability to avoid or unwind certain pre-petition payments that were made and completed prior to the commencement of the bankruptcy case. The avoiding powers are found in §§544-549 of the Code, and the most commonly used are (i) preferences and (ii) fraudulent transfers. The trustee also acquires applicable state law rights of any creditor to avoid transfers for the benefit of the estate under §544(b) of the Code. While Louisiana uses the revocatory action, La. C.C. art. 2036, et seq., virtually all other states use a form of the Uniform Fraudulent Transfer Act.

Preferences (§547 of the Code). A preference is a pre-petition transfer by the debtor to a creditor within 90 days of the bankruptcy filing on account of an antecedent debt while the debtor is insolvent. Subject to certain affirmative defenses,[1] a Chapter 7 trustee can avoid or “claw-back” preferential payments and obtain a judgment against the creditor who received them. The claw-back period is extended to one year for transfers to insiders, including family members. However, the payment of a bona fide domestic support obligation is not an avoidable preferential transfer. See 11 U.S.C. §547(c)(7).

Fraudulent Transfers (§548 of the Code). A fraudulent transfer is generally considered any transfer by the debtor made within two years of the bankruptcy filing (i) where the debtor intended to hinder, delay, or defraud creditors or (ii) by which debtor received less than equivalent value and where the debtor was insolvent on the date of the transfer. 

Separation of property agreements are obviously suspect.  However, payments or transfers of ownership from one former spouse to another, even as part of a community property settlement, may also give rise to fraudulent transfer avoidance claims. See In re Hinsley, 201 F.3d 638 (5^th Cir. 2000); In re Beverly, 374 B.R. 221 (B.A.P. 9^th Cir.2007).

 

About the Authors...

William G. "Bill" Cherbonnier Attorney at Law

Fernand L. "Ferdie" Laudumiey Chaffe McCall LLP

Written on behalf of the Bankruptcy & Debtor/Creditor Rights Committee.