International Society of Primerus Law Firms

The New Bankruptcy Act & Its Impact on Family Law

By: Madeline Marzano-Lesnevich

Lesnevich & Marzano-Lesnevich, LLC

Hackensack, NJ

Im going to speak with you about the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, and its impact on us, as family lawyers.

In light of the current economy and real estate market, you need to be familiar with the main concepts and buzz words, and how they could affect your practice.

The Bankruptcy Abuse Prevention and Consumer Protection Act went into effect on October 17, 2005. The 2005 Act significantly impacted Orders of support, property distributions, payment of our counsel fees, payment of 3rd party obligations, and other relief which we include in our property settlement agreements in the ordinary course of our practice of family law.

According to the Administrative Office of the United State Courts, there were 2 million 78 thousand 415 (2,078,415) bankruptcy petitions filed in 2005 the United States. However, since the 2005 Act was enacted there has been a significant decrease in the total number of filings for bankruptcy in the United States. In 2006 there were only 617 thousand 660 (617,660) bankruptcy petitions filed and in 2007 there were only 850 thousand 912 (850,912) bankruptcy petitions filed. This is a clear indication of the impact that the 2005 Act has had on debtors.

It is now more difficult for a debtor to discharge debt in bankruptcy, and it is more likely that debtors will be compelled to comply with their divorce-related obligations.
The definition of a domestic support obligation has been expanded, the list of discharge exceptions has been extended, and support obligations have been elevated in the list of priorities – - all to a non-debtor spouse or former spouses advantage.

Generally, Chapter 7 is a liquidation chapter. Bankruptcy petitions filed under Chapter 7 begin with the identification of the debtor’s non-exempt assets; and the sale of the assets is overseen by the Trustee in an effort to establish a pool of money from which outstanding creditors are paid. These creditors are paid in an order of priority established by the Bankruptcy Code. One of the most significant changes brought about by the 2005 Act is the designation of domestic support obligations as a first priority, thereby assuring that such obligations are paid before all other obligations. A straightforward Chapter 7 bankruptcy action can be over rather quickly, in some cases lasting no more than four months.

Whereas Chapter 7 is devoted to liquidation, with the Trustee serving the primary roles of identifying and selling the debtor’s assets, Chapter 13 is devoted to reorganization, with the Trustee’s primary role shifting to the establishment of a repayment plan, funded by all of the debtor’s disposable income.

The purpose of this plan under Chapter 13 is to allow for creditors to be repaid over a period of three to five years.

Ordinarily, creditors receive more money in Chapter 13 than in Chapter 7.

Chapter 11 is usually reserved for businesses. However, it can be used by individuals who want to reorganize, but who do not otherwise qualify for reorganization under Chapter 13 because their debt is too significant, or their income is insufficient to fund an appropriate plan. Finally, Chapter 12 is a reorganization chapter reserved for farming entities, and, under the 2005 Act, now includes fishing entities. Bankruptcy petitions filed under Chapter 12 are the least common petitions filed by debtors. Well focus on Chapter 7 liquidation, Chapter 11 (usually reserved for business), and Chapter 13 reorganization.

But no matter which Chapter is utilized, it is imperative that we, as family lawyers take some action to protect the economic rights or property interests of our clients. We should:

? Obtain complete copies of all schedules and statements of financial affairs, filed by the debtor. Compare those with the financial disclosures made in the family court proceedings. Has the debtor failed to list assets? In the bankruptcy petition? In the family court action?

? Attend a 341 (a) meeting; that is, a creditors meeting. The debtor will be compelled to submit, under oath, to the questions of the Bankruptcy Trustee and the creditors. Again, are there any discrepancies with disclosures made in the family court proceedings? Request that the Trustee inquire into a specific asset if you are aware of discrepancies.

? The Notice of the 341 (a) meeting will set forth the deadlines for filing proofs of claims and for asserting the non-dischargeability of claims. Note the deadlines. Decide whether your client needs the services of a bankruptcy attorney. If not, file a Notice of Appearance. If yes, refer the client to a bankruptcy attorney. Either way, a Proof of Claim should be filed on behalf of your client.

One of the most significant changes to the Bankruptcy Code are the prerequisites that a debtor must meet before filing, including credit counseling and a Chapter 7 means test.

In other words, a debtor seeking to file a Chapter 7 bankruptcy proceeding must first qualify for Chapter 7 protection. To qualify, the debtor must fail the means test – which means the debtor does not have sufficient income with which to complete a Chapter 13 plan which, remember is a reorganization plan under which debts are repaid.

Pursuant to the means test, if the Debtor with primarily consumer debt is found to have the means to pay his or her debt, that debtor will not be permitted to proceed with a Chapter 7 action, but will rather be required to proceed under Chapter 13, and submit to the repayment plan established by the Trustee.

The results of the means test have ramifications that extend beyond the determination of which Chapter the debtor must proceed by– the ramifications can have a direct impact upon the attorney filing the Chapter 7 petition on the debtor’s behalf. Specifically, if the Chapter 7 petition is filed, and it is ultimately determined that the debtor has the means to pay his debts pursuant to a Chapter 13 action, the attorney filing on the debtor’s behalf may be sanctioned, including provision for disgorgement of fees and for payment of the Chapter 7 Trustees fees related to the dismissal.

With regard to the test itself, the debtor’s means to pay will be subject to two separate criteria. The first criterion of the means test mandates a calculation of the debtors current monthly income, which is comprised of the debtor’s average monthly income over the last six months, multiplied by twelve months. The product [you remember that term] is then compared with the median annual income in the state where the debtor resides. If the debtor’s income is below the median annual income for his or her state, he or she may file for Chapter 7. Our materials give you the website for the median annual income figures for each state. But, if the debtor’s median income is greater than the applicable median annual income for his or her state, a debtor will be subjected to the second criterion, which itself is a two-part test; If the debtor satisfies either part, he or she will be required to file under Chapter 13 reorganization, and not Chapter 7. The two-part test [I dont expect you to remember this but follow along]: First, the debtors current monthly income, less the debtors current monthly expenses, is multiplied by 60; If the product equals or exceeds $10,000, the debtor must file under Chapter 13 and not Chapter 7. Second, if that product is less than $10,000.00, but falls between $6,000 and $10,000, and if the product is more than 25% of the debtors unsecured debt, the debtor has to file under Chapter 13, and not Chapter 7.

Of the prerequisites impacting family law, actually the most important one, is that

a debtor seeking Chapter 13 protection must be and must remaincurrent with his or her support obligation. In Chapter 13 bankruptcies, the debtor is to arrive at a plan that is acceptable to the trustee and by which his or her debts shall be repaid. The 2005 Act permits the debtor to have discharged certain debts (including non-support debts arising out of a marital settlement agreement) as soon as the debtor has made all payments pursuant to the plan.

One tremendous benefit to the debtor filing a Chapter 13 bankruptcy proceeding is that if the proposed plan is accepted and followed, the debtor filing a Chapter 13 bankruptcy proceeding is afforded the opportunity to retain his or her residence. However, the 2005 Act incorporated an additional requirement for discharge. The Act states that

[I]n the case of a debtor who is required by a

judicial or administrative order, or by statute, to pay

a domestic support obligationsuch debtor must certify

that all amounts payable under such order or such

statute due on or before the date of the certification

(including amounts due before the petition was filed, have

been paid

In other words, only a debtor who is current on his or her domestic support obligation will find relief under a Chapter 13 proceeding. The 2005 Act has also provided that, failure of the debtor to pay any domestic support obligation that first becomes payable after the date of the filing of the petition is grounds for dismissal, of the bankruptcy proceeding. The debtor must be current with his support up to the date of the filing of his certification, and the debtor must remain current with his support obligation. If not current and this is the remedy you need to be aware of the trustee may sell the debtors residence to satisfy the domestic support obligation.

Prior to the 2005 Act, the filing of any bankruptcy proceeding had automatically stayed determinations or adjudications of the property interests of a debtor, the exercise of control over the property, and the assertions of many claims against the debtor or his property. Pursuant to the 2005 Act, the only divorce-related activities that are stayed by the filing of bankruptcy proceedings are the division of marital property and the collection of certain non-support payments from what is determined to be property of the bankrupt estate.

Therefore, no automatic stay issues on

? paternity actions;

? actions for the establishment or the modification of support;

? actions concerning custody or parenting time;

? the dissolution of marriage (remember, however, there still cannot be a division of property). On this, one should look to individual states criteria for a bifurcated proceeding;

? any domestic violence proceedings;

? the collection of domestic support obligation from property that is not property of the estate – there is also no automatic stay;

? income withholding from property of the estate or of the debtor when used for the payment of a domestic support obligation under a judicial or administrative order, or by statute; or

? the interception of tax refunds

Once a bankruptcy petition has been filed, there will be a look-back by the trustee to determine fraudulent and preferential transfers. Transfers to a non-debtor spouse, not constituting support, may be fraudulent; specifically the transfer of a residence to the non-debtor spouse may be considered fraudulent. Payment of alimony or child support will be deemed a preferential transfer if the debt was assigned to a third-party.

We need to protect certain transfers from being voided, or deemed a fraudulent or preferential transfer, if the debt was assigned to a third-party.

For example, in cases where a Marital Settlement Agreement or Property Settlement Agreement provides that a Husband is assuming certain debts from which the wife is being held harmless, we need to include detailed, explanatory, protective language, such as

It is further understood by and between the parties that the Husband has assumed the aforementioned debts and agreed to indemnify and hold the Wife harmless for same because of the relative financial resources of the parties. It is specifically understood that the Wifes alimony, support and maintenance has been calculated with this assumption of debt considered, and it is hereby made subject to same. It is further understood that the Wife does not have the financial resources to pay such obligations and compelling her to do so would cause irreparable harm and financial detriment which substantially exceeds the financial benefit to the Husband, if the Wife were to assume such obligations. It is further understood that this obligation to the Wife will not be dischargeable in any bankruptcy filed by the Husband.”

Its very important for us, as family law practitioners, to craft language in our agreements which will not only protect our clients in the event of a spouse or former spouses bankruptcy, but also protect our clients when the Bankruptcy Trustee does the look-back.

What constitutes property of the bankruptcy estate?

A marital estate is created and fixed upon the filing of a divorce complaint. Section 541 of the 2005 Act governs the determination of whether marital property constitutes property of the bankruptcy estate.

In Chapter 7 cases, earned income of the debtor is not property of the estate, but in Chapters 11, 12 and 13 cases, earned income of the debtor is property of the estate.

Discharging debt has become harder under the 2005 Act.

The exceptions to discharge listed in 523 are applicable to Chapter 7, 11, and 12 proceedings, as well as hardship debts discharged under chapters 12 and 13 proceedings. It is important to note the distinctions for each chapter. When faced with bankruptcy the first thing to look at is the chapter being used.

Prior to the enactment of the 2005 Act, 523 contained two exceptions to discharge that related to debts in the context of a dissolution of marriage. The first excepted from discharge any debt:

to a spouse, former spouse, or child of the debtor, for alimony to, maintenance for, or support of such spouse or child in connection with a separation agreement, divorce decree or other order of a court of record but not to the extent that such debt was assigned to another entity or such debt included a liability designated as alimony or support but is not actually alimony or support.

Be careful of payments to 3rd parties.

The exception to discharge under the former Bankruptcy Act contained substantial limitations. The old exception only applied to a creditor who was a spouse, former spouse, or child of the debtor.

Now, with the expanding nature of family law, and of our definition of family, many significant potential creditors with debts arising from a family-like context have been deprived of their debts being protected by the discharge exception. For example, legal guardians and relatives, such as grandparents or siblings who have undertaken custodial responsibility for a debtors children, could not rely upon the language of the old bankruptcy provisions; even a creditor who is the non-biological, or even the biological parent of the debtors child, would not fall within the language of the prior statute unless he or she was the spouse, or former spouseof the debtor. So, if parents were unmarried, the non debtor spouses support was not protected.

The 2005 Act replaced the limiting language with the phrase Domestic Support Obligation. Any debt or obligation that falls within the definition of domestic support obligations is now excepted from discharge in bankruptcy.

A Domestic Support Obligation (DSO) is defined as any obligation, including interest that: is established or may be established prior to, at or after the bankruptcy filing (this is substantially broader than before); is owed to or recoverable by any adult who may be responsible for a child (e.g. spouse, ex-spouse, child, childs parent, legal guardian or other responsible relative) or a governmental unit; is in the nature of alimony, maintenance or support; and which has been established by a separation agreement, divorce court, property settlement agreement, order of any court or determination made by any governmental unit.

It may not be assigned to a non-governmental entity unless it was assigned voluntarily solely for purposes of collection. This term DSO (Domestic Support Obligation) is utilized in many amended provisions of the Bankruptcy Code. For example 523a5 now reads that any DSO is non-dischargeable, automatically, from any bankruptcy case. Any non-DSO domestic obligation is now, automatically, non-dischargeable in Chapters 7, 11 and 12 cases, but may be discharged in a Chapter 13 case. No adversary proceedings need to be initiated in Chapter 7 cases to determine the non-dischargeability of domestic obligations they automatically survive the discharge.

A subject of interest to us, a counsel fee award stemming from a divorce action, is just as subject to discharge as any debt for which no exception is otherwise provided. Prior to the 2005 Act, the issue as to whether or not a debtors obligation to pay counsel fees could be dischargeable in bankruptcy hinged upon the determination of whether or not the award was deemed alimony, maintenance, or support. To a large extent it still is. Again, with the new, more inclusive definition of domestic support obligation, and with further exceptions for all other debts arising from a divorce settlement agreement, the distinction is not as important for Chapter 7 proceedings as it is for Chapter 13 proceedings. However, for Chapter 13 proceedings, the issue of whether a counsel fee obligation stemming from a divorce proceeding may be excepted from discharge will depend upon whether the obligation is deemed part of a domestic support obligation. You need to be protective in your MSA language.

The Bankruptcy Code establishes an order by which claims are paid from the bankruptcy estate, after such estate has been accumulated. All creditors with claims of a higher priority designation must be paid, and their debts satisfied in full, before credits with claims of lower priority designations receive payment.

But, prior to the 2005 Act, domestic support obligations were considered the seventh priority. Therefore, under the prior act, a creditor seeking to collect monies owed from a domestic support obligation was often unlikely to do so, because by the time his or her debt was considered, the debtors estate had been expended to creditors of higher priority. There was simply no money left for support obligations.

The 2005 Act, however, elevated domestic support obligations to the number one priority, with debts recoverable by a spouse, former spouse, child of the debtor, a childs parent, legal guardian or responsible relative being paid first, and governmental units to which support obligations have been assigned being paid second.

The 2005 Acts biggest beneficiaries are Creditor ex-spouses. A debtor may no longer discharge any divorce related obligation in Chapter 7 and may only discharge property settlements upon the completion of a Chapter 13 plan and the issuance of his or her discharge. Significant provisions are now in place requiring that the debtor be, and remain current, with post-petition support payments. Bankruptcy under the 2005 Act is no longer a good way for a payor spouse to renegotiate divorce-related provisions.

The 2005 Act has had substantial implications, both positive and negative, for family law and family law practitioners. The upside is increased security for the non-debtor spouse in preserving and collecting upon their debts in an equitable and expeditious fashion. The downside is the increased transactional costs associated with the current, and more complicated, requirements. Over the past few years, as domestic practitioners have acclimated to the changed rules and new requirements, it has become clear that a working knowledge of the 2005 Act is really essential. You need to be aware of the issues, you need to contemplate whether bankruptcy is in the pipeline for your clients spouse or ex-spouse or co-parent, you need to know if you need to refer someone to a bankruptcy attorney.

For more info on Lesnevich & Marzano-Lesnevich, visit the International Society of Primerus Law Firms or lmllawyers.com.

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