The fundamental concept that every debtor is entitled to a clean slate under the Bankruptcy Code has long been limited by the inability of the debtor to discharge an obligation to pay family support or debts arising from a divorce decree or separation agreement. Sections 523(a)(5) and (15) of the Code explicitly set forth that support obligations and marital debts are excepted from discharge, subject to certain prescribed limitations. The Seventh Circuit, in the benchmark case of In re Crosswhite, 148 F.3d 879 (7th Cir. 1998), best articulated the theory that "the debtor should not use the protection of a bankruptcy filing in order to avoid legitimate marital and child support obligations." It is apparent from reading the cases in the Crosswhite genre that courts are continuing to constrict the ability of debtors to discharge support and support-related obligations.

Two different federal appellate courts recently faced the issue of determining the dischargeability of debts labeled as "property distribution" owed to the creditor spouses in state divorce proceedings. In the matter of In re Werthen, 282 B.R. 553 (B.A.P. 1st Cir. 2002), the Bankruptcy Appellate Panel for the First Circuit found that installment payments owed by the debtor to his former spouse emanating in part from the creditor's marital share in the debtor's ownership interest in his family business were not dischargeable in bankruptcy. The court found, inter alia, that the amount and structure of the payments were "in part made in lieu of more generous alimony awards," 282 B.R. at 560. As such, the court agreed with the trial court below that the installment payments were intended to provide support to the creditor and the children of the parties.

The Eleventh Circuit reached a similar conclusion in the matter of Cummings v. Cummings, 244 F.3d 1263 (11th Cir. 2001). Here, a Florida divorce court awarded to the creditor spouse the sum of $6.3 million as an "equitable distribution award," payable by the debtor in three equal installment payments. The Eleventh Circuit noted with particularity that the divorce court indicated that the creditor spouse would depend on the equitable distribution award to support herself and the children of the parties. The court further noted that state divorce courts often designate a support obligation as "property settlement" and thereafter adjust alimony awards depending on the nature and amount of marital assets available for distribution (citing In re Gianakis, 917 F.2d. 759 (3rd Cir. 1990)).

---

It is apparent from reading the cases in the Crosswhite genre that courts are continuingto constrict the ability of debtors to discharge support and support-related obligations.

---

Another federal appellate court recently analyzed the issue of whether legal fees ordered to be paid by the debtor to the creditor's family court attorneys arising from custody proceedings are dischargeable in bankruptcy. In In re Maddigan, 312 F. 3d 589 (2nd Cir. 2002), the Second Circuit held that the award of legal fees creates a debt that is not dischargeable in bankruptcy. The court found that the fact that "a debt is payable to a third party does not prevent classification of the debt as being owed to the (debtor's) child." Id. An interesting secondary issue in the Maddigan matter arose from the fact that the debtor and the mother of the debtor's child were never married. The Second Circuit stated that the amendment of §523(a)(5) in 1984 to include "other orders of courts of record" (in addition to separation agreements and divorce decree) was specifically made to "plug the loophole that allowed fathers of children born out of wedlock to escape child support obligations in bankruptcy." Id. (citing the dicta of the district court in In re Magee, 111 B.R. 359, 360 (M.D. Fla. 1990)).

There have been several recent noteworthy opinions from the bankruptcy trial courts relating to dischargeability of marital obligations. For one, in In re Brown, ___ B.R. ___, 2003 Bankr. Lexis 80 (Bankr. W.D. Pa. 2003), the Bankruptcy Court for the Western District of Pennsylvania ruled that an obligation of a debtor to pay to a creditor spouse a sum in consideration of the award to the debtor of the marital business was not dischargeable in bankruptcy, even though the parties agreed, by a "so-ordered" stipulation signed after the divorce decree, that the obligation was equitable distribution and not spousal support (apparently in an prescient attempt by the debtor to establish a basis for discharge of the debt). The Brown court held that it "must look beyond the label attached to a given obligation to establish its true nature," 2003 Bankr. Lexis 80, pg. 9, citing Gianakis, supra, 917 F.2d. at 762. The court further found, in the absence of any stated intention by the state divorce court, that the obligation in question was intended to provide support to the creditor spouse. This finding was based on the review by the Brown court that by function of the imposition of the subject obligation by the trial court, the award provided a semblance of parity with respect to the parties' income, and that it enabled the creditor spouse to provide herself with the necessities of life. There is no doubt that the Brown ruling further amplifies the sentiment expressed in Werthen and Cummings that the actual pecuniary effect of an obligation set forth in a marital decree outweighs the characterization of such obligation by the parties or the court of decree.

The bankruptcy court for the District of Connecticut recently faced the balancing test set forth as part of §523(a)(15) of the Code. The test provides that upon a showing by the creditor that a debt was incurred in the course of a divorce, the burden thereafter shifts to the debtor to show that the debtor is unable to pay the debt or that the benefit of a discharge to the debtor outweighs the detrimental consequences to the creditor. The bankruptcy court found in In re Rogan, 283 B.R. 643 (Bankr. D. Conn. 2002), that the debtor, a young associate at a mid-sized law firm, failed to meet his burden under the balancing test to the extent that he could not establish as a matter of law his right to discharge under the test. The court explicitly noted inter alia that based on the debtor's prospects for an increase in income and his relatively young age, the debtor would not be unduly burdened by the non-discharge of his obligation.

Recent Opinions Permitting Discharge

The news was not all bad for debtors seeking to discharge marital obligations. The bankruptcy court for the Central District of Illinois handed the debtor a victory in In re Bucher, ____ B.R.____, 2003 Bankr. Lexis 96 (Bankr. W.D. Ill. 2003). The court directed that certain debts owed to various creditors could be discharged by the debtor, notwithstanding a divorce decree that the debtor was responsible for the debts and would hold the spouse harmless from those debts. The court found under §523(a)(15) of the Code that the debtor was unable to pay the subject debts based on her net pay and her other obligations, and thus held that discharge was therefore reasonable.

A debtor was also successful in In re Bailey, 285 B.R. 15 (Bankr. N.D. Okla. 2002). The bankruptcy court for the Northern District of Oklahoma found that the intent of an installment award owing to a creditor spouse, even though labeled as "alimony" in part, was to compensate the spouse for the marital value of the debtor's business. The court rejected the creditor's allegation of "quasi estoppel," which such allegation was made based on the prescribed ability of the debtor to treat the payments as deductible for federal income tax purposes. The basis for such rejection was that the court found that neither party had considered the tax consequences of the award prior to the agreement incorporated into the decree. The court further opined that the parties intended the payments to constitute only the marital value of the business, notwithstanding the creditor's assertions to the contrary.

Conclusion

Notwithstanding the rulings in Bucher and Bailey, it appears that the trend in the bankruptcy judiciary throughout the nation is to further strengthen the ability of creditor spouses to enforce marital obligations, even as such rulings further erode the debtors' ability to truly achieve the "fresh start" contemplated by the Bankruptcy Code. It is evident from all of the recent case law that mere "labels" of a particular obligation within a divorce decree or agreement will be viewed as having no import in a subsequent adversary proceeding brought by a creditor spouse, and that the intention of the parties and/or the practical effect of the obligation to the parties is what will be reviewed within the proceeding. Family law practitioners representing the "obligor" within the scope of a marital proceeding would be well advised, if possible, to structure a payment sequence so that such debt is truly one for distribution, and not for spousal or family support. Of course, the hard part will be to convince a future bankruptcy judge or tribunal that the structure survives the Crosswhite test.