Lump Sum Divorce Payment: Exempt Property in Bankruptcy

by Brian Vertz on September 9, 2010

In Re Miller, 424 B.R. 171 (M.D. Pa. 2010)

Wife/Debtor filed a chapter 13 bankruptcy petition, in which she attempted to classify an “income maintenance award” of $88,500 received in a divorce decree as property exempted from the bankruptcy estate.  The divorce decree provided that Wife was to receive $88,500 cash in order to effectuate a 67%/33% division of marital property.  Next, Wife’s former divorce lawyer filed a proof of claim for unpaid legal fees and objected to Wife’s schedule of exemptions, claiming the lump sum cash award was not exempt under 11 U.S.C. § 522(d)(10)(D).  The Chapter 13 Trustee also filed objections to Wife’s exemptions, asserting the same grounds as her former lawyer.  Wife and her former lawyer stipulated that the forty-seven page report by the divorce master was incorporated into the divorce decree at issue.

In the report, the divorce master specifically stated that the husband’s obligation to Wife was for “necessary living expenses, including the mortgage, taxes, insurance, and upkeep on the marital residence” and that it “‘should not be dischargeable in bankruptcy.’” In awarding 67% of the marital property to Wife, the master found Wife had no job skills, and at the time, was making $1,300 per year cleaning houses.  The master awarded Wife alimony for the period of two years so that she could obtain additional education and employment during that time.  At the time when the matter came before the bankruptcy court, however, Wife had not received additional education and was not employed.

The bankruptcy court began its’ analysis with a discussion of 11 U.S.C. § 522(d)(10)(D), which provides “alimony, support or separate maintenance, to the extent reasonably necessary for the support of the debtor and any dependent of the debtor…may be exempted under subsection (b)(2) of this section.”  The court noted exemptions are broadly construed, and the burden is on the party objecting to the exemption to prove the exemption is not available. The court considered three possible approaches to determining whether the obligation in Wife’s divorce decree was in the nature of support.

The court first considered In re Gianakas, 917 F.2d 759 (3d Cir. 1990), which held that federal law, not state law, determines whether a divorce obligation is in the nature of support, maintenance or alimony. The Third Circuit in Gianakas set forth a three-part test to determine the nature of whether an obligation is alimony, maintenance or support.  Yet, the bankruptcy court in Miller noted that Gianakas had addressed the discharge of a debt under 11 U.S.C. § 253(a), not a property exemption claim  under 522(d)(10)(D).  Further, Gianakas dealt with the dischargeability of an obligation under a consentual agreement rather than a court-imposed divorce decree.

Before applying the three factors set forth in Gianakas, the Miller court discussed two alternative approaches to defining support obligations in the context of a discharge determination from other federal courts.  The court reviewed the Fifth Circuit’s decision in In re Evert, 342 F.3d 358 (5th Cir. 2003), which set forth four criteria for determining whether divorce-related debts were exempt under § 552(d)(19)(D).  The Evert court held that if:

in the agreed divorce decree there is 1) also a meaningful separate alimony provision, 2) the obligation in question is described as being part of the property division, 3) the label given to the obligation in question is matched by its actual characteristics, and 4) the evidence does not suggest the parties conspired to disguise the true nature of the obligation in order to subvert the bankruptcy or tax laws, then the label given by the state court is sufficient and there is no need to look behind it to determine whether it is really alimony or a property settlement.

Evert, 342 F.3d at 368.  The Evert court concluded that the Gianakas factors should be applied only when the settlement agreement is ambiguous.  The Miller court, however, disagreed with Evert holding that a bankruptcy court must accept the state court’s characterization of an obligation unless the marital settlement agreement is ambiguous.  For these reasons, the Miller court rejected the Evert approach.

The Miller court next considered the approach taken by the District Court for the Eastern District of Michigan in In re Harbaugh, 257 B.R. 485 (E.D. Mich. 2001).  The Michigan court relied upon the legislative history of § 552(d)(10)(D) in holding that the parties’ intent behind the marital settlement agreement or the intent of the court issuing the order should be paramount in characterizing a divorce obligation.  The Harbaugh court found “Congress intended for section 552(d)(10)(D) to exempt only those monies, and potentially other equivalent awards, that concern general spousal sustenance” and therefore, the court should exempt only those payments from “the bankruptcy estate that (1) are intended by the parties or the state court to support a spouse and (2) are, in the judgment of the bankruptcy court, reasonably necessary for such purpose.” Harbaugh, 257 B.R. at 491.

The Miller court eventually endorsed the three-part Gianakas test to determine whether a divorce obligation is an exempt property under 11 U.S.C. § 522(d)(10)(D). In doing so, the Miller court pronounced its intent to avoid inconsistency with the standards by which dischargeability is judged under § 253(a). Applying the first part of the Gianakas test, the bankruptcy court first considered “the language and substance of the agreement in the context of surrounding circumstances, using extrinsic evidence if necessary.” Miller, at 177, citing Gianakas, at 762-63. Wife’s former divorce lawyer argued that the lump sum cash obligation was not support because it was set forth in a section of the master’s report entitled “Discussion and Conclusions of Law with respect to Equitable Distribution.”  Wife conceded that the sum was awarded in this section of the report, but asserted that he substance of the master’s report indicated the award was for the purpose of support.

Applying the second and third factors in Gianakas, the Miller court considered the “parties’ entire financial situation” and “the function served by the obligation at the time of the divorce or settlement.”  Miller, at 177, citing Gianakas, at 762-63.  The court held that it was “crystal clear” that the lump sum distribution to Wife was not only “related to” her support but “founded upon that need.” The court also noted that Wife’s lawyer, by stipulating to the master’s report, had thereby stipulated that the award was necessary to support Wife.  Considering the parties’ financial situation, the court noted the disparity between the parties’ incomes and earning capacities, as Husband earned far more than Wife at the time of the master’s report and at the time of the court’s opinion.  The court also noted the fact that the award was intended to pay for the necessities of life while Wife obtained additional education and employment.  Based on these factors, the court concluded the divorce obligation “was intended by the state court to serve as support and was not a division of property.” Miller, at 178.  Based on this finding, the court allowed Wife to exempt the $88,500 award from the bankruptcy estate and overruled the objections of Wife’s former counsel and the Trustee.

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