When The Marital Community Doesn’t Get a Bankruptcy Discharge

By Cathy Moran, Esq.

Community property works differently in bankruptcy. I probably don’t have to tell you that.

On the issue of assets and debts, community property is pretty straightforward. All of the community property comes into the estate upon the commencement of a bankruptcy case, even when only one spouse files. §541(a)(2).

Every creditor with a right to be paid from the community can file a claim, regardless of which spouse incurred the debt. §101(7). So creditors of the nonfiling spouse are proper claimants in the filing spouse’s bankruptcy case.

If the bankruptcy estate contains separate property as well, §726 creates a distribution scheme that segregates community assets from separate property assets in paying community and non community debts.

So far pretty straightforward. Right?

The community property discharge

Then we get to discharge. Because all of the community property comes into the estate, and all of the community claims are treated in the estate, any future community property acquired by the spouses is free of the claims of pre petition community creditors. §524(a)(3).

The non filing spouse’s debts are not discharged in her spouse’s bankruptcy. But going forward, her prepetition creditors can’t reach post petition community property. The community gets the benefit of the filer’s discharge. Her creditors can reach her separate property, during or after the community ceases to exist.

Snow White and the Devil Incarnate

The opportunities for mischief in the community discharge are obvious. Alan Pedlar observed that the Devil could effectively get a discharge of his nefarious debts if he was married to Snow White: she files bankruptcy, listing all the community claims and the community gets a discharge. Thus the Devil’s community assets going forward are immune to the claims of those he defrauded pre petition.

However, the Bankruptcy Code has a remedy for that, poorly understood and too infrequently used.

Limiting the community property discharge

The Bankruptcy Code excepts from the community property discharge any claim that would be nondischargeable in a bankruptcy case filed by the non filing spouse.

The gotcha is that the holder of a nondischargeable claim must file a timely adversary in the innocent spouse’s bankruptcy case to get that determination of nondischargeabilty.

So, having recognized the debtor as the spouse of his debtor, a creditor must file an adversary for a determination that his community claim is non dischargeable, within the time limits of §523(c).

But how do you frame such a complaint? Who is your defendant when it’s not the debtor who committed the acts complained of? In Willard v. Lockhart-Johnson, the 9th Cir. BAP held that due process required that the non-debtor spouse be joined in the action.

In his concurrence, Judge Christopher Klein laid out the reasoning more fully. In a nutshell, the nonfiling spouse, whose actions created the debt, is a required party under FRBP 7019, addressing who must be joined in an adversary.

The takeaway

When you represent a party whose spouse’s action raising the prospects of non dischargeability, the possibility of a dischargeability challenge needs to be discussed. To get the benefit of the community property discharge, creditors of the non filing spouse need to be scheduled.

If you represent a creditor with an arguably non dischargeable claim, you cannot be indifferent to the bankruptcy filing of a spouse.

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Cathy Moran has headed her own small firm Moran Law Group in Mountain View, California, for nearly 30 years. Family law and tax issues as they play out in bankruptcy are areas of particular interest to Cathy.