BB&K attorney Cathy Ta writes about community property and community claims in bankruptcy in Riverside Lawyer magazine.
Riverside Lawyer - February 23, 2016
When a Chapter 7, 11, or 13 case is filed, a new entity is created called the bankruptcy estate. A bankruptcy estate is comprised of all of the debtor’s non-exempt legal or equitable interests in property as of the time of the filing, wherever located and by whomever held, plus certain property that the debtor acquires (or becomes entitled to acquire) within 180 days after the case is filed. The idea is that “property of the estate” is broadly defined so as to maximize payment to creditors of the debtor; in exchange, at the end of the case, the “honest but unfortunate debtor” will receive a discharge that relieves the debtor from personal liability.
Notably, property of the estate also includes all interests of the debtor and the debtor’s spouse in community property1 as of the time of the filing – even when the debtor’s spouse does not file for bankruptcy. Specifically, under bankruptcy law, the estate includes: (1) community property that is under the sole, equal or joint management and control of the debtor; (2) community property that is liable for a claim against the debtor; and (3) community property that is liable for a claim against the debtor and the debtor’s spouse. This means that property of the estate includes all community property except community property that is under the sole management of the debtor’s spouse. The purpose for including community property in the bankruptcy estate is so that creditors of the debtor as well as creditors with claims against community property (that may or may not be creditors of the debtor) may share ratably in the distribution of community property as they would have been able to under state law. In other words, a debtor who files bankruptcy without his or her spouse would not disadvantage creditors that hold claims against community property based on whether they are creditors of the debtor or the debtor’s spouse – these creditors will be paid alike. In exchange, the discharge will apply to bar these creditors from reaching the same type of community property that is acquired after the filing of the case. Therefore, a debtor’s bankruptcy filing not only discharges the debtor from personal liability, but also the non-filing spouse’s debts against community property that is property of the estate.
A community property debt is defined under state law. In California, a community property debt is any debt incurred by either spouse before or during marriage,2 regardless of which spouse has the management and control of the property and regardless of whether each spouse is a party to the debt. In contrast, separate property of a person is liable for all of that person’s debts, whether incurred before or during marriage; the only debt for which separate property is not liable is a debt incurred by that person’s spouse before or during marriage. In a bankruptcy case, this means all of the filing spouse’s separate property as well as community property (except for those under the sole management of the spouse) is included in property of the bankruptcy estate for payment to creditors.
So, what happens when a debtor files a bankruptcy case without the spouse? In a Chapter 7 liquidation case, a Chapter 7 Trustee takes control of community property that passes to the bankruptcy estate, including whether or not to exercise the power to sell community property. In a Chapter 11 or 13 reorganization case, the debtor controls community property that passes to the bankruptcy estate. This means that the non-filing spouse loses control over community property, whether or not the non-filing spouse authorized (or even knew in advance of) the debtor’s filing, given that spousal authorization is not a filing requirement under bankruptcy law. At minimum, a non-filing spouse participates in the bankruptcy case by being entitled to notice and hearing before any disposition of community property. The non-filing spouse also could participate by joining the bankruptcy case as appropriate or in the case of a bad faith filing, defeating the bankruptcy case through a motion to dismiss.
Once a bankruptcy case is filed, the bankruptcy court exercises exclusive jurisdiction over property of the estate so as to orderly administer assets and liabilities of the bankruptcy estate. Typically, a bankruptcy court will not overturn a property division agreement approved by a state court, but, it may do so if the division was not at arms-length and fraudulent as to creditors. The practical effect is that the spouse that first files bankruptcy will determine not only the fate of community property, but also who and which court will exercise control over it during the bankruptcy case.
In short, bankruptcy law is crafted to include community property as part of the bankruptcy estate so that in general, all community debt may be paid from community property (before separate property is used to do so). This is the case even when only one spouse files for bankruptcy.
1. In California, community property is any property acquired by a spouse during the marriage (that is not a gift or inheritance) while domiciled in the state.
2. “During marriage” is the period that does not include when the spouses are living separate and apart before a divorce or legal separation. In California, spouses may hold property as joint tenants, tenants in common, community property, or community property with a right of survivorship; regardless, the property would be treated as community property.
This article originally appeared in the March/April 2016 edition of Riverside Lawyer magazine, a publication of the Riverside County Bar Association. Reprinted with permission.
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