Bankruptcy Court Rules Liability Under Prenuptial Agreement Non-Dischargeable, But No Legal Fees Incurred In Bankruptcy Proceedings

March 20, 2014 | Comments Off on Bankruptcy Court Rules Liability Under Prenuptial Agreement Non-Dischargeable, But No Legal Fees Incurred In Bankruptcy Proceedings
Posted by Donald F. Campbell, Jr.

When entering into prenuptial agreements, parties should be aware that debts owed under such agreements are likely not dischargeable under the United States Bankruptcy Code (the “Code”), regardless of how carefully drafted.

In DeStephano v. DeStephano (In re DeStephano), the New Jersey Bankruptcy Court determined that the debts owed by a former husband, DeStephano, under a prenuptial agreement totaling over $182,000 were non-dischargeable even though the Agreement specifically stated that the payments were “not alimony.”   On June 4, 2002, DeStephano and his fiancé, Mrs. Fowler, entered into the prenuptial agreement (the “Agreement”) whereby DeStephano agreed that, should he aFowler ultimately separate, DeStephano would pay her the following Property Settlement Payments: (1) $12,000 within 30 days of termination; (2) $1,000 per month for a period equal to the number of months that the relationship lasted beginning on June 6, 2002; and, (3) $27,000 as repayment of monies loaned to the Debtor plus accrued interest.  The Agreement specifically states that the payments “are not alimony and will not be tax deductible.”  The Agreement further states that Fowler is “giving up all rights to … alimony and to equitable distribution…”   In 2009, Fowler instituted divorce proceedings and on October 5, 2010, the State Court entered a Final Judgment for Divorce which made no mention of support or equitable distribution.

In December of 2010, Fowler instituted subsequent State Court proceedings seeking to enforce the terms of the Agreement; however, those proceedings were stayed after DeStephano filed for Chapter 7 Bankruptcy protection under the Code.  DeStephano listed Fowler as a creditor who was claiming she was owed $300,000.00.  DeStephano indicated on his bankruptcy schedules that he disputed Fowler’s claim.  Fowler filed an adversary proceeding in the Bankruptcy Court seeking an order from the court that DeStephano’s debt to Fowler was non-dischargeable under the Code.  Section 523(a)(5) provides an exception from the discharge for any debt for a “domestic support obligation,”  which has been defined as a debt that is owed to or recoverable by a former spouse of the debtor in the nature of alimony, maintenance, or support of such spouse without regard to whether such debt is expressly so designated, established before, on or after the debtor’s bankruptcy filing by applicable provisions of a separation agreement, divorce decree, property settlement agreement, or order of a court record.  11 U.S.C. §101(14A).

Determination of whether a debt is in the nature of support, the creditor bears the burden to show: (1) the creditor is a person with a particular relationship with the debtor, (2) the nature of the obligation is for support, (3) the source of the obligation is an agreement, court order, or other determination, and (4) the assignment status of the obligation must be consistent with 11 U.S.C. §523(a)(5)(D).  The court must look to the intent of the parties at the time of the agreement.

In this matter, the Bankruptcy Court determined that the payments owed to Mrs. Fowler were, in fact, non-dischargeable.  The court ruled that Mrs. Fowler proved (1) she is the former spouse of the debtor, (2) that the source of his obligations was through the Agreement and that (3) she did not assign the obligation to a third party.  The critical issue was whether the nature of the obligation constituted support.  Fowler argued that the intent was to provide her support in case the parties did divorce.  In support of her argument, Fowler pointed to portions of the Agreement with the Debtor which state that the Debtor agreed to support the Debtor during the marriage and after by agreeing to make “property settlement payments” to Fowler and that the Agreement was “in full and complete satisfaction of all claims for support, maintenance, and/or alimony.”  DeStephano argued that the agreement specifically states that the payments are “not alimony” and that the agreement specifically sets forth that any amounts due to the Plaintiff are not to be deemed spousal support or equitable distribution and testified that the parties never specifically contemplated that Fowler would not have to work and would be supported if the marriage failed.  The Debtor testified that his intention in entering into the agreement was to protect his pre-marital assets.

The Bankruptcy Court disagreed with the Debtor’s interpretation of the Agreement.  The Court ruled that the payments due to Fowler upon the termination of the marriage were intended to be an were “in the nature of” alimony and support payments.  As such the payments were not dischargeable.  The Court also concluded that the debtors were also not dischargeable under Section 523(a)(15) which states that debts are not dischargeable if “…incurred by the debtor in the court of a divorce or separation or in connection with a separation agreement, divorce decree or other order of a court of record, or a determination made in accordance with State or territorial law by a governmental unit.”  The Bankruptcy Court ruled that “there was no doubt” DeStephano incurred the debts in connection with the divorce decree.  The State Court upheld the agreement as valid and enforceable and controlled the dissolution of the marriage.

Interesting, the Bankruptcy Court refused Fowler’s request to have the legal fees incurred in the bankruptcy proceedings deemed a non-dischargeable debt.  Though the agreement entitled Fowler to legal fees incurred in seeking enforcement of payments due under the agreement, the Bankruptcy Court found those rights did not extend into the non-dischargeability proceedings.  The Court cited to In re Clemente, 2011 WL 2039072 at *2 (D.N.J. May 23, 2011) which held there were only three ways to seek an award of counsel fees in a bankruptcy action: (1) an award of fees using the bankruptcy court’s equitable powers under 11 U.S.C. §105(a); (2) an award of fees under Bankruptcy Rule 7054; and (3) an award of fees as a sanction under Bankruptcy Rule 9011.  Since there was an absence of an agreement or statutory right to legal fees, the bankruptcy court had no authority to aware such fees.

This decision demonstrates the importance of considering the impact of insolvency proceedings on a pre-nuptial agreement.  Careful drafting is critical or the parties may find themselves on the wrong side a non-dischargeablility decision.

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