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Divorce and Bankruptcy: The Legal Intersection of Two of Life's Most Challenging Moments

Two of the most difficult and stressful legal processes that individuals participate in are divorce and bankruptcy proceedings. Unfortunately, as lives are upturned and finances stretched, one often closely follows the other.

Such was the case in a recent case in the United States Bankruptcy Court for the Western District of Michigan.

A husband and wife (both Michigan residents) used equity from property owned by the wife - prior to and during the marriage - to finance a roofing repair business started by the husband in Florida. To accomplish this, the wife quit-claimed her interest in the property to herself and the husband. They then refinanced the property and borrowed $200,000 from the lender. The loan funds were used to pay off the wife's original mortgage on the property ($120,000), pay down the husband's credit card debt and fund the new business.

They then agreed that the husband would make monthly mortgage payments on the new loan until the payments equaled the amount of the original mortgage - $120,000. They subsequently refinanced the loan with two new lenders. Shortly thereafter the husband's business failed, and the husband and wife started divorce proceedings in 2011.

In the judgment of divorce (the "JOD") the state court awarded the husband the property that was used to fund his business, along with one truck and one car owned by the family. The wife received another piece of real property, two trucks, one car and a recreational vehicle. The husband also agreed to pay the wife $40,000 ($2,000 per month), representing reimbursement for a portion of her pre-marital equity in the refinanced home. At the time of the divorce, that property had been foreclosed and had no value.

The parties transferred the property following entry of the JOD and the husband made $6,000 in payments to the wife before he filed for personal bankruptcy. The Chapter 7 Trustee filed an adversary proceeding against the wife, alleging that the transfers made by the husband pursuant to the JOD were fraudulent.

The court ruled that, despite the fact that the wife received the majority of the couple's tangible property pursuant to the JOD, the transfers were not avoidable.

The trustee's complaint alleged that the transfers were constructively fraudulent under 11 U.S.C. §§544(b) and 548, preferential under 11 U.S.C. §547, and subject to turnover under 11 U.S.C. §550. The court began by analyzing whether the transfers were fraudulent. According to relevant law, a trustee may avoid either the transfer of an asset, or the incurrence of an obligation, by a debtor. The transfer of an asset or incurrence of an obligation must be either actually fraudulent or constructively fraudulent (where the effect of the transfer or obligation justifies avoidance). In this case, the trustee alleged that the transfers were constructively fraudulent.

The court analyzed whether the transfer at issue constituted the transfer of an asset or the incurrence of an obligation. It noted that while the trustee's complaint framed the issue as the transfer of an asset, the trustee was, in fact, challenging the incurrence of an obligation. The court explained that if it were to consider whether the husband transferred an asset then, as a matter of law, it would find "that [the wife] gave dollar-for-dollar value for each item of property that the state court ordered the [husband] to transfer under the JOD because each dollar in value relieved the [husband] of his obligations under the JOD."

The court further stated that "[t]herefore because it is not a fraud to pay one's debts, the actual transfer of the property or reimbursement payments does not offend the fraudulent transfer laws; rather the Trustee is seeking to avoid as constructively fraudulent the Debtor's assumption of the obligation memorialized in the JOD." The question for the court, then, was whether the husband received "less than a reasonably equivalent" in exchange for his assumption of the obligations memorialized in the JOD.

The court identified challenges in conducting the "reasonably equivalent value" analysis in a divorce setting. First is the fact that federal courts are hesitant to upset or interfere with state family law decisions. Although such decisions do not have preclusive effect, "a federal court deciding whether to avoid transfers that a family court ordered in an earlier divorce action should, as a matter of comity, pause before undermining the decision of its state court colleagues.

Ultimately, the court held that the husband did receive reasonably equivalent value for the obligations he assumed pursuant to the JOD. It emphasized that it was important to understand the intangible and other benefits he received under the divorce decree. The court wrote "[I]t is reasonable to infer that the JOD represented a fair division of the marital and pre-marital (separate) property, in light of the competing claims of the spouses under Michigan's divorce statutes." The wife, therefore "gave reasonably equivalent value."

If you have questions about the issues raised in this case, or bankruptcy issues in general, please contact a Foster Swift bankruptcy attorney.

Categories: Chapter 7, Western District of Michigan

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practice focuses on bankruptcy, municipal law, collections, and trial-level and appeals litigation. In the bankruptcy arena, she represents primarily Chapter 7 trustees. Laura has handled a wide range of trial and appellate matters for individual and business clients and has appeared before the U.S. Sixth Circuit Court of Appeals, the Michigan Court of Appeals, and the United States Bankruptcy Court for the Western District of Michigan, as well as Michigan circuit and district courts across the state.

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