A recent U.S. Supreme Court decision has thrown th spotlight on an increasingly common problem in divorce settlements: the threat that one spouse can wipe out the other's share of marital assets by filing for bankruptcy.
"Bankruptcy has become an enormous element in the divorce practice since the beginning of this recession," said Stuart B. Walzer, a divorce lawyer with Walzer & Gabrielson in Los Angeles.
The crux of the problem is that divorce law and bankruptcy law are at odds. The intention of the former is an equitable distribution of property at the end of the marriage. The intention of the latter is to give a debtor a fresh start by wiping out debts.
"You have two completely different sets of laws for divorce and bankruptcy that don't mesh," said Henry J. Sommer, a Philadelphia lawyer and author of "Collier Family Law and the Bankruptcy Code," just published by Matthew Bender & Co. "It )) probably happens fairly frequently that people file for bankruptcy when they figure out they can wipe out debt to a former spouse."
There are some things that cannot be wiped out or "discharged" by a declaration of bankruptcy. They include taxes, mortgages, child support and alimony. The Supreme Court clearly identified in its May 23 decision certain circumstances under which a property settlement, too, would survive.
The case grew out of the divorce of a Wisconsin couple in 1986. A divorce court awarded the couple's house, with equity of $59,000, to the husband, Gerald Sanderfoot. He was ordered to pay his ex-wife, Jeanne Farrey, $29,208 in two equal installments as her share of the joint assets.
The court gave Ms. Farrey a lien on the house to enforce her claim. But Mr. Sanderfoot filed for bankruptcy without paying Ms. Farrey a penny.
Because the law allows a bankrupt person to keep his or her home, Mr. Sanderfoot was able to move all the marital assets to his side of the ledger. He was upheld by two federal courts, but the Supreme Court reversed them.
Divorce agreements like the Sanderfoots' -- in which one party pays the other over a period of time, sometimes referred to as a structured settlement -- are common.
Typically, there is not enough cash or other liquid assets to divvy up at the time of divorce, particularly if one person wants to keep the family home.
Ms. Farrey's lawyer, Brady C. Williamson of LaFollette & Sinykin in Madison, Wis., claims that the case ends the confusion over whether a divorce lien survives bankruptcy.
"The question of lien avoidance has represented this great gray area that has now been resolved," said Mr. Williamson, a specialist in bankruptcy law who also teaches consti
tutional law at the University of Wisconsin law school. "The decision will have a potential impact on every married couple with real estate who decides to get divorced."
However, some lawyers say that the ruling is a narrow one. They point to the fact that the couple held the home jointly prior to the divorce. The divorce gave the property to Mr. Sanderfoot and a lien to Ms. Farrey at the same time.
The Supreme Court made much of the issue of timing, arguing that because Mr. Sanderfoot had no separate interest in the home at the time the lien was granted, he could not avoid the lien through bankruptcy.
If Mr. Sanderfoot had held the home in his name only, then gotten the divorce, the decision might have been different, said Helene Brezinsky, a partner at Rosenman & Colin in New York. "The structured payout is still a very high-risk gambit," she said. "If it is not secured in precisely this manner, you face total wipeout in bankruptcy."