Can Trustees Avoid Transfers Made Pursuant to Divorce Decrees or Other Agreements Incident to Divorce?
This issue arose in a case I am currently working on, and the short answer is yes, and divorce lawyers would be served well by becoming familiar with this possibility. Situations where this might arise can vary substantially. The most obvious scenario involves a sham divorce that is specifically intended to hinder, delay, or defraud a creditor. While not common, and likely difficult to prove, property settlements in divorce that are specifically designed to prevent creditors from getting to the assets of one spouse are clearly avoidable in a subsequent bankruptcy filing. But other, less obvious situations can also lead to avoidance – situations where there was no intent on the part of either spouse to avoid creditors and often where a subsequent bankruptcy is not even contemplated by the parties at the time of entering into the property division agreement.
A quick primer on fraudulent transfer law under the Bankruptcy Code (“Code”) is appropriate. 11 U.S.C. § 548 addresses fraudulent transfers under the Code. Therein, bankruptcy law provides for two types of fraudulent transfers – so-called “actual” fraudulent transfers; and constructive fraudulent transfers. Actual fraudulent transfers are addressed in § 548(a)(1)(A) of the Code, and they involve the type of conduct referenced above. Intent – often difficult to prove – is a required element of these types of transactions. Constructively fraudulent transfers are addressed in § 548(a)(1)(B), and in a fact that surprises a lot of divorce attorneys, intent is not an element of constructive fraudulent transfers. Instead, constructively fraudulent transfers are determined simply by an analysis of what one spouse gave up in comparison to what they received. If one spouse received less than a “reasonably equivalent value” in exchange for a transfer, then that transfer is subject to avoidance in a subsequently filed bankruptcy case of the transferor spouse.
In the case I’m involved with, it is apparent that one of the spouses entered into what can only be described as a one-sided agreement incident to divorce out of guilt. That spouse may have been unfaithful in the marriage and felt that the easiest thing to do was simply agree to the settlement – which by all appearances led to the transferee spouse receiving property whose value substantially exceeded that received by the transferor spouse. The divorce court signed off on the agreement, and the transferor spouse filed for bankruptcy just over a year later – well within the 2-year fraudulent transfer period described in § 548.
Subsequent to the bankruptcy filing, the trustee that we represent filed an adversary proceeding seeking to avoid the transfers that occurred pursuant to the agreement incident to divorce. The transferee spouse has lodged a variety of defenses – none of which are likely to be successful. For example, one argument put forth asserts that property transfers occurring under an agreement incident to divorce are not “transfers” as that term is used in the Bankruptcy Code. A similar argument urges that the agreement incident to divorce is res judicata such that the fraudulent transfer allegations represent a collateral attack on the state court judgment. However, those arguments have been flatly rejected by numerous bankruptcy courts. One case that addressed these issues squarely emanated out of a bankruptcy court in the Northern District of Ohio – that of In re Neal, 478 B.R. 261 (2012).
In Neal, the Ohio Bankruptcy Court granted summary judgment to a trustee who sought to avoid a transfer made pursuant to a property settlement pursuant to divorce between the debtor and her spouse in which the debtor spouse relinquished all her equity in the marital residence less than two years prior to her bankruptcy filing. In responding to the non-debtor spouse’s arguments similar to those referenced above – namely whether a transfer pursuant to a divorce decree could constitute a fraudulent transfer – the bankruptcy court concluded:
Because “‘[dissolution] proceedings and fraudulent conveyance proceedings encompass different policy objective[s],’” that it “must look at the actual division of property to determine if the Debtor received reasonably equivalent value for the assets she transferred to the Defendant and the liabilities she retained as a result of the Decree.” Neal, 461 B.R. at 438–39 (citing Reisz v. Stinson (In re Stinson), 364 B.R. 278, 282 (Bankr.W.D.Ky.2007)).
In Neal, just like in my case, the property settlement agreement included a provision finding that the property division was “fair and equitable”. Citing the Sixth Circuit’s holding in Corzin v. Fordu (In re Fordu), 201 F.3d 693 (6th Cir. 1999), the Neal court found that a “fair, just and equitable property division” did not preclude the trustee from litigating the issue of whether the transfers could be avoided as a constructive fraudulent conveyance under 11 U.S.C. § 544(b) and Ohio law. Id. at 696–97.
The Sixth Circuit analyzed Fordu under the principles of issue preclusion and claim preclusion and determined that the state court dissolution decree was not entitled to preclusive effect under either doctrine. Id. at 704, 710. The Sixth Circuit in Fordu also determined that the marriage dissolution decree was not entitled to any claim preclusive effect for two main reasons:
- First, Ohio law requires “an identity of parties or their privies” before claim preclusion can apply. Id. at 705. Because the chapter 7 trustee is a “representative of all creditors of the bankruptcy estate,” the Sixth Circuit determined that he is more than just a successor-in-interest to the debtor. Id. As a result, the court concluded that the trustee was not in privity with the debtor in the marriage dissolution proceeding. Id. at 705–06.
- Secondly, the Sixth Circuit determined that “the standards for measuring the fairness of a property division in the domestic relations arena and reasonably equivalent value in a fraudulent transfer case are separate and distinct.” Id. at 707. Like the law of most states, under Ohio law, a domestic relations court must analyze a number of factors in making an equitable division of property. That analysis is “not constrained by a reasonable equivalence standard.” Id., at 708. As a result, the Sixth Circuit determined that a domestic relations court “could produce a division of marital property that would satisfy the requirements of [Ohio law], yet not pass muster under the reasonable equivalence test.” Id.
The Court in Neal went on to reject an additional argument made by the non-debtor spouse that, because the divorce case wasn’t hotly contested, that the analysis should change. In rejecting that argument, the court found that its sole task was to compare the value of what Debtor received with the value of what Debtor transferred in the course of the marriage dissolution proceedings. It did that and concluded that the transfer met all of the elements of a fraudulent transfer, and therefore the trustee was allowed to avoid that transfer and claw back the proceeds to the debtor’s estate.
Divorce attorneys who are structuring property settlement agreements that are substantially slanted to one party should seriously consider the ramifications of this line of cases – no matter how willing a spouse on the losing end of a property settlement agreement might be to agree to just about anything to be done with their spouse.
Have questions? Don’t hesitate to schedule a consultation with us!