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IN THE INLAND EMPIRE, TIMING IS EVERYTHING: DIVISION OF COMMUNITY PROPERTY AND BANKRUPTCY

What happens when one spouse files bankruptcy prior to sale or transfer of family residence?

The result depends on whether the Judgment or Order dividing the community property was entered prior to the bankruptcy filing.

Example one: The family residence has equity of $200,000. You have a reimbursement claim for a $100,000 separate property down payment on the family residence (Family Code section 2640). The remainder of the money is community property to be divided equally between the parties. During a settlement conference the parties agree to the above terms and execute a Marital Settlement Agreement awarding you $100,000 of net escrow proceeds for your separate property down payment, with the remainder (after escrow fees and commissions) to be divided equally. The Agreement further states that the property shall be listed for sale forthwith (without delay). Your attorney agrees to prepare the Judgment.
Prior to entry of Judgment, your spouse files a Chapter 7 Bankruptcy. You are served with notice of the Bankruptcy and Automatic stay. What happens to the sale of the house and your separate property interest? The bankruptcy estate includes the interest of both the debtor and nondebtor spouse in all community property not yet divided by the family court at the time of the bankruptcy filing. (11 USC §541(a)(2).) Because your spouse filed bankruptcy before the Judgment or Order dividing the community property was entered, your Marital Settlement Agreement does not affect the community property, which is now in the hands of the bankruptcy trustee and may be used to satisfy your spouse’s debts. Thus, if the nonbankrupt spouse wishes to overcome the automatic stay to permit continuation of a pending marriage dissolution property division proceeding, he or she must file a motion with the bankruptcy court to lift the stay (11 USC §362(d).) Additionally, the property cannot be sold without the approval of the bankruptcy court.

Example two: Same facts as above, except in this case the Judgment or Order dividing the property is entered prior to your spouse filing Bankruptcy.
The result is different than in example one because once a state court Judgment is entered, the Order is res judicata as to the division of marital property and is binding on the bankruptcy trustee. In re Gendreau (9th Cir. 1997) 122 F3d 815, 818-819. The Bankruptcy Act generally does not vest the trustee with any better right or title to the bankrupt’s property than the bankrupt had at the moment of bankruptcy. In re Keller (9th Cir. BAP 1995) 185 B.R.796, 800-801. In Keller the court held that once the Family Court ordered the residence sold and retained jurisdiction to approve any disbursements, those proceeds were at all times subject to distribution pursuant to the courts direction, beyond the reach of the debtor, alienation by his creditors, and were not part of the bankruptcy estate. Id at 800.
Additionally, the stay does not impede the exercise of state court property division jurisdiction over community property interests abandoned by the trustee in bankruptcy. Once the debtor spouse is discharged in bankruptcy or the bankruptcy case is closed, state court property jurisdiction is fully restored and the abandoned community property remains subject to a state court community property division. Marriage of Seligman (1993) 14 CA4th 300, 303.

THE STATE COURT NOTICE REQUIREMENT:

Keep in mind that the debtor spouse (the party who filed bankruptcy) has a duty to file the proper notice form with the Family Court. California Rules of Court 3.650 imposes a duty to notify the state court and other parties when a state court proceeding is stayed. (see CRC 3.650(b)(1)-(4)). The party who caused the stay of state court proceedings must immediately serve on other parties who appeared in the case and file with the state court a notice of the stay (form CM-180]and attach a copy of the order or other document showing that the proceeding is stayed.

If you have questions regarding BANKRUPTCY as it relates to family law matters, please contact our office to schedule a consultation. The Law Office of Family Law Specialist Richard E. Bawden also handles legal issues regarding adoption, annulment, mediation, domestic violence, child custody, child support, spousal support as well as pre-marital agreements. Telephone (909)792-0222, or email us at [email protected]

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