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Recent Ninth Circuit Decision On Divorce Settlements and Bankruptcy

A recent decision by the Bankruptcy Appellate panel of the Ninth Circuit shows how difficult it can be for a person who files bankruptcy to discharge a domestic support obligation. Often, parties to a divorce settle on division of property, spousal support, and other items in one settlement. Later, if the party making payments seeks to declare bankruptcy, whether the payments are a domestic support obligation can be a complex legal issue that requires an experienced California bankruptcy attorney.

Under the bankruptcy code, a domestic support obligation is a debt that accrues on before, on, or after the date of an order for relief in a bankruptcy case, including interest that accrues on that debt, that is owed to or recoverable by i) a spouse, former spouse, or child of the debtor or such child’s parent, legal guardian, or responsible relative, or (ii) a governmental unit.

In Chapter 7 Bankruptcy, obligations to a former spouse are simply not dischargeable. It is immaterial whether the obligation is a division of property or a support obligation, and whether the obligation results from a court order or a separation agreement.

The rule for Chapter 13 Bankruptcy is more complicated. Similar to Chapter 7, past due domestic support obligations are not dischargeable. However, other types of debts to a former spouse sometimes are. Typically, a debtor who declares Chapter 13 must pay all of their secured debts and priority debts, but only a portion of their unsecured debts. A domestic support obligation is a priority debt, but other spousal obligations may be unsecured debts, and thus dischargeable based on the debtor’s disposable income.

This difference between a support obligation and other debts to a former spouse is the focus of the Ninth Circuit’s recent decision in Ashworth v. Ehrgott.

Ashworth v. Ehrgott

In the case, Ashworth filed for Chapter 13 Bankruptcy. Ehrgott, his ex-spouse, filed a proof of claim seeking priority for a domestic support obligation in the amount of about $250,000. Ashworth objected, arguing that the obligation stemmed from the two parties’ settlement in a civil action that occurred about the time of their divorce. In the civil lawsuit, Ehrgott sued Ashworth for $10 million for battery, fraud, intentional and negligent infliction of emotional distress, and negligence.

Ehrgott and Ashworth settled the civil action in the same settlement agreement as all the other claims from their divorce. Ashworth argued that if it wasn’t for the civil lawsuit, he would not have agreed to the settlement, thus the settlement should be dischargeable because it was not a domestic support obligation. The bankruptcy court did not agree.

The test for whether a settlement is a domestic support obligation (and thus not dischargeable) is the parties’ intent at the time of the settlement. The Ninth Circuit noted a huge difference between the two parties’ income, the fact that Ashworth claimed the payments as “alimony” on his taxes, and his arguments in a previous lawsuit that the payments should reduce his child support obligations as evidence that the settlement was a domestic support obligation.

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