Divorce, Bankruptcy and the Automatic Stay— What You Need to Know

By AllynMarie Smedley Esq.
Nowadays it is becoming more and more common to have the issue of bankruptcy arise within the context of divorce litigation. What is important to know is that upon the filing of a bankruptcy petition by one or both of the parties in a divorce action, some portions of the divorce case come to a halt due to the entry of the automatic stay by the bankruptcy court. This article provides an overview of the automatic stay, its impact on the matrimonial proceeding, and the components of a comprehensive order lifting the automatic stay to ensure your case can proceed to its conclusion without further disruption, at minimal additional expense to your client.

Upon the filing of a bankruptcy petition, an automatic stay is entered pursuant to Section 362(a) of the Bankruptcy Code. This stay prevents the commencement of continuation of lawsuits against the debtor, and creditors cannot institute or continue collection efforts against the debtor.

In a family law context, once a debtor files a Chapter 7, 11 or 13 bankruptcy petition, the automatic stay prevents a nondebtor spouse from filing a complaint for divorce as long as the complaint is seeking to distribute property that is considered to be property of the bankruptcy estate. Depending on the chapter filed, this can include the debtor’s prospective income and his or her assets of the debtor. If a divorce matter is pending at the time the bankruptcy petition is filed, the automatic stay will prevent the family court from distributing any assets that are considered to be a part of the bankruptcy estate. The family court matter becomes inactive until the stay is lifted. However, the stay does not apply to all of the issues that can arise in a family law context.

There are exceptions to the automatic stay. The filing of a petition does not act as a stay of the “commencement or continuation of a civil action or proceeding”:

  • for the establishment of paternity; 11 U.S.C. §362(b)(2)(A)(i)
  • for the establishment or modification of an order for domestic support obligations; 11 U.S.C. §362(b)(2)(A)(ii)
  • concerning child custody of visitation; 11 U.S.C. §362(b)(2)(A)(iii)
  • for the dissolution of a marriage (unless the proceeding seeks equitable distribution of property of the estate); 11 U.S.C. §362(b)(2)(A)(iv), and

regarding domestic violence. 11 U.S.C. §362(b)(2)(A)(v).

Therefore, you can proceed against a debtor for an order relating to one of the items above. Just because a bankruptcy has been filed, that does not mean you cannot pursue an action for support against the other party, or enter orders relating to custody and parenting time. You just cannot enter into an agreement that settles the equitable distribution issues ancillary to the dissolution of the marriage because the stay prevents this.

If you have an action pending in the family part at the time a bankruptcy petition is filed, the judge needs to be made aware of the action. He or she will enter an order placing the matter on the inactive list, thereby taking your case off of its assigned track until the stay is lifted.

In the meantime, it is usually best to have your client (if you represent the nondebtor spouse) retain a bankruptcy attorney to represent his or her interests in the bankruptcy proceeding. T

he first thing the bankruptcy attorney will need to do is file a motion to have the automatic stay lifted, or enter into a consent order with the debtor-spouse’s bankruptcy attorney so the parties can proceed with their divorce without being in violation of the automatic stay. The consent order should contain a number of provisions designed to allow the case to proceed to its conclusion without requiring further involvement of the bankruptcy court.

The order should provide that:

  • the automatic stay is lifted and terminated with regarding to the parties, the state court and the divorce action;
  • the parties can pursue the divorce action to a conclusion, including the entry of a final judgment of divorce;
  • the state court can conduct all hearings necessary, including motion hearings, the matrimonial early settlement panel and conferences to enter a judgment in the divorce;
  • the state court can determine and issue final orders (such as a qualified domestic relations order) concerning all issues relative to the dissolution of the parties marriage. This includes equitable distribution of all property (even property listed on the debtor’s bankruptcy petition), alimony and child support, custody and visitation, the payment of counsel fees, resolution of marital tort claims that are permitted under Tevis v. Tevis, 1 allocation of marital debts, indemnification as to marital debts, insurance issues, the cause of action for dissolution and all other issues necessary to enter a final judgment of divorce in the divorce action;
  • any determination of any domestic support obligation or any other obligation not denied in Title 11
  • that the parties may execute a binding marital settlement agreement without further order of the bankruptcy court;
  • that the parties may execute any and all documents necessary to carry out the terms of the final judgment without further order of the bankruptcy court;
  • that if the case is converted to a case under any other chapter of Title 11 (from a Ch. 13 to a Ch. 7, for example) the relief granted under the order lifting the stay remains valid and effective, without need for any further order of the bankruptcy court, and it should be binding on and subsequently appointed trustees in the converted case; and
  • that if the debtor’s bankruptcy case is dismissed, the relief granted under the order lifting the stay will remain valid and effective without need for further order of the bankruptcy court in any subsequently filed bankruptcy case. The order should also provide that it will be binding on any future bankruptcy case. This, of course, assumes the family part action is pending at the time of refilling.

Once the order is filed you can notify the family part judge. The case will then be removed from the inactive list. It is extremely important that the order lifting the stay contain these provisions. This will save your client time and expense down the road if, for example, the debtor’s case is converted from a Chapter 13 to a Chapter 7 proceeding. The stay you obtained in the Chapter 13 case does not automatically carry over to the Chapter 7 proceeding; you would have to obtain a new order lifting the stay or obtain the approval from the trustee regarding any marital settlement agreement you and your adversary enter into. Having a comprehensive order in the first place can avoid problems down the line for both parties, and ensure that the divorce action is resolved as smoothly as possible.

The benefit of hiring separate bankruptcy counsel in addition to drafting this order is that this attorney will intervene in the debtor-spouse’s bankruptcy proceeding on your client’s behalf by filing a proof of claim. This proof of claim will assert all of the monies the debtor-spouse may owe to your client as a result of the dissolution of the parties’ marriage. This can include alimony and child support, Tevis claims, and the cash value of the client’s share of marital assets.

The bankruptcy attorney will also monitor the bankruptcy case to ensure that a major asset of the estate, such as a home, is not at risk of having the automatic stay lifted due to the debtor failing to make payments as required under the plan. At the conclusion of the divorce matter, this attorney can file an amended proof of claim regarding the final resolution of the case and ensuring that the payments made to the non-debtor spouse are non-dischargeable in that proceeding.

While it seems like a small matter, lifting the automatic stay in a bankruptcy proceeding is a crucial element in bringing the divorce matter to a resolution in the family part. Having a comprehensive order lifting the stay can eliminate a lot of future problems in the case of a conversion or dismissal of the matter. It will save your client time, money and unneeded stress in what is already a trying time for most people.

■ Endnote 1. 101 N.J. 287 (1985).

AllynMarie Smedley, a partner at Trace Jenkins, practices family law in Woodbury. The author would like to thank William Mackin, Esq. for the form of order used as the basis of discussion regarding the lifting of the automatic stay in this article.