Rochelle's Daily Wire

A final decree of divorce containing a division of marital property does not create a debtor/creditor relationship between the former spouses, according to an October 27 opinion by Bankruptcy Judge David T. Thuma of Albuquerque, N.M. The divorce decree converts marital property into separate property, so that the property given to a nonbankrupt spouse does not become property of the estate of the bankrupt spouse.

After years of marriage, a couple divorced. Before the husband’s bankruptcy, the state court entered a final decree of divorce, dividing marital property. Although the decree was complex, one aspect is important for our purposes.

The husband was a federal employee and a participant in a retirement plan for federal workers. The divorce decree gave the wife half of the retirement account. Time passed, and the husband had not given his former wife her half interest in the retirement account. So, she brought a motion for contempt in the matrimonial court.

The husband opposed the contempt motion and also filed a chapter 13 petition. His plan promised to pay 100% to unsecured creditors. The debtor listed the entire retirement account among his assets. The court confirmed the 100% plan.

The matrimonial court declined to make a final ruling on the contempt motion in view of the automatic stay. So, the wife filed a motion in the bankruptcy court to modify the automatic stay, to permit her to complete a division of the retirement account and enforce other aspects of the property settlement. Alternatively, the wife asked Judge Thuma to declare that the automatic stay did not apply, on the theory that half of the account was outside of the bankruptcy estate.

Judge Thuma began his analysis from the proposition that the divorce decree was entitled to full faith and credit. He stated the question as being whether the divorce only gave the wife a claim to half of the retirement account or whether the divorce decree gave each spouse “a half interest as separate property.”

Judge Thuma held that the divorce decree “divided the [retirement] account and awarded [the wife] a separate property interest in her portion. Thus, when Debtor filed this case, [the wife’s] portion of the [retirement] account did not become part of the bankruptcy estate.” He found “substantial case law support for this conclusion.”

On point, Judge Thuma cited In re Brown, 168 B.R. 331 (Bankr. N.D. Ill. 1994), where the court said:

The majority view among courts considering the question in the bankruptcy context is in accord with Illinois law, i.e., that a former spouse’s interest in a debtor’s pension becomes the sole and separate property of the nondebtor spouse upon entry of a final judgment of divorce. The divorce decree does not create a debtor/creditor relationship between the debtor spouse and the nondebtor spouse. Instead, each becomes an owner of a portion of the pension.

Judge Thuma identified practical reasons supporting the majority view. In particular, he said there would be tax advantages in separating the ownership interests to avoid tax consequences from making withdrawals. He also said that the lack of a qualified domestic relations order did not change the result.

Judge Thuma said he would modify the stay to permit the state court to enforce the divorce decree. However, he exhorted the parties to settle, because a settlement under the auspices of the bankruptcy court could offer relief that “neither this Court nor the state court could order.”