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An Interesting Twist in the Collection of Domestic Support Obligations in Bankruptcy

In bankruptcy, a “domestic support obligation” (DSO) is generally defined as a debt that is in the nature of “alimony, maintenance and support.”  DSOs are never dischargeable and are priority claims for distribution purposes.  However, the analysis does not end there.  Can the holder of a DSO claim continue to pursue all collection remedies when his or her spouse files for bankruptcy?  It depends upon a lot of factors, including the chapter of bankruptcy at issue.

In 2019, Congress enacted the Small Business Reorganization Act of 2019 (SBRA), known as Subchapter V under Chapter 11 of the Bankruptcy Code, which went into effect in February of 2020.  Under Subchapter V, an individual engaged in commercial or business activities with debts less than $7.5M (this amount was increased in the CARES Act and is set to decrease after March 27, 2021) may be a debtor under Subchapter V.  Generally, Subchapter V enables a debtor to reorganize a lot easier than the regular Chapter 11 process.

What happens if the Subchapter V debtor owes a DSO?  Generally, the “automatic stay” provisions in the Bankruptcy Code prohibit efforts to collect from a debtor.  The Bankruptcy Code, however, contains certain exceptions from the automatic stay for certain domestic relations matters.  One of the exceptions allows for the collection of a DSO from “property that is not property of the estate.”  How does that exception apply in Subchapter V?

In a regular individual chapter 11 case (and in a chapter 13 case), property of the estate includes post-petition earnings.  Thus, the automatic stay would prohibit post-petition collections from post-petition earnings.  However, in a Subchapter V case, an interesting twist occurs, such that post-petition earnings are not included in property of the estate, unless a “nonconsensual” plan is ultimately confirmed (as compared to a consensual plan, which generally means the debtor received support from creditors).  Note that the Bankruptcy Code appears to retroactively include post-petition earnings in property of the estate (as of the filing of the case) upon confirmation of a nonconsensual plan.

This raises some interesting issues that have not been decided by the courts due to the recent enactment of the SBRA.  It appears that a DSO creditor can collect from a Subchapter V debtor’s post-petition earnings during the case, but what happens if a nonconsensual plan is confirmed?  What happens if a nonconsensual plan is confirmed and the case is later converted to another chapter?  Is the DSO creditor at risk for being sued for receipt of estate property?  Probably not because the DSO claim is still a priority claim in another chapter.  Could another creditor argue that the plan cannot be confirmed because the debtor no longer possesses all property of the estate?  The point is that with all new legislation, there are always unresolved issues.  Whether you’re on the debtor side, or the creditor side, my advice is to consult counsel who is familiar with both domestic relations matters and bankruptcy matters.

Author: Steve Metz, Esq.
Articles have been Reprinted with permission from the charlotte observer and Mike Hunter.

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