Law Offices of Steven K. Brown
Attorney At Law
1221 Locust Street, Suite 500
St. Louis, Missouri 63103

Telephone: 314-421-2011
Fax: 314-421-6470
Special Issues Involving Community Property in Bankruptcy
In general, each spouse owns an undivided one-half interest in community property. All property owned by a spouse is presumed to be community property. A person having a community property interest in an asset may be able to transfer the entire asset or no interest in the asset at all, depending on his or her management rights under state law. If the community property asset can be unilaterally transferred to a third party, the transferor spouse receives the proceeds of the sale as community property, and the third party receives the asset unencumbered by any interest of the spouse of the transferor. The third party does not own the asset as community property with the transferor's spouse. Only spouses can own community property.

Classification of Ownership of Assets

The classification of ownership of an asset may be critical in determining the rights of creditors under state law to recover from that asset. When one spouse files for bankruptcy, creditors' rights may also be affected by the type of ownership. If the asset is community property, the entire asset in most instances will be in the bankruptcy estate of either spouse. Community property in the bankruptcy estate is controlled by the trustee or debtor in possession, even though it may have been controlled only by the nonfiling spouse before the bankruptcy. If a joint case for both spouses is filed, their community property is entirely in both estates, which effectively requires consolidation of the cases, at least as to the community portions of both estates.

As long as the marriage is intact, the claims of the bankruptcy trustee or debtor in possession supersede claims of the nonfiling spouse to his or her community property interest in the included assets. This results from the inclusion of all of a community property asset in the estate, not merely the debtor's one-half interest. If a divorce is pending, the jurisdiction of the state court is suspended as to property of the estate. Property of the estate is determined on the date of filing the bankruptcy petition, and community property assets are property of the debtor's bankruptcy estate and under the jurisdiction of the bankruptcy court, just as if the marriage were to continue intact. Community property is usually divided incident to the final judgment of divorce, and an asset that during the marriage was community property is thereafter the solely owned property of the former spouse awarded that particular asset. The asset is no longer community property.

The rule in community property states generally is that all property of spouses is presumed to be community property and a party wishing to rebut the presumption has the burden of proving an asset is classified as other than community property. The separate property of a spouse residing in a community property state is generally property brought to the marriage or acquired by gift or inheritance. Spouses may determine by agreement how particular assets are owned and, in some instances, the way property is titled, such as in joint tenancy. Premarital and postmarital agreements that partition community property or that classify property acquired in the future as separate or community property are generally recognized.

Reclassification of Property by Agreement of the Spouses

Many couples enter into marriage agreements that affect how their property is owned or controlled during the marriage and how it is disposed of at death or divorce. Such an agreement can be executed by a couple planning to marry or may be executed during marriage. A common type of marriage agreement is one that divides existing community property so half is the separate property of the husband and half is the separate property of the wife. The impact of such an agreement entered into before the bankruptcy is the one-half of the former community property is omitted from the property of the estate of the filing spouse.

Incident to Divorce

The division of community property at the time of divorce may also affect the property includable in the bankruptcy estate of a spouse that files after the divorce is final. However, the divorce is the point at which one former spouse cannot affect or control the other former spouse's property. Some community property states provide remedies in a nonbankruptcy situation allowing creditors to recover former community property from the spouse receiving such property if the creditor could have recovered community property had the divorce not occurred.

Community Claims

All community property states allow recovery of some debts incurred by one spouse from the community property of the spouses. Consequently, a creditor of a nondebtor spouse may have a claim in the bankruptcy of the debtor spouse and must receive notice. A claimant's right to a distribution from property of the bankruptcy estate of a spouse depends in large part on whether the creditor has a ''community claim.'' For a creditor to determine if it has a community claim, it must determine if hypothetically any community property present might be liable under state law for the type of debt owed the creditor; the debtor need not actually own such property, nor must such property be in the estate. Most obligations incurred by either spouse during marriage meet the definition of community claims. Most obligations incurred by the debtor before marriage will be community claims because community property from at least one source, such as the debtor's postpetition earnings, is recoverable by the creditor. Some premarriage debts of the nondebtor spouse may also be community claims.

Disallowance of Some Community Claims

Some states have marshaling requirements for community and separate debts such that they must be satisfied from one classification of property before another classification of property can be reached. If such a claim could reach any community property, it would still be a community claim. However, a claim may be disallowed if it is unenforceable against the debtor or the debtor's property under any applicable law.

After Divorce

The property received in the debtor's divorce prior to the bankruptcy is no longer community property. The creditor of the debtor's former spouse can file a claim in the bankruptcy, but to the extent the creditor is owed more than there is property of the estate subject to the debt, the claim would be disallowed.

Claims Against the Debtor by the Debtor's Spouse or Former Spouse

As a rule, economic claims of spouses against each other, other than for support, are determined incident to the property division at the time of divorce. If one spouse has misused community property, or used it to enhance the value of his or her separate property, or paid separate debts with community property, the property division will reflect the appropriate adjustment. The property division is res judicata as to the liability for property claims between the spouses, and any claim a former spouse has relating to community property that was not raised in the divorce would be barred.

Administration of the Bankruptcy Estate

When community property is included in the estate, after payment of general administration expenses, the community property is segregated from other property and subestates are created. Claims are then classified as community claims against the debtor, community claims against the nondebtor spouse, and as noncommunity or separate claims against the debtor. Community claims against the debtor and the debtor's spouse are paid from community property, except to the extent such property is solely liable for debts of the debtor and not his or her spouse.

Effect of Discharge When Only One Spouse Has Filed

The discharge of only one married debtor operates as an injunction preventing a discharged creditor having an allowable community claim from attempting to recover from subsequently acquired community property of the debtor. The injunction preventing recovery of community property of the debtor also protects the nondebtor spouse's interest in the same community property.

Reaffirmation Agreements

A reaffirmation is a promise by the debtor to pay a prepetition debt that is otherwise discharged in bankruptcy. The agreement is enforceable in the same manner as any other obligation incurred after bankruptcy. If an obligation under state law can be satisfied from community property, then both spouses' interest in community property will be subject to recovery by the creditor in the event of default on the reaffirmed debt, even though only the debtor spouse executed the reaffirmation.

Copyright 2005 LexisNexis, a division of Reed Elsevier Inc.


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