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Can Matrimonial Settlements Survive Bankruptcy?

Recent bankruptcy case will make it harder for bankruptcy trustees to set aside matrimonial settlementsby Craig D. Robins, Esq.
 
Recent bankruptcy decision protects divorce transfers
 
With bankruptcy filings so prevalent these days, and divorce being a major reason for seeking bankruptcy relief, matrimonial attorneys are frequently concerned as to whether a divorce settlement will hold up in a bankruptcy proceeding.
 
Fraudulent Transfer Theory 
 
Here’s the reason for concern: If a debtor transfers a valuable asset to a spouse (or soon-to-be ex-spouse) prior to filing for bankruptcy, and the debtor-spouse does not receive reasonable value in return, then the transfer is deemed a “fraudulent transfer.” In such a case, the bankruptcy trustee can sue the person who received the asset to bring it back into the bankruptcy estate, so that all creditors can share in its value.  One additional element of a fraudulent transfer is that the debtor must have been insolvent at the time of transfer.
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The general principle for demonstrating that a transfer was not a fraudulent transfer is to show that there was “reasonably equivalent value.”
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Since a divorcing spouse will frequently enter into a matrimonial settlement by giving the other spouse valuable assets such as an interest in real estate, bank accounts, investments, or other personal property, both parties do not want a bankruptcy trustee to try to set the transfer aside.
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For a period of time, some courts have held that innocent spouses who received such a transfer were no different from any other party who received a large transfer without sufficient consideration.
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However, a case just decided by the United States Circuit Court of Appeals will give many divorcing spouses greater comfort that a trustee will not be able to set aside a marital settlement.
 
Recent Circuit Case
 
In the Matter of Bledsoe, decided June 25, 2009, the Ninth Circuit had to decide under what circumstances a bankruptcy court may avoid a transfer made pursuant to a state-court divorce decree.
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I previously mentioned this case in an article two years ago, when Long Island Chapter 7 bankruptcy trustee Robert L. Pryor discussed the lower court’s decision, at a symposium on the new bankruptcy laws.
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The Circuit Court affirmed that decision and held that a trustee can only set aside a matrimonial settlement if he alleges and proves “extrinsic fraud.”  The Court also held that a divorce decree that follows from a regularly conducted, contested divorce proceeding conclusively establishes “reasonably equivalent value” in the absence of fraud or collusion.
 
Practice Tip #1:  Be wary that the bankruptcy court will always access the totality of the facts.  In a local case in the Central Islip Bankruptcy Court decided by Judge Dorothy Eisenberg last year, Long Island bankruptcy trustee Marc A. Pergament brought suit to set aside a transfer of real estate made pursuant to a divorce.  Pergament v. Cersosimo, (2008).  Judge Eisenberg dismissed the trustee’s suit, stating:
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“A review of case law has shown that it is the rare bankruptcy court that will intrude on a state court divorce judgment and declare a transfer made therein to be a fraudulent conveyance.  However, rare does not mean never. If the court, upon review of the conveyance, determines that it was done to defraud creditors or was done for little to no consideration, then the court may make a finding that the transfer was a fraudulent conveyance.”
 
Practice Tip #2:  There is no guarantee that New York bankruptcy courts will follow the Bledsoe Ninth Circuit case.  However, considering that our Second Circuit is fairly liberal and desirous of protecting innocent spouses, it is highly likely that any New York bankruptcy court reviewing this issue will give the Bledsoe decision a great deal of weight.
 
 Practice Tip #3:  In order for a divorce settlement to be upheld by the bankruptcy court, it must be ratified in some way by the matrimonial court.  That means that any transfer should be accurately described in a stipulation of settlement.  In addition, the stipulation must be specifically referred to and adopted by the divorce decree.  It is not enough that the parties merely stipulate to a settlement; the court must specifically approve the settlement.  This can be accomplished by using the typical language in the divorce decree, that the stipulation survives the divorce decree and is not merged into it.

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About the Author.  Long Island Bankruptcy Attorney Craig D. Robins, Esq., [1]is a regular columnist for the Suffolk Lawyer [2], the official publication of the Suffolk County Bar Association [3]in New York. This article appeared in the September 2009 issue of the Suffolk Lawyer. Mr. Robins is a bankruptcy lawyer who has represented thousands of consumer and business clients during the past twenty years. He has offices in Patchogue, Commack, Woodbury and Valley Stream. (516) 496-0800. For information about filing bankruptcy on Long Island [4], please visit his Bankruptcy web site: http://www.BankruptcyCanHelp.com [4].
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