Equal division would not be contrary to bankruptcy law . . .
In reversal, Fourth District holds that bankruptcy discharge of wife’s share of debt to holder of second trust deed on the family home does not preclude trial court from dividing sale proceeds from that home equally; trial court erred by awarding wife more than half to make up for discharged debt
In re Marriage of Walker
(September 29, 2015)
California Court of Appeal 4 Civil G050448 (Div 3) 240 Cal.App.4 th 986, 193 Cal.Rptr.3d 134, 2015 FA 1709, per Ikola, J (O’Leary, PJ and Thompson, J, concurring). Orange County: Scott, J, reversed. For appellant: Brian Saylin, CFLS, (714) 971-1979. For respondent: Paul Samarin, (562) 491-3538. CFLP §§O.8, O.58.0.5.
During their marriage, Cheryl and Roy Walker owned their family home in Westminster. In 2006, they filed for divorce. In December 2007, Cheryl filed for Chapter 7 bankruptcy protection, listing the family home as a secured asset, pegging its value at $400,000, and reporting two deeds of trust totaling $298,009 as liens against the house. Those deeds of trust were held by Washington Mutual Home Loan, for $195,009, and State Farm Bank for $103,000. Cheryl also claimed the estimated equity in the family home of $101,990 as exempt. In April 2008, the U.S. Bankruptcy Court granted Cheryl a discharge of all the listed debts under Chapter 7.
Cheryl and Roy ultimately sold the Westminster house in April 2013. Among others paid from escrow, State Farm Bank received $95,732, after certain adjustments. The net proceeds from the sale totaled $176,580 and were held in a trust account by Cheryl’s attorney pending resolution of other issues. In January 2014, Cheryl filed a motion for an order to disburse the sale proceeds, contending that they should not be divided equally. She argued that her share of the debt to State Farm Bank had been discharged in bankruptcy, and that dividing the proceeds equally would mean that she was charged for a discharged debt. On that theory, Cheryl claimed that she was entitled to an additional $47,866 from Roy’s share of the proceeds to make up for the discharged part of the second deed of trust. After receiving additional briefing, the trial court granted Cheryl’s motion and disbursed $134,089 to her and $42,490 to Roy.
After moving unsuccessfully for reconsideration and a new trial, Roy appealed, and the Fourth District reversed.
What does it all mean? . . .
The justices framed the issues as whether (1) dividing the sale proceeds from the family home equally would violate bankruptcy law; and (2) the fresh start Cheryl received from discharging her debts in bankruptcy means that she should be awarded “the lion’s share” of the sale proceeds. The panel began by explaining that a bankruptcy debtor who has complied with his or her obligations under Chapter 7 is entitled to have all debts discharged that arose before the order for relief. The discharge, they continued, per 11 USC §524(a)(2), “ ‘operates as an injunction against the commencement or continuation of an action . . . or an act, to collect, recover or offset any such debt as a personal liability of the debtor . . . .’ ” The justices noted that in the usual bankruptcy, the trustee would have sold the Westminster house and used the proceeds to pay off the creditors who had filed claims. Here, however, that was not done because Cheryl had claimed the existing equity in the house as exempt, leaving only the existing debt secured by deeds of trust. Accordingly, Cheryl and Roy were allowed to keep the house and sell it themselves after Cheryl’s bankruptcy had closed.
No offense to bankruptcy law . . .
Finding no case directly on point to support her contention, Cheryl relied on cases such as In re Marriage of Williams (1984) 157 Cal.App.3d 1215, 203 Cal. Rptr. 909, 1984 CFLR 2525, 1984 FA 122, in which the court held that one spouse’s bankruptcy discharge of community debts leaves the other spouse liable for them and that spouse is precluded from offsetting the discharged obligation against his or her own payment obligation. The trial court had acknowledged that holding, and reasoned that, regardless of the effect of the discharge on a secured debt, it could not put Cheryl’s discharged debt “ ‘on her side of the property division ledger.’ ” The justices didn’t agree. They found that Cheryl’s discharge in bankruptcy meant that, as a secured creditor, State Farm Bank was not entitled to pursue Cheryl personally for payment of the amount due, but could still utilize its lien/trust deed, which as not eliminated by the discharge, as a means of recovering the debt. Moreover, Cheryl and Roy could not sell the Westminster house without extinguishing State Farm Bank’s lien. They could do that, the panel said, by either selling the underlying property or paying off the lien; they chose to sell the property and pay off the lien with the proceeds. The payment from escrow to State Farm Bank, the justices found, was not a payment to recover a discharged debt, but rather a necessary condition to extinguishing the lien and closing the house sale. Dividing the sale proceeds, the panel determined would not be contrary to bankruptcy law. Moreover, principles of community property required Cheryl and Roy to absorb equally the burden of extinguishing the lien. Summing up, the justices held that the trial court erred by failing to divide the sale proceeds equally between Cheryl and Roy. Accordingly, they reversed and remanded for the trial court to issue a new order in line with this opinion.
Most long-time family law attorneys have been taught that a bankruptcy by one spouse during a disso leaves the other spouse holding the bag for payment of those debts. This case shows us that the discharge of a lien or other secured interest may not mean that the bankrupt spouse gets off scot-free. In a footnote, the justices caution that they are not concerned with whether Roy should have opposed the discharge of the State Farm debt or whether the bankruptcy court erred by ordering the debt discharged. The question here is the effect of the discharge.
In another footnote, the panel wonders, as we did, why Cheryl limited her contention to the debt owed to State Farm Bank. They ask why she couldn’t claim that the debt owed to Washington Mutual was also discharged and that making the payment to Washington Mutual out of escrow was repayment of a debt rather than extinguishment of a lien. The justices could find no satisfactory explanation for her position, and we can’t either, despite the fact that the premise underlying the one debt “logically applies with equal merit to Washington Mutual’s secured debt.”