Don and Dora have been married for decades, during which time Don ran a donut shop. When the donut shop was struggling, unbeknownst to Dora, Don borrowed money and signed a personal guaranty.
When the economy turned, Don’s donut shop did not survive. And with the business gone, Don could not repay the loan. Don moved on and did not give it another thought.
Then one day, a process server knocked at their door and handed Dora legal papers for a one-million-dollar lawsuit from a bank she had never heard of.
Dora feared losing everything, but recent changes to the bankruptcy code may finally offer a way to discharge debts without dismantling their marital community.
When Only One Spouse Signs
In Arizona, there is a strong presumption that all property acquired during marriage is community property.As a result, long-married couples are unlikely to have separate property. Generally, either spouse can bind the marital community, and such obligations may be enforced against community property.
But an issue frequently arises when only one spouse signs a guaranty during the marriage. A guaranty is unenforceable against community property unless it is signed by both spouses. This issue also arises when a creditor obtains a judgment against only one of the spouses and fails to join the other spouse. Although not a surprise to Arizona attorneys familiar with our community property laws, out-of-state lenders seeking loan guaranties are frequently caught off guard.
Don’s failure to pay on the loan and receipt of the bank’s lawsuit mean that Don is likely to have a significant judgment entered against him. Although the judgment cannot be enforced against their community assets, it can be repeatedly renewed and enforced against any separate assets that Don might acquire. This is also a concern for when the marriage ends by divorce or death. Community assets may become separate property and be available to satisfy the judgment.
Discharging Separate Obligations in Sub V
For individuals with total debts of $3,424,000 or less, there is a bankruptcy option called Subchapter V. Bankruptcy allows individuals to subject their assets to administration by the bankruptcy court, declare certain assets as exempt, pay creditors to the extent of their non-exempt assets, and discharge their debts. Similar to Arizona statutes, the Bankruptcy Code recognizes that creditors may have claims against specific assets, but not against others. As closely as possible, the Code mirrors the rights creditors would have under state law.
When a bankruptcy is filed, a bankruptcy estate is created for administration. If either spouse files bankruptcy, the bankruptcy estate includes any separate property of the filing spouse and all community property. The Code defines a “community claim” and requires segregation of community property from separate property. In our scenario, multiple sub-estates are created for the different property allocations. Code Section 726(c) establishes specific rules for distributing community property, based on whether creditors have claims to it.
Here, the marital community can use Subchapter V to pay community debts, while discharging a spouse’s separate obligations, to the extent those obligations exceed that spouse’s separate property. In our scenario, Don has no separate assets to distribute to his separate creditors, like the bank. Thus, Subchapter V is an avenue for Don to discharge the bank’s lawsuit against him and bring reassurance to the marital community going forward.
A Way Forward
Traditionally, bankruptcy hasn’t offered a practical option to address single-spouse guaranties signed during marriage, or judgments entered against just one spouse for debts incurred during marriage. But in Subchapter V, the debtor retains control over their assets, and the case timeline is accelerated. A trustee is appointed to assist the parties in formulating a consensual plan of reorganization and to address any creditor disputes or claims.
Subchapter V may permit a married couple, such as Don and Dora, to reorganize their financial assets by applying their community assets to community liabilities while discharging separate obligations. Finally, Subchapter V offers a sensible way to address single-spouse obligations, while preserving the marital community and its property.
Click here to read Dale and Kortney's article published by Maricopa Lawyer.
about the authors
Dale C. Schian is a veteran insolvency strategist and counselor representing businesses and individuals in all aspects of commercial creditor and debtor-related endeavors. He is regularly involved in complex out-of-court workouts, restructurings, and Chapter 11 reorganizations.
Kortney Otten focuses her practice on commercial bankruptcy and business law, including contracts, transactions, and litigation. Her significant experience in state, federal, and appellate courts enables her to advise businesses effectively on resolving problems through mediation and settlement advocacy.