You Signed What?! How Subchapter V Can Resolve Single-Spouse Debt Without Dismantling the Marital Community

You Signed What?! How Subchapter V Can Resolve Single-Spouse Debt Without Dismantling the Marital Community

The knock comes in the middle of an ordinary evening.

Don and Dora are at the kitchen table, watching the news and playfully arguing about whose turn it is to unload the dishwasher. They have been married for decades. High school sweethearts who stayed together through college, children, and the long, busy years that followed. Dora works as a bookkeeper. Don spent twenty years building Don’s Donuts from nothing. They are not wealthy, but they are comfortable. A well-kept home. Relatively new cars. Savings for retirement and their children’s college expenses. They pay their bills. Their credit is solid. They have done almost everything right.

When the economy turned, Don’s Donuts did not survive. The closure was painful but survivable. Dora’s job kept them afloat, and Don quickly found new work. Life went on.

Then someone knocks.

Dora answers the door to a stranger holding a clipboard. He asks whether Don lives there. She says yes. He hands her a thick packet of papers and walks away.

She flips through the pages, confused for a moment until realization hits her. She’s staring at a lawsuit from a bank she has never heard of.

Dora looks at Don. “What is this?”

Don hesitates, then explains to his wife: When the donut shop was struggling to stay open, it borrowed money from a bank. The bank required a personal guaranty. He signed it. With the business gone now, there is no prospect of repayment.

Dora keeps reading and her stomach drops.

“They are suing you for one million dollars,” she says.

She knows what that number means. Their home. Their savings. Everything they have built together. Gone.

But the story does not end there. What Don and Dora do not yet know—and what many married couples in their position never realize—is that the law draws a sharp line between community obligations and single spouse liability.

Recent changes to the bankruptcy code may finally offer a way to confront debts like this without dismantling the marital community they worked a lifetime to build.

When Only One Spouse Signs

For individuals with debts of $3,424,000¹ or less, there is a bankruptcy option called Subchapter V. This can enable marital communities to pay their community debts while discharging a spouse’s separate obligations—to the extent those obligations exceed that spouse’s separate property

The issue frequently arises from a guaranty given by one spouse during the marriage. Unless signed by both spouses, a guaranty is unenforceable against community property. The problem can also arise when a debt is incurred during marriage, but the creditor takes judgment against the spouse who incurred the debt and fails to join the other spouse in the complaint and judgment. Both scenarios result in a judgment against only one spouse that cannot be enforced against community assets.

A strong presumption exists in Arizona that all property acquired during marriage is community property. Single-spouse guaranties and judgments are frequently unenforceable against property acquired during marriage. However, judgments can be renewed repeatedly. Until recently, there was no practical means to discharge them in bankruptcy without adversely affecting the marital community and the spouse who is not responsible for the debt. Subchapter V provides an effective process for discharging separate spousal obligations, while paying community obligations and retaining community assets.

Discharging Separate Obligations in Sub V

Arizona is a community property state. There is a strong presumption that all property acquired during marriage is community property. In re Foster, 240 Ariz. 99, 101, 376 P.3d 702, 704 (Ct. App. 2016). As a result, most long-married couples are unlikely to have any separate property. Generally, either spouse can bind the marital community, and such obligations may be enforced against community property. A.R.S. §§ 25-214(B); 25-215(D). However, for a debt arising from a guaranty to be enforced against the marital community, both spouses must sign the guaranty. A.R.S. § 25-214(C)(3). Absent the joinder of both spouses, a guaranty may only be enforced against the signing spouse’s separate property.²

Although the foregoing is unlikely to surprise Arizona attorneys, lenders outside of Arizona who fail to engage local counsel when seeking loan guaranties are frequently surprised.

For Don and Dora, this means Don is unlikely to have a defense against the lawsuit and is likely to have a significant judgment entered against him. Although the judgment cannot be enforced against Don and Dora’s community assets, it can be repeatedly renewed³ and enforced against any separate assets that Don might acquire.

Absent an inheritance or Dora’s consent, it is unlikely that Don will acquire separate assets during marriage. Eventually, all marriages end—whether by divorce or death. If Don ceases to be married to Dora, his assets may become available to satisfy the judgment. The nightmare scenario for Don would be to lose Dora and suddenly face collection efforts on a judgment that has been accruing interest for 20 or more years.

Bankruptcy’s Limits

Bankruptcy permits 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. If an individual lacks non-exempt assets, there is nothing to administer or distribute to creditors; the case is considered to be a “no-asset case.” The overwhelming majority of bankruptcy filings are no-asset cases. In Arizona and elsewhere, all Chapter 7 cases are presumed to be no-asset, and creditors are directed not to file claims.⁴

In our scenario, unless Don still has pre-marital assets or acquired separate assets during marriage,⁵ he likely has no assets to distribute to his separate creditors. Like Arizona statutes, the Bankruptcy Code⁶ recognizes that creditors may have claims against specific assets, but not against others.

Traditionally, bankruptcy has not been an option to discharge separate debts. If either spouse files for bankruptcy, the bankruptcy estate includes any separate property of the filing spouse and all community property.⁷ The Code defines a “community claim”⁸ and requires that community property be kept separate from separate property.⁹ Upon filing bankruptcy, an estate is created for administration.¹⁰ In most cases there is only one estate. However, with separate and community obligations to administer, in our scenario multiple sub-estates are created.¹¹ Code § 726(a) establishes the standard rules for distributions; however, § 726(c) establishes specific rules for the distribution of community property based on whether creditors have claims to community property. As closely as possible, the Code mirrors the rights creditors would have under state law.¹²

Bankruptcy Dead Ends

While the Code also respects state statutory schemes in distributing property,¹³ in a Chapter 7 proceeding, everything, including all community property, is delivered to a trustee.¹⁴ The trustee will liquidate the non-exempt assets and distribute the proceeds to creditors. After creditors are paid, any excess may be returned to Don and Dora, but the last thing they want is to see their community assets liquidated, which may leave them with nothing.

A Chapter 13 might accomplish a similar result, but it has an unsecured debt limit of $526,700, which is too small for most individuals with guaranties. A complete discussion of Chapter 13 is beyond the scope of this article; however, judgments taken against only one spouse for debts arising during marriage are another way separate obligations may arise. A review of the Maricopa County judgment index for just one common credit card issuer reflects thousands of judgments against individuals without including any spouse. A Chapter 13 plan based on the concepts discussed here may offer relief for individuals who incurred debts during marriage that were reduced to judgment without joining their spouse.

Typically, for individuals, traditional Chapter 11 is too expensive, time-consuming, and has technical requirements that can be very hard to meet. In traditional Chapter 11, the plan of reorganization must comply with the absolute priority rule. If the debtor wishes to retain assets, the absolute priority rule requires that either creditors be paid in full or the plan comply with an exception to that rule. The 2005 amendments to the Code make it difficult for an individual to meet these requirements.¹⁵

A Way Forward

However, in a Subchapter V proceeding, the absolute priority rule does not apply, the debtor retains control over their assets, and the timeline is accelerated. Although a Subchapter V trustee is appointed, they are charged with assisting the parties in formulating a consensual plan of reorganization and addressing any creditor disputes or claims.

Importantly to Don and Dora, Subchapter V permits them to use their community assets to pay their community creditors, while segregating their separate assets and limiting the claims of separate creditors to only those assets. Because most married couples have little or no separate property, there will often be no assets to distribute to separate creditors.

Using Subchapter V in this way permits a married couple, like Don and Dora, to reorganize their financial assets by applying their community assets to community liabilities while discharging single-spouse obligations. They may have separate assets that entitle separate creditors to a distribution, but they still obtain finality and avoid the prospect of a separate judgment forever lurking in the background. Finally, Subchapter V offers a practical way to address single-spouse obligations while preserving the marital community and its property.

Back to Ordinary

Months later, the kitchen table looks the same, but the weight in the room is gone.

Don and Dora sit side by side, paperwork neatly stacked rather than scattered in panic. The lawsuit is no longer the first thing they think about in the morning or the last thing they discuss at night. The million-dollar number has lost its power. Their home is still theirs. Their savings are intact. The life they built together is no longer balanced on a technicality.

Don did not have to wait for the worst day of his life for the judgment to come due. Dora did not have to fear that a signature she never made would someday undo everything they shared. Through Subchapter V, their community obligations were addressed, and the shadow that followed them quietly disappeared.

For the first time since the knock at the door, the future feels ordinary again. And that, for Don and Dora, is the real relief.

Click here to read Dale and Kortney's article published by Arizona Attorney Magazine.

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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.

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1. The Subchapter V and Chapter 13 debt limits are adjusted each year for inflation. ↩︎
2. Guaranties must be in writing. ARS § 44-101(2). ↩︎
3. A.R.S. § 12-1612. ↩︎
4. If there is later determined to be assets available to distribute to creditors, a second notice is sent directing creditors to file claims and setting a deadline. ↩︎
5. For example, by inheritance. ↩︎
6. Title 11, U.S.C. All references to the Code are to the applicable sections of the Bankruptcy Code. ↩︎
7. Code § 541(a)(2). ↩︎
8. Code § 101(7). ↩︎
9. Code § 726(c). ↩︎
10. Code § 541(a). ↩︎
11. In re Hicks, 300 B.R. 372, 377-78 (Bankr. D. Idaho 2003). ↩︎
12. In re Merlino, 62 B.R. 836, 840 (Bankr. W.D. Wash. 1986). ↩︎
13. In re Soderling, 998 F.2d 730, 733 (9th Cir. 1993). ↩︎
14. Code §§ 542-43. ↩︎
15. Zachary v. California Bank & Trust, 811 F.3d 1191, 1198-99 (9th Cir. 2016). ↩︎