Marriage of Vaughn: Discharge of Debts in Bankruptcy During Divorce Does Not Waive Reimbursement Claims for the Spouse Stuck With the Tab

Marriage of Vaughn (2018) 29 Cal.App.5th 451:

Chapter 7 Debt Discharges Under Federal Law Do NOT Necessarily Include Reimbursement Claims That Exist Within a California Divorce, as Between the Spouses Themselves

I have a case that has been pending since 2012 - I came into it in 2016 - where my client, the H (a brave California fire-fighter Captain), was forced to file a Chapter 13 bankruptcy to repay approximately $250,000 in marital debt over 60 months (payments of $2,500 each and every month from his paycheck), after his former spouse filed a Chapter 7 proceeding once she filed the divorce proceeding, and so discharged her own financial responsibilities to the marital creditors, as between she and them. Under the federal bankruptcy laws as they appeared to exist prior to Marriage of Vaughn, certified for publication in November 2018, the W's bankruptcy discharge also extinguished any obligation on her part to repay any of what my client has and will be forced to pay under the term of his Chapter 13 plan.

11 U.S.C. section 523 sets forth the superseding federal law on what debts are, or are not, dischargeable in bankruptcy. Most family law attorneys are thoroughly family with section 523(a)(5), which expressly exempts from discharge "a domestic support obligation" - i.e., spousal support, alimony, or child support. However, section 523(a)(15) also exempts from discharge an obligation "to a spouse, former spouse, or child of the debtor and not of the kind described in paragraph (5) that is incurred by the debtor in the course of a divorce or separation or in connection with a separation agreement, divorce decree or other order of a court of record, or a determination made in accordance with State or territorial law by a governmental unit;...."

Until Vaughn, a Bankruptcy Appellate Panel decision from the Ninth Circuit appeared to interpret section 523(a)(15) to prohibit CA family law courts from permitting Epstein or other post-separation reimbursements from being recoverable in a divorce from the other spouse, where the chapter 7 spouse received her discharge before the the finalization of the divorce proceedings. That case is In Re Heilman, 430 B.R. 213 (9th Cir. BAP 2010).

I had been facing an attorney for the W in this case, who claimed Heilman cut off my client's rights to recover his chapter 13 payments towards what was indisputably community property debt that he was forced to assume upon the W's Chapter 7 bankruptcy, for the simple reason that he was also on the hook to the marital creditors and his earnings exceeded $150,000/year (and so he was not eligible for his own Chapter 7 discharge). Heilman on its face seemed to support that position. Fortunately for my client, their case went into stasis, and we now have a new decision that makes it clear that spouses who discharge their obligations in bankruptcy to third parties still owe the other spouse who didn't manage to dodge the debt bullet.

In Vaughn, the CA trial court ruled that the H's bankruptcy discharge in Chapter 7 did not operate to obliterate his obligation to reimburse W, as between themselves, of joint debts that she suffered as a result of the marriage and the ensuing divorce proceedings. In affirming the trial court, the Justices ruled: "We accordingly hold that a debt is nondischargeable pursuant to section 523(a)(15) if the nature of the debt is such that its discharge would directly and adversely impact the finances of the debtor’s spouse or former spouse...." [Underline added].

So if you have a case involving a bankruptcy proceeding, filed before or during the divorce, you now have authority for the proposition that the bankruptcy discharge that applies to third parties, i.e., the creditors, does not apply as between the spouses to deny a financially injured spouse the right to be reimbursed.