Bankruptcy Beat: Former Spouses’ Relative Income a Critical Factor in Determining Whether the Assumption of Mortgage Payments Constitutes a “DSO”

by Pullman & Comley, LLC
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Disputes between general creditors and creditors asserting domestic support obligation claims are becoming commonplace in consumer bankruptcy cases.  The dispute typically arises because spouses’ or former spouses’ claims are entitled to priority over general unsecured creditor claims if what is owed by the bankrupt to a spouse or former spouse constitutes a “Domestic Support Obligation,” or more commonly known as a “DSO.”  What constitutes a DSO is not always clear and sometimes requires intricate analysis.  A recent United States District Court opinion from the Eastern District of New York, Rockstone Capital, LLC v. Metal, et al, 508 B.R. 552 (E.D.N.Y. 2014), illustrates how closely courts scrutinize an obligation claimed to be a DSO by a spouse or former spouse. The Rockstone Capital case clearly sends the message that if a spouse or former spouse is going to claim a debt owed is a priority DSO, he or she better be ready for the scrutiny.

The couple at issue in the Rockville Capital case, Keith Bub and Alisa Metal, married on October 2, 1994.  Over the course of their marriage, the couple obtained three loans which were used primarily to fund Keith’s business. To secure the loans, mortgages were granted against the marital residence to Bank of America, CitiMortgage and the United States of America Small Business Administration (“SBA”).  The couple maintained separate bank accounts and split most of their expenses equally. After discovering her husband’s infidelities, Alisa filed for divorce sometime in 2005, and on November 13, 2007, a New York court entered a judgment of dissolution which incorporated a settlement reached between the parties (the “Agreement”) . The Agreement provided for no alimony between the parties, Keith received $610,000 as his property settlement comprised of real property and cars and Alisa received $491,000 as her property settlement comprised of the marital home and a car. As part of the Agreement, Keith agreed to assume sole responsibility for the loans from CitiMortgage and the SBA.  Since Alisa was a co-signor of the SBA loan, Keith also agreed to provide security for his payment of the SBA loan so as not to adversely affect Alisa’s credit, and promised that the lien by the SBA would be removed within 36 months of the Agreement.  To secure the obligation, Keith granted Alisa a mortgage on a Florida property being held by a trust of which he was the sole beneficiary.

In January 2011, Keith stopped making payments on the SBA loan, and as a result, Alisa commenced a foreclosure action with respect to the Florida property. On November 22, 2011, Keith filed a Chapter 7 bankruptcy case.  In the bankruptcy case, Alisa filed a claim for $221,546.66 as a DSO priority claim pursuant to 11 U.S.C.§507(a)(1)(A).  Rockstone Capital, LLC (“Rockstone”), the holder of a judgment against Keith and the largest unsecured creditor, filed a general unsecured claim in the amount of $774,225.35.  Rockstone filed an objection to Alisa’s claim arguing that the obligation was not a DSO, and thus, not entitled to priority.

The Bankruptcy Court held that Alisa’s claim was a DSO entitled to the highest priority under 11 U.S.C.§507(a)(1).  Rockstone filed an appeal and the issue on appeal was whether Keith’s obligation to pay the SBA loan and to remove the lien from the marital residence was “in the nature of…support” as set forth in the Bankruptcy Code’s definition of a DSO codified in 11 U.S.C. §101(14A)(B). 

The District Court reiterated that whether an obligation is “in the nature of support” is a question of fact evaluated under federal bankruptcy law, and without regard to whether an obligation is so designated in the separation agreement or divorce decree.  Further, the District Court stated that the Bankruptcy Court correctly considered three factors in evaluating whether the assumption of mortgage payments constitutes a DSO. Those factors included: 1) whether the debtor’s obligation directly or indirectly provided shelter for the former spouse; 2) whether the debtor’s spouse would have been unable to remain in the marital home but for the debtor’s obligation; and 3) whether there was a discrepancy in the incomes between the spouses. However, the District Court found that although the Bankruptcy Court properly recognized that the discrepancy in incomes was a critical factor to assess, the Bankruptcy Court did not make enough factual findings to give this factor proper consideration. At best, the record reflected inconsistencies as to what the parties’ relative incomes were at the time of the divorce. In light of the lack of factual development on the income issue, the District Court vacated the Bankruptcy Court’s order finding that Alisa’s obligation was a priority DSO, and remanded the case back to the Bankruptcy Court for findings consistent with its direction regarding relative income.

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