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In all too many cases, after a final divorce decree is entered, a former spouse files a petition in bankruptcy. It is well settled under bankruptcy law that spousal or child support awards are not dischargeable. See 11 U.S.C. 523(a)(5). Equitable distribution awards, however, are considered debts of the bankruptcy estate that may or may not be dischargeable in bankruptcy, depending on the results of the balancing test. The balancing test provides that a debt incurred in connection with a divorce may be discharged if the debtor does not have the ability to pay or if "discharging such debt would result in a benefit to the debtor that outweighs the detrimental consequences to a spouse, former spouse, or child of the debtor." 11 U.S.C. 523(a)(15). The test became effective with the enactment of the Bankruptcy Reform Act of 1994. Prior to this addition, equitable distribution awards were dischargeable in bankruptcy. See, e.g., Perlow v. Perlow, 128 B.R. 412, 415 (E.D.N.C. 1991) ("[Wifeís] right to equitable distribution is a general unsecured claim and [husband] properly listed it as a debt against the estate.").
However, even before the Bankruptcy Code provided for limited immunity to be accorded to debts incurred in connection with a divorce, certain portions of equitable distribution awards were frequently held to be nondischargeable in bankruptcy. In particular, courts have consistently found that awards of a share of a debtor spouseís pension or retirement benefits to the recipient spouse are not considered part of the debtor spouseís bankruptcy estate and, therefore, are nondischargeable. Courts have adopted numerous theories to prevent the discharge of these pension awards in bankruptcy, including (1) that the recipient spouse held his or her interest in the pension as his or her separate property; (2) that the debtor spouse acted as a constructive trustee of the recipient spouseís interest; (3) that the obligation was nondischargeable as a postpetition debt; and (4) that the pension award was actually intended as an award in the nature of maintenance or support and would be nondischargeable under 523(a)(5). dischargeability of pension awards in bankruptcy 10 years ago. See Marcia L. Retchin, Dischargeability of Deferred Distribution Pension Awards Under Federal Bankruptcy Law, 6 Divorce Litigation 118 (1994). Even though the treatment of equitable distribution awards in bankruptcy has substantially changed since that time with the addition of 523(a)(15), the issue of the dischargeability of pension awards is still very significant in the present day. Even though 523(a)(15) would seem to provide some protection from the discharge of pension awards, it is still much simpler to avoid the application of the test set forth in that provision. As a majority of courts have found that such awards do not become a part of the bankruptcy estate, it is possible to prevent the discharge of pension awards in bankruptcy without being subject to the requirements of 523(a)(15).
Furthermore, the earlier article only addressed the dischargeability of deferred distribution pension awards. However, since that time, numerous cases have also addressed the dischargeability of immediate offset pension awards. As a result, this article will review the current state of the law concerning the dischargeability of pension awards under both the deferred distribution and the immediate offset methods.
II. Nondischargeability of Deferred Distribution Pension Awards
A. Separate Property Interest Created
An overwhelming majority of courts have held that a deferred distribution pension award is not dischargeable in bankruptcy. The most common theory relied on by the courts is one where the deferred distribution pension award becomes the sole and separate property of the recipient spouse immediately upon entry of the final divorce decree. Under this theory, the debtor spouse does not own the share of the pension awarded to the recipient spouse, and, therefore, the pension award is not part of the bankruptcy estate.
This theory that a pension award becomes the sole and separate property of the recipient spouse was employed by the United States Court of Appeals, Ninth Circuit, in In re Gendreau, 122 F.3d 815 (9th Cir. 1997), cert. denied, Gendreau v. Gendreau, 523 U.S. 1005, 118 S. Ct. 1187, 140 L. Ed. 2d 318 (1998). Pursuant to the partiesí divorce, the wife was awarded a 50% interest in the marital portion of the husbandís two pension plans. A qualified domestic relations order (QDRO) was subsequently entered in order to effect the distribution of the husbandís pensions, ordering the plan administrator to pay directly to the wife her interest in the pensions. The plan administrator concluded that the courtís order did not constitute a valid QDRO and refused to disburse the wifeís share until the plan administrator was presented with an amended order.
Approximately six months after the plan administrator refused to enforce the deficient QDRO, the husband filed for bankruptcy under Chapter 7. The husband then moved for a declaratory judgment that the award of a share of his pensions to the wife constituted a debt dischargeable in bankruptcy. The bankruptcy court denied the husbandís motion and granted the wifeís request for summary judgment. The Bankruptcy Appellate Panel (BAP) affirmed this decision that the pension award to the wife was not dischargeable, and the husband appealed.
On appeal, the husband argued that the wife failed to have a property interest in his pension in the absence of a valid QDRO. Under the anti-alienation rules of ERISA, pension benefits may not be assigned unless a proper QDRO has been submitted to the plan administrator. As the wife did not obtain a valid QDRO, the husband contended that she merely had a right to obtain payment that would be included in the definition of debt under the Bankruptcy Code.
The Ninth Circuit Court of Appeals affirmed the decision of the bankruptcy court and held that the award of the share of the husbandís pensions did not constitute a dischargeable debt. The court found that the wifeís claim for payment from the husbandís pensions does not lie against the husband but, rather, constitutes a claim directly against the plans themselves.
The order required United to pay directly to [the wife] her share of the proceeds and instructed the plan administrator to separately account for the portion awarded to [the wife] until the benefits are distributed and provided that the "benefits awarded by this Order shall not be assigned, pledged, or otherwise transferred, voluntarily or involuntarily, before [the wife] has received those benefits." Also, ERISA provides that "[d]uring any period in which the issue of whether a domestic relations order is a qualified domestic relations order is being determined (by the plan administrator, by a court of competent jurisdiction, or otherwise), the plan administrator shall segregate in a separate account in the plan or in an escrow account the amounts which would have been payable to the alternate payee [the wife] during such period. . . ." 29 U.S.C. 1056(d)(3)(H)(i) (emphasis added).
If the plans failed to pay [the wife], her recourse would be to sue the plans, not [the husband]. See id. at 802 ("To obtain the pension funds, [the wife] would file a civil court action against the administrator. [The wifeís] claim is against United, not the Debtor.") In no way can [the husband] be personally liable to [the wife] for this money, so it cannot be a personal debt of [the husband] that is dischargeable in bankruptcy. Even if [the wife] did not have a QDRO at the time [the husband] filed for bankruptcy, his bankruptcy cannot eliminate her right to obtain a QDRO and seek payment from a different party.
122 F.3d at 818.
The court was concerned more with the existence of the wifeís right to obtain a QDRO as opposed to whether any such order was actually prepared. The court concluded that as long as the divorce judgment was legally sufficient to allow the wife to obtain a QDRO, her property interest in the husbandís pensions was then fixed at the time of the judgmentís entry.
Likewise, we agree with the BAP that the order by the Family Court, if not itself a proper QDRO, at least gave [the wife] a right to obtain a proper QDRO that could not be discharged in [the husbandís] bankruptcy proceeding. [The wifeís] interest in the pension plans (or, at a minimum, her right to obtain a QDRO which would in turn give her an interest in the plans) was established under state law at the time of the divorce decree. See id. at 803. [The husbandís] interest in the plans was limited at that time, or at least subject to being limited at any time [the wife] obtained a QDRO (much like a current property ownerís rights may be subject to divestment by a contingent interest). See id. at 802-03. Bankruptcy recognizes state property rights, and filing bankruptcy cannot give a debtor a greater interest in an asset than that which he owned pre-bankruptcy. Id. at 802. Whether or not [the wifeís] domestic relations order, as issued, was a QDRO is irrelevant: The QDRO provisions of ERISA do not suggest that [the wife] has no interest in the plans until she obtains a QDRO, they merely prevent her from enforcing her interest until the QDRO is obtained. See id. at 804 n. 4. [The husband] did not file bankruptcy before [the wife] had an interest in the plans he filed bankruptcy before the plan administrator was authorized under ERISA to pay her according to that interest. As such, [the wife] does not have an unmatured "debt" against [the husband] that is dischargeable in bankruptcy; rather, [the wife] has a claim to her own interest in the plans that will be enforceable when the domestic relations order is approved as a QDRO.
Id. (courtís emphasis). The court further held that to allow the husband to discharge the pension award simply because of the fact that he filed for bankruptcy before the wife was able to have a valid QDRO prepared "would be contrary to both ERISA and bankruptcy purposes." Id. at 819. The court then summarized its holding as follows:
ERISA section 1056 permits a state court to apportion pension proceeds pursuant to state domestic relations laws so long as the order complies with the sectionís QDRO requirements. Whether [the wife] had acquired a QDRO at the time of [the husbandís] bankruptcy, however, is irrelevant for the purposes of this appeal. [The wife] does not have a personal claim against [the husband] that could be discharged by his bankruptcy her rights are against United. Furthermore, [the husbandís] rights to Unitedís pension plans were limited, or subject to limitation by [the wife], at the time of the divorce decree and he cannot use bankruptcy to obtain a greater interest in an asset than that which he possessed prior to bankruptcy. Finally, to allow [the husband] to cut off [the wifeís] right to obtain a QDRO based on the timing of his bankruptcy petition would subvert Congressí efforts to safeguard the financial interests of plan participantsí spouses and protect plan administrators from inconsistent claims on pension proceeds, without furthering bankruptcyís goal of preserving a pool of assets to be divided among the debtorís creditors. Accordingly, we hold that [the wifeís] claim against the pension plan for a portion of the benefits is not discharged by [the husbandís] bankruptcy petition.
Id. For other cases holding that a divorce judgment operates to transfer to the recipient spouse a sole and separate property interest in a deferred distribution pension award, see Walston v. Walston, 190 B.R. 66 (E.D.N.C. 1995); In re Carbaugh, 278 B.R. 512 (B.A.P. 10th Cir. 2002); In re Califf, 195 B.R. 499 (Bankr. N.D. Ala. 1996); In re Granados, 214 B.R. 241 (Bankr. E.D. Cal. 1997); In re McQuade, 232 B.R. 810 (Bankr. M.D. Fla. 1999); In re Rueff, 259 B.R. 895 (Bankr. C.D. Ill. 2000); In re Britten, 227 B.R. 820 (Bankr. S.D. Ind. 1997); In re Gomez, 206 B.R. 663 (Bankr. E.D.N.Y. 1997); In re Baker, 274 B.R. 176 (Bankr. D.S.C. 2000); Clark v. Clark, 219 A.D.2d 787, 631 N.Y.S.2d 467 (3d Depít 1995); Brogan v. Brogan, 31 Va. App. 769, 525 S.E.2d 618 (2000); and Dewey v. Dewey, 188 Wis. 2d 271, 525 N.W.2d 85 (Ct. App. 1994). Cf. Adkins v. Adkins, 675 So. 2d 199 (Fla. 1st Dist. Ct. App. 1996) (applying same rule to profit-sharing plan).
The courtís decision in Gendreau is notable for two reasons. The first reason is the courtís holding that a recipient spouseís property interest in the otherís pension is not dischargeable in bankruptcy. The second reason is its position that a QDRO is not necessary to give rise to this nondischargeable interest. While the court acknowledged the necessity of a valid QDRO in order to effectuate the division of a pension under ERISA, the court concluded that the lack of a valid QDRO did not serve to abrogate the recipient spouseís interest in the pension. The court found that the contrary result would result in great inequity to the recipient spouse.
As noted above, the purpose of the QDRO exception was to protect the financial security of divorcees. This protection would be meaningless if [the husband] could thwart his spouseís interest by filing bankruptcy before she obtained a QDRO, a process which everyone (including Congress) recognizes as time-consuming. Furthermore, the result would be a windfall to [the husband] and would not further bankruptcyís goal of accumulating a pool of assets to be distributed among creditors. [The husband] exempted his interest in the pension plan from the bankruptcy estate. Thus, discharging [the wifeís] interest in the plans would not enlarge the pool of assets available to [the husbandís] creditors, it would only enlarge his personal wealth.
122 F.3d at 819. This position that the actual existence of a QDRO is irrelevant to create a separate property interest in the recipient spouse as long as the right to obtain one is present in the divorce decree has become the rule in the majority of jurisdictions addressing this issue. As demonstrated in Gendreau, even the preparation of an invalid QDRO will not serve to defeat the recipient spouseís property interest. For other cases holding that the lack of a QDRO will not defeat a recipient spouseís sole and separate property interest in a deferred distribution pension award, see In re Carbaugh, 278 B.R. 512 (B.A.P. 10th Cir. 2002) (divorce decree gave wife property interest in husbandís retirement plans even though she had yet obtained a QDRO); In re Rueff, 259 B.R. 895 (Bankr. C.D. Ill. 2000) (divorce decree vested husband with separate property interest in his share of wifeís pension that could not be discharged; lack of QDRO did not affect husbandís interest); and Dewey v. Dewey, 188 Wis. 2d 271, 525 N.W.2d 85 (Ct. App. 1994) (fact that wife failed to obtain QDRO prior to husbandís bankruptcy filing did not affect her interest in the husbandís pension). See also Brown v. Pitzer, 249 B.R. 303 (S.D. Ind. 2000) (immediate offset pension award contained in divorce judgment resulted in present transfer to wife of property interest in husbandís pension and property interest did not constitute debt even if wife had failed to obtain a QDRO). But see In re King, 214 B.R. 69 (Bankr. D. Conn. 1997) (wifeís deferred distribution pension award dischargeable where no QDRO had been entered; discussed in depth in Part V(A), infra).
B. Debtor Spouse as Constructive Trustee
Another theory relied on by the courts to conclude that a deferred distribution pension award is not dischargeable in bankruptcy is that the divorce judgment ordering such an award operates to create a constructive trust relationship between the debtor and the recipient spouse. The Eighth Circuit Court of Appeals utilized such a constructive trust theory in Bush v. Taylor, 912 F.2d 989 (8th Cir. 1990), to find that the recipient spouseís interest in the husbandís pension was not dischargeable in bankruptcy.
In Bush, pursuant to a final decree of divorce, both parties were awarded a one-half interest in the husbandís pension as their respective sole and separate property. The husband was expected to convey one-half of the amount he received each month from his pension. Seven years after the divorce judgment, the husband was in considerable arrears on his obligation. Returning to court, the parties executed an agreed judgment that ordered the husband to pay the amount of his arrearages. The judgment also reduced the wifeís interest in the pension to a flat payment of $500 per month plus one-half of any increases as opposed to one-half of the benefits received by the husband. Despite this reduction in his obligation, the husband again ceased making the required payments. Five years after the agreed judgment was entered, the husband and his current wife filed for bankruptcy under Chapter 7. The husband listed the wifeís interest in his pension as a debt and sought to discharge the obligation.
The bankruptcy court discharged any amounts that accrued between the entry of the agreed judgment and the time of the petition. The court, however, refused to discharge his obligation to pay the wife her share of any postpetition benefits, finding that such a result would unjustly enrich the husband and deprive the wife of her marital property rights. The bankruptcy courtís decision was affirmed by the district court under a constructive trust theory. The United States Court of Appeals, Eighth Circuit, reversed the decision, holding that the wifeís claim against the husbandís pension constituted a dischargeable debt. The court then agreed to rehear the case en banc.
The court, sitting en banc, reached the opposite conclusion and affirmed the decision of the bankruptcy court. The court held that the wifeís interest in the husbandís pension was not dischargeable. The court adopted the constructive trust theory relied on by the lower courts and found that the husband acted as a constructive trustee of the pension benefits awarded to the wife as her separate property in the divorce decree.
As the courts below held, the facts of this case give rise to a trust relationship between [the husband] and [the wife]. Her share of the pension was her sole and separate property and [the husband] received it (via the monthly pension checks) as a constructive trustee for her benefit. We have no difficulty in affirming the judgment of the District Court on this ground.
In a footnote, the court proceeded to reject alternative arguments that would characterize the wifeís interest as a dischargeable debt. Although the wifeís interest was reduced from one-half of the pension to a flat amount of $500 per month plus one-half of any increases, the court did not accept that this fact alone changed the nature of the husbandís payments into a debt. The court concluded that the change in amount did not alter the fact that the wife was still entitled to receive a portion of the husbandís pension benefits. "The change in amount for whatever reason does not make the payments any less her property than they were originally." Id. at 993 n.5.
In that same footnote, the court dismissed another argument that the wifeís interest was reduced to a judgment by virtue of the earlier agreed judgment. The court noted that the arrearages due at the time of the agreed judgment were in fact reduced to judgment but that the wifeís interest in future payments was not. Thus, the court found that her interest could not be considered a dischargeable debt simply because of the entry of the agreed judgment.
In a following footnote, the court stated its belief that the district court was wrong in concluding that the arrearages accrued by the husband between the date of the agreed judgment and the husbandís bankruptcy petition were dischargeable. The court concluded that the husband was acting as a constructive trustee of the wifeís interest prior to the filing of his bankruptcy petition. Thus, the funds received by the husband that should have been conveyed to the wife would have also been held in a constructive trust for the wifeís benefit. However, as the wife did not appeal this portion of the lower courtís opinion, the court noted that this issue was not properly before it.
In general, the constructive trust theory employed by the court in Bush will only be applied in cases where the pension benefits must pass through the debtor spouse and are not paid directly to the recipient spouse by the plan administrator. As evidenced by the courtís decision in Bush, in these types of cases, the court will find that the recipient spouse has a separate property interest in the deferred distribution pension award and will hold that the debtor spouse merely receives the recipient spouseís share as a constructive trustee, and, thus, the debtor spouse holds any unpaid amounts in a constructive trust for the benefit of the recipient spouse. For other cases imposing a constructive trust on a debtor spouse who fails to pay over the recipient spouseís share of a pension award, see In re McCafferty, 96 F.3d 192 (6th Cir. 1996) (divorce judgment making an immediate offset pension award created a constructive trust in favor of wife and was not part of husbandís bankruptcy estate; discussed in depth in Part IV, infra), and Guarino v. Corrozzo, 2003 WL 152641 (Tenn. Ct. App. Jan. 23, 2003) (constructive trust imposed on husband for his failure to pay the wife her share of the deferred distribution pension award). Cf. In re Dahlin, 94 B.R. 79 (E.D. Va. 1988), affíd, 911 F.2d 721 (4th Cir. 1990) (court order containing language stating a deferred distribution pension award gave rise to express trust in favor of recipient spouse).
The court in Bush also found an alternative basis to support its decision that held that any postpetition pension benefits received were not dischargeable in bankruptcy since these payments had not yet been received at the time of the husbandís bankruptcy petition. The court concluded that as these benefits constituted postpetition debts, these payments could not be discharged. For further discussion of this theory, see Part II(C), infra.
C. Payments Not Yet Due
A third theory utilized in a number of courts to support the finding that deferred distribution pension awards are not dischargeable is one where such awards represent postpetition debts that may not be discharged in bankruptcy. Under this theory, only the portion of the pension award that was payable before the filing of the bankruptcy petition could be discharged.
A leading example of a court applying this theory can be found in In re Zeitler, 255 B.R. 172 (E.D.N.C. 1999). In Zeitler, the husband was ordered to pay the wife a share of his retirement benefits accrued during the partiesí marriage. The wife was to receive a fixed percentage of the husbandís benefits at the time of the husbandís receipt of these benefits. Ten years after the partiesí divorce, the husband retired and began receiving benefits. The husband did not pay the wife her share of the benefits as set forth in the divorce judgment. Although the husband claimed to have sent letters to the wife notifying her of his retirement, the wife asserted that she never received the letters and did not learn of the husbandís retirement until almost a year after he began receiving benefits.
The wife petitioned to have the husband held in contempt for failing to convey her share of his retirement benefits. The wife also contacted the husbandís plan administrator, which refused to make payments directly to the wife, stating that the divorce judgment did not meet the requirements for a valid QDRO. During the pendency of the wifeís contempt action, the husband filed for bankruptcy under Chapter 7. The husband claimed that both the amount of benefits he owed to the wife at the time of his bankruptcy filing as well as an unliquidated claim representing the wifeís share of future benefits were dischargeable in bankruptcy. Unsurprisingly, the wife asserted that her claims were not dischargeable. The bankruptcy court found that the amount of benefits received prepetition were dischargeable but that amounts received after the husband filed for bankruptcy would be considered postpetition debt and consequently not dischargeable. In reaching this decision, the bankruptcy court divided the wifeís claims in the husbandís retirement benefits into three types: (1) claims for her share of prepetition payments received by the husband but not paid to her; (2) claims for her share of postpetition payments received by the husband but not paid to her; and (3) claims for her share of postpetition payments that will be received by the husband in the future.
On appeal, the United States District Court, Eastern District of North Carolina, affirmed the bankruptcy courtís decision and also adopted its characterization of the wifeís claims for use on appeal. The husband contended that the debt owed to the wife was incurred prior to his bankruptcy filing. The husband argued on appeal that the language of the divorce judgment required that the husband pay the wife "a lump sum equal to the full amount of her entitlement" on the date of his retirement. Id. at 177. Both the bankruptcy court and the district court rejected this position. The court concluded that the husbandís interpretation was patently inconsistent with the facts of the case.
[The husband] did not receive his retirement benefits in one lump sum, but in monthly payments. Thus, the only logical interpretation of the dissolution decree is that appellant was required to pay [the wife] a percentage of each monthly benefit he received.
Id. The court then turned to address the benefits that would be received by the husband after he filed his bankruptcy petition. Based on its interpretation of the divorce judgment, the court concluded that the wifeís share of these benefits constituted postpetition debts and were not dischargeable.
Thus, this court agrees with the [b]ankruptcy court that payments due to [the wife] which [the husband] received and did not pay to her arose post-petition and are[,] therefore, not dischargeable under 11 U.S.C. 727(b), as that section provides only for discharge of pre-petition debt.
Id. For other cases holding that deferred distribution pension awards constitute postpetition debts that are not dischargeable in bankruptcy, see Bush v. Taylor, 912 F.2d 989 (8th Cir. 1990) (even if pension award was a property settlement, husbandís obligation on payments not yet received could not be discharged as postpetition debts); In re Grossman, 259 B.R. 708 (Bankr. D.N.D. 2001) (wifeís share of pension not dischargeable except as to benefits payable at the time he filed for bankruptcy; future payments could not constitute debt until they became payable); and Brogan v. Brogan, 31 Va. App. 769, 525 S.E.2d 618 (2000) (payments to wife were not debts until they became due each month). But see In re Ellis, 72 F.3d 628 (8th Cir. 1995) (husbandís obligation to make installment payments "did not become post-petition debt merely because the dates of payment had not yet arrived").
As a final holding, the court in Zeitler also dismissed the husbandís argument that the wife had failed to secure her rights in these payments because she had failed to obtain a QDRO prior to his bankruptcy filing. See Part II(A), supra, for further discussion on this issue.
III. Deferred Distribution Pension Awards Acting as Support or Maintenance
A small minority of jurisdictions have traveled a decidedly different route in order to reach the same destination concerning the dischargeability of deferred distribution pension awards. These courts have treated deferred distribution pension awards as a type of support or maintenance and, thus, not subject to discharge under 11 U.S.C. 523(a)(5). Representative of these decisions is In re Cuseo, 242 B.R. 114 (Bankr. D. Conn. 1999). After the end of the partiesí 15-year marriage, the wife was awarded one-half of the payments received by the husband from his disability pension. The court ordered that a QDRO be prepared in order to allow the wife to receive her share of the pension. The plan administrator initially refused to accept the prepared QDRO and declined to make payments to the wife. The court then ordered the husband to pay directly to the wife her share of the pension until a subsequent QDRO could be prepared and approved by the plan administrator. The husband failed to make any payments to the wife, and, before another QDRO could be approved, the husband filed for bankruptcy under Chapter 7.
The husband sought to discharge his obligation to pay the wife one-half of his disability pension. The wife responded, arguing that the award was nondischargeable under 523(a)(15) as her share of the pension was intended to be her primary source of support from the husband. Both parties acknowledged that there was no dispute concerning the material facts of the case, and both parties moved for summary judgment.
Despite the wifeís reliance on 523(a)(15), the bankruptcy court framed the issue of the award of one-half of the husbandís disability pension to the wife in the context of whether the award was in the nature of maintenance or support. "The substantive inquiry required in assessing the dischargeability of the Disability Pension Award in this proceeding is whether that award was for alimony, maintenance or support." 242 B.R. at 119. The court concluded that the only relevant issue in the case was whether the Connecticut court intended the award of a share of the husbandís pension to act as a support obligation "or to effect some other purpose, such as a division of property or as punishment for fault leading to the underlying marital dissolution." Id. Although the court found that "[t]here is no question that the language of the Disability Pension Award, standing alone, evidences a division of property with respect to an asset acquired during the period of the partiesí marriage," the court stated that it was able to look beyond the express language used to the intent of the Connecticut court in making the award. Id. at 120. The bankruptcy court noted that the Connecticut court had stated that the wife "would have available to her the income from the pension to help her maintain herself" and that any contrary interpretation of its order would constitute "a manifest injustice." Id. (emphasis in original). The court concluded that the Connecticut court did not consider the potential for discharge of its pension award in bankruptcy. The court inferred that if such consideration had been given then the Connecticut court "would have articulated at that time the ímaintenance and supportí purpose of that award." Id. Based on its conclusions about what the Connecticut court would have done, the court concluded that the classification of the pension award to the wife as a division of property was erroneous when the court intended the award to operate as support.
In view of the above, this Court finds that despite the Memorandum of Decisionís use of the phrase "property settlement", the Disability Pension Award of one-half of the Debtorís Disability Pension was for the "maintenance and support" of the Defendant within the meaning of Section 523(a)(5).
Id. For other cases that have treated deferred distribution pension awards as support or maintenance and, thus, nondischargeable in bankruptcy, see In re Kestella, 269 B.R. 188 (Bankr. S.D. Ohio 2001) (divorce judgment imposed lien on husbandís retirement plan if he failed to meet his financial obligations under the divorce decree; judicial lien was in the nature of support and not dischargeable); In re White, 265 B.R. 547 (Bankr. N.D. Tex. 2001) (wifeís share of husbandís pension was in the nature of support and not dischargeable; husband had treated payments as support for income tax purposes and was estopped from claiming differently during bankruptcy proceedings, even though divorce decree characterized payments as a division of marital property); and Vaughan v. Vaughan, 131 Ohio App. 3d 364, 722 N.E.2d 578 (4th Dist. 1998) (wifeís share of husbandís pension was in the nature of support and not dischargeable).
While the result of these cases that characterize pension awards as being in the nature of support or maintenance is just, the choice of these courts to follow such a tortured analysis to reach the correct result is needlessly complicated and somewhat disingenuous. For example, in Cuseo, the bankruptcy court had to ignore the express language used in the divorce decree stating that the pension award was intended as a property division and, instead, infer intentions to the state court that were contrary to the express language of the judgment. The far easier method to find that pension awards are nondischargeable in bankruptcy is the majority position that such an award grants a recipient spouse a separate property interest in the pension. The majority position eliminates the need to consider whether or not the facts of a particular case support the finding that the award was intended for maintenance or support. Due to the increased complexities associated with treating pension awards as support, these cases understandably represent a minority position.
IV. Nondischargeability of Immediate Offset Pension Awards
As discussed in Part II, supra, courts generally find that a deferred distribution of a spouseís pension benefits will not be dischargeable in bankruptcy. Deferred distribution is not, however, the only manner in which the marital share of a spouseís pension may be divided. Courts may order instead that the pension be divided through an immediate offset award to the recipient spouse. In dividing pensions in this manner, a court must determine the present value of the pension in question and award the recipient spouse a definite amount from this present value. A growing number of jurisdictions have reached the conclusion that there is no fundamental difference in the separate property interest granted to the recipient spouse regardless of the manner of distribution. These jurisdictions have held that, like deferred distribution pension awards, immediate offset pension awards are also nondischargeable in bankruptcy.
One of the growing number of jurisdictions is the Ninth Circuit Court of Appeals, which found that an immediate offset pension award could not be discharged in bankruptcy in In re Lowenschuss, 170 F.3d 923 (9th Cir. 1999). The wife was awarded a fixed percentage of the husbandís interest in his pension plan. The court ordered the husband to directly transfer this share directly to the wife. Instead of complying with the court order, the husband transferred over $8 million out of the pension plan and out of Pennsylvania. The husband also left Pennsylvania, moving to Nevada, where he subsequently filed for bankruptcy under Chapter 11. The husband asserted that his pension was excluded from his bankruptcy estate as an ERISA-qualified pension. The bankruptcy court ultimately ruled that the award of a share of the husbandís pension to the wife constituted a monetary award against the husband and did not create a property interest in the plan in the wifeís favor. The bankruptcy courtís decision was vacated on appeal by the district court, which remanded the case with instructions to grant the wife leave to seek a QDRO. The husband appealed.
The Ninth Circuit Court of Appeals affirmed the district courtís opinion and held that the divorce judgment effectively awarded an ownership interest in the husbandís pension and not just a money judgment enforceable against the husband. Turning to Pennsylvania law, the court noted that the pension award was made utilizing the immediate offset method of distribution. The court explained the application of the immediate offset method as follows:
In the Pennsylvania divorce proceedings, the divorce court ordered the equitable distribution of the marital property under the immediate offset method. Under the immediate offset method, "the non-pension-holding spouse receives an immediate distribution of marital assets." Elhajj v. Elhajj, 413 Pa. Super. 578, 605 A.2d 1268, 1269 (1992). Thus, Pennsylvania law frames the equitable distribution of a pension plan under the immediate offset method as the immediate and actual distribution of the pension plan assets and not merely as the award of a money judgment against a debtorís interest in those assets. See id.; Lyons v. Lyons, 401 Pa. Super. 271, 585 A.2d 42, 46-47 (1991) (requiring "an actual present distribution of [non-pension-holding spouseís] share of the pension"); Zollars v. Zollars, 397 Pa. Super. 204, 579 A.2d 1328, 1330 (1990) (requiring distribution of marital property assets).
Id. at 929-30. In addition to the conclusions it drew from Pennsylvania law concerning the effect of the state courtís use of the immediate offset method to divide the husbandís pension and the immediate creation of a property interest in the wifeís favor, the court found further support for this conclusion in the express language used in the pension award to the wife.
The divorce courtís intent to award [the wife] a property interest in the Pension Plan assets is further demonstrated by its explicit instruction that Debtor pay [the wife] her 38.7% share of the Pension Plan directly from the Pension Plan assets instead of some other source. In addition, the divorce courtís intent is clear from its entry of judgment in [the wifeís] favor and against both Debtor and the Pension Plan instead of only Debtor. Based on the foregoing, we find that the bankruptcy court erred in ruling that [the wife] held only a money judgment against Debtor. Instead, the Divorce Decree awarded [the wife] an outright ownership interest in the Pension Plan assets.
Id. at 930.
Based on its determination that the divorce decree had the effect of giving the wife a separate property interest in the husbandís pension, the court reached the following conclusion.
Because [the wife] owns outright 38.7% of the Pension Plan assets, her interest in those assets is not subject to discharge in Debtorís bankruptcy. [The wifeís] interest in the Pension Plan was established under Pennsylvania law at the time of the Divorce Decree. See In re Gendreau, 122 F.3d 815, 818 (9th Cir. 1997). As we stated in Gendreau, "Bankruptcy recognizes state property rights, and filing bankruptcy cannot give a debtor a greater interest in an asset than that which he owned pre-bankruptcy." Id. at 819. Because Debtor filed his bankruptcy petition after [the wifeís] ownership interest in the Pension Plan was created, [the wifeís] interest in the Pension Plan is not a "debt" under the Bankruptcy Code, and therefore cannot be discharged in Debtorís bankruptcy. See id. at 818-19. Instead, [the wifeís] ownership interest in the Pension Plan assets is separate from Debtorís bankruptcy proceedings.
The court in Lowenschuss seemed to draw a distinction between an award of a share of the husbandís pension and the award of a money judgment in the amount of the wifeís interest. Id. at 931. It can be inferred from the courtís decision that if the divorce judgment had only granted the wife a money judgment against the husband to represent her immediate offset award of her share of the pension then that judgment may have been dischargeable in bankruptcy. Based on this inference, it is important to make certain that divorce judgments dividing pension benefits using the immediate offset method utilize language indicating the granting of an ownership interest as opposed to a money judgment, especially if it is likely that one party will declare bankruptcy after the entry of the judgment.
In addition to holding that an immediate offset pension award can grant a recipient spouse a nondischargeable property interest in a debtor spouseís pension, at least one court has been willing to utilize the constructive trust theory applied by some courts to deferred distribution pension awards to find that an immediate offset pension was nondischargeable. In In re McCafferty, 96 F.3d 192 (6th Cir. 1996), the court found that the wife was entitled to one-half of the value of the husbandís pension that accrued during the marriage, which amounted to approximately $100,000. The final decree described this award as a property distribution. The husband was ordered to pay the wifeís interest in his pension in monthly installments out of the benefits he received. Seven months after their divorce, the husband filed for bankruptcy under Chapter 7. The husband listed the wife as an unsecured creditor and sought to discharge the courtís pension award to the wife. In response, the wife argued that the award was in the nature of support or maintenance and was not dischargeable. In a subsequent state court proceeding, the state court declared that the pension award was intended as a division of marital property and not as a support award. The wife then altered her argument in the bankruptcy proceeding to reflect this position, arguing that the divorce decree immediately divested the husband of any interest in her share of the pension. The bankruptcy court rejected the wifeís argument and found that the pension award was dischargeable. This decision was affirmed by the trial court, and the wife appealed.
The United States Court of Appeals, Sixth Circuit, reversed the decision of the bankruptcy court and held that the pension award was not dischargeable in bankruptcy. The court found that, under Ohio law, the divorce decree awarded the wife a separate interest in a portion of the husbandís pension. The court then turned to the question of whether the husband held the wifeís share of the pension in a constructive trust for her benefit. The court found that such a constructive trust existed and, thus, the wifeís share of the pension could not be considered part of the bankruptcy estate.
Although no court order had ever designated the husband as a constructive trustee for the wife, the court found that the language of the divorce order was sufficient to give rise to a constructive trust relationship. The court noted several decisions under Ohio law where a constructive trust arose by operation of law. The court also found support for its conclusion that the husband acted as a constructive trustee in the language of an earlier bankruptcy court opinion.
One bankruptcy court in Ohio has stated that "where there is a valid Domestic Relations Court order predating the bankruptcy, there has in fact been a judicial determination by a court in a separate proceeding that the Debtorís property is held for the benefit of another."
Id. at 198 (quoting In re McGraw, 176 B.R. 149, 151-52 (Bankr. S.D. Ohio 1994)). The court concluded that the wifeís immediate offset pension award gave her a separate property interest in the husbandís pension, and, thus, the husband only held her share as a constructive trustee for her benefit.
The court having entered judgment for the stated amount as "a distribution of her interest" in the retirement plan, we believe [the husband] retained only a bare legal title in the designated portion of the planís benefits and that [the wife] became the equitable owner of the retirement plan to that extent. Thus, this property interest never became part of the bankruptcy estate. 11 U.S.C. 541(d). Since it would result in an unjust enrichment for [the husband] to receive the entire value of the retirement benefits, a constructive trust arose to the extent of the interest awarded to [the wife]. The divorce decree provided the required judicial order.
96 F.3d at 199.
For other cases holding that immediate offset pension awards are not dischargeable in bankruptcy, see Brown v. Pitzer, 249 B.R. 303 (S.D. Ind. 2000) (immediate offset pension award resulted in present transfer to wife of property interest in husbandís pension), and In re Nouri, 2003 WL 23192668 (Bankr. M.D. Pa. Aug. 1, 2003) (QDRO awarding wife specific amount as opposed to percentage of husbandís pension did not create a debt; wife had vested property interest).
V. Dischargeability of Pension Awards
A. Deferred Distribution
While the overwhelming majority rule in this country is that deferred distribution pension awards are not dischargeable in bankruptcy, a few courts have adopted the minority position that such awards may in fact be dischargeable. Representative of these decisions is In re King, 214 B.R. 69 (Bankr. D. Conn. 1997).
In King, the wife was awarded a 10% interest in the husbandís pension plan when the benefits became distributable to the husband. The court also ordered that a QDRO be prepared so as to provide for the wifeís participation in the husbandís plan. The wifeís attorney submitted a draft QDRO to the husbandís counsel, requesting certain information needed to complete the order. Neither the husband nor his attorney responded to this request, and, approximately one month later, the husband filed for bankruptcy under Chapter 13. The husband sought to discharge obligations imposed upon him in the divorce judgment, including the pension award.
The bankruptcy court found that the pension award to the wife was in the nature of a property division and was not intended as support and, thus, was dischargeable in bankruptcy. The court noted that it was the intent of the divorce decree to "effect a self-executing assignment" of a share of the husbandís plan to the wife. Id. at 77 (emphasis in original). The court also stressed the necessity of a valid QDRO to effect the division of the pension under ERISA and found that the wife had no property interest in the husbandís pension without first obtaining one. The court proceeded to reject several arguments that would support finding a property interest even without the entry of a QDRO.
First, the court rejected the argument that the wife had no claim against the husband, but only had a right to payment of the benefits from the plan itself. The court found that the language of the divorce decree left the husband with a contingent obligation to pay the wife the equivalent of her share of the pension should the pension plan fail to do so. Because of this contingent claim, the court found that the wife retained a claim against the husband that could be discharged in bankruptcy.
The second argument rejected by the court was that the assignment of the wifeís interest in the husbandís pension was complete as of the date the divorce decree was entered. The court found, however, that the wifeís interest in the pension was not complete as of the date of the decree since the decree could not constitute a valid assignment of the husbandís pension under ERISA.
The Decree itself could not effect an assignment of pension rights, as it might have with other types of property, because the pension planís ERISA-compelled anti-alienation provision, see 29 U.S.C. 1056(d)(1) (1992), preempts all state law under which an assignment might be made unless such assignment is accomplished through a QDRO. 29 U.S.C. 1056(d)(3)(A) (1992). A QDRO must be prepared in strict conformance with federal standards, 29 U.S.C. 1056(d)(3)(B)-(E) (1992), and is not effective until deemed "qualified" by the subject pension plan. See 29 U.S.C. 1056(d)(3) (1992). Accordingly, under ERISA, the Refereeís intended creation in the [wife] of a 10% stake in the [husbandís] pension plan was not, and is not, effective unless and until a QDRO is prepared, filed, and deemed qualified. Because these steps were not completed as of the Petition Date, the [wife] held no vested interest in the pension plan, but had, inter alia, a contingent and unmatured "right to payment" from the [husband]. Thus, there existed on the Petition Date "debt(s)" owed by the [husband] with respect to the Pension Award.
Id. at 78-79.
The court in King distinguished its holding and its strict requirement that a valid QDRO be entered from the Ninth Circuitís decision in Gendreau. The court rejected the holding in Gendreau that a divorce order that establishes a spouseís right to obtain a QDRO is sufficient to protect that spouseís interest in a future bankruptcy proceeding. The court found that that holding necessarily served to impermissibly elevate state law over federal law.
In so concluding, the Ninth Circuit denigrates the primacy of federal law by elevating [the] presumed state-created rights of the ex-spouse over the federally- protected property rights of the debtor-pensioner. This creation and limitation of the "rights" and "interests" of the parties is not supported by the plain language of ERISA, and is at odds with ERISAís strict anti-alienation requirement, as consistently recognized by the United States Supreme Court.
King, 214 B.R. at 79-80. The court also concluded that the Gendreau decision was contrary to the general principles of statutory construction. Based on these conflicts with Gendreau, the court concluded that the wifeís pension award was dischargeable. The King court summarized its holding as follows:
In summary, because of ERISAís anti-alienation provision, the Refereeís Pension Award which was plainly intended as a division of property failed to vest the Defendant with any property rights in the Plaintiffís pension plan as of the Petition Date. Accordingly, the obligations of the Plaintiff with respect to the Pension Award are dischargeable debts in this bankruptcy case.
214 B.R. at 81.
The courtís decision in King is in direct conflict with the majority rule that the existence of a QDRO is not necessary to transfer a property interest in a pension award to a recipient spouse. As discussed in Part II, supra, the majority of jurisdictions have held that a divorce decree is generally sufficient to create a property right in the recipient spouse. The majority rule affords protections to the recipient spouse that are lacking in the minority position. There is ample time for a debtor spouse to seek to avoid his obligations imposed in a divorce decree given the considerable time involved in drafting a valid QDRO and having it accepted by the plan administrator. The minority rule would fail to protect a recipient spouse under these circumstances, while, under the majority rule, such actions would not serve to terminate the recipient spouseís property interest.
B. Immediate Offset
As discussed in Part IV, supra, a growing number of jurisdictions have held that both immediate offset and deferred distribution pension awards are dischargeable in bankruptcy. However, some courts still choose to treat these two types of pension awards differently and hold that immediate offset pension awards are not dischargeable in bankruptcy. One such case is the Eighth Circuit Court of Appealsí decision in In re Ellis, 72 F.3d 628 (8th Cir. 1995).
In Ellis, the wife was awarded $300,000 as her share in the husbandís pension and profit-sharing plan. The judgment provided that the award would constitute a judgment lien against the husbandís interest in the plan. On appeal, the award was modified to allow the husband to pay the award in installments of $50,000 plus interest every six months. Less than one month before the first installment payment was due, the husband filed for bankruptcy under Chapter 7. The wife contested the dischargeability of the pension award. The bankruptcy court held that the pension award constituted a property settlement that was dischargeable by the husband in bankruptcy. The wife moved to amend the bankruptcy courtís judgment. Pursuant to the wifeís motion, the court reversed its decision and found that the pension award was nondischargeable pursuant to the Eighth Circuitís earlier decision in Bush. The district court affirmed, and the husband appealed.
On appeal, the husband argued that the wifeís motion to amend the judgment was procedurally incorrect and, alternatively, that the court erred in concluding that the pension award was nondischargeable. The United States Court of Appeals, Eighth Circuit, reversed the lower courtís decision, agreeing with the husband that the decision should be reversed on procedural grounds. The court then turned to the question of the dischargeability of the pension award and concluded that the husbandís obligation was dischargeable in bankruptcy.
The court proceeded to distinguish its earlier decision in Bush from the facts of the case before it. The Ellis court noted that the divorce judgment in Bush awarded the wife a fixed portion of the husbandís pension benefits, payable when received by the husband, as her "sole and separate property." 72 F.3d at 632. The court noted that the Bush court found that the wifeís interest was not included as part of the husbandís bankruptcy estate. Turning to the facts of the case before it, the court found that the pension award was not subject to the same treatment as the one in Bush since the wifeís interest in Ellis was distributed through the immediate offset method as opposed to the deferred distribution approach used in Bush.
Here, [the wife] was not awarded a fixed share of payments to be received by [the husband] from his employerís pension and profit-sharing plan as her "sole and separate property," as was the case in Bush. Instead, the divorce court awarded [the wife] a sum certain that represented her "interest" in the plan and in Vantage Footwear, but it was not in any way linked to pension or profit-sharing payments to be received by [the husband]. If the amount was to have been more than a division of property, that is, if it was based on actual payments due [the husband] from an ERISA-regulated pension and profit-sharing plan, then a QDRO should have and presumably would have been executed. But the installment payments owed to [the wife] were not [the wifeís] "sole and separate property" payable by [the husband] only when he received payments from his companyís plan. Rather, the $300,000 was a division of marital property representing the divorce courtís determination of [the wifeís] present interest in the pension and profit-sharing plan and in the company itself. It was owed to [the wife] regardless of any later changes in the value of the plan or of the company.
Id. at 632-33.
Although the portion of the courtís opinion in Ellis holding that the pension award was dischargeable could be considered dicta as the court had already concluded that the lower courtís decision should be reversed on procedural grounds, this part of the opinion is especially noteworthy considering the courtís complete rejection of its earlier decision in Bush that deferred distribution pension awards are not dischargeable. This puts the Ninth Circuit at odds with the Eighth Circuit, which has held that there is no fundamental difference between deferred distribution and immediate offset pension awards for purposes of dischargeability in bankruptcy. See Gendreau;Lowenschuss. The Eighth Circuit follows the more reasoned rule there is no difference in the ownership interest received by the recipient spouse through either an immediate offset or a deferred distribution pension award despite the differences in these two methods. Only the property interest granted the recipient spouse should matter in determining whether such an award should be dischargeable in bankruptcy.
Despite the better-reasoned approach of the Eighth Circuit, the Seventh Circuit also follows the Ninth Circuit in holding that immediate offset pension awards may be dischargeable in bankruptcy.
In In re Reines, 142 F.3d 970 (7th Cir. 1998), cert. denied, Kolodziej v. Reines, 525 U.S. 1068, 119 S. Ct. 797, 142 L. Ed. 2d 659 (1999), the wife was awarded a one-half interest in the husbandís pension pursuant to the partiesí divorce. The wife was to begin to receive her benefits when the husband turned 50. The trial court also entered a QDRO to effectuate the division of the husbandís pension. It was later determined that the husbandís pension was exempt from property division, and, thus, the trial courtís award to the wife was unenforceable under state law. The wife sought to reopen the divorce judgment based on this fact. The court heard evidence as to the value of the wifeís interest in the pension and ultimately awarded her a lump-sum award as a replacement for her previous monthly award.
The husband later filed for bankruptcy under Chapter 13. The wife was the husbandís primary unsecured creditor as a result of the lump-sum award. The husband proposed a plan in which he would pay off his unsecured debts at 50% of their value. The wife objected to the dischargeability of the husbandís obligation. The wife argued that the lump-sum award was in the nature of support or maintenance and could not be discharged. The husband contended that the award merely represented a division of marital property which was dischargeable. The bankruptcy court agreed with the husband and held that the lump-sum award constituted a dischargeable property division. This decision was then affirmed by the district court.
The United States Court of Appeals, Seventh Circuit, likewise affirmed the bankruptcy courtís decision, holding that the lump-sum award was a division of property and not a debt in the nature of support or maintenance. The court noted that the burden was on the wife to establish that the debt was nondischargeable. The court then engaged in a review of numerous factors to determine the proper classification of the lump-sum award.
How, then, is [the husbandís] debt to be classified? The answer depends on the intent of the parties. Unfortunately for [the wife], there is no clear intent expressed to treat the debt as maintenance in the settlement papers. And categorizing a marital debt as maintenance in the absence of an expression of intent is not a default position. So with no clear intent expressed, we must look to other factors to try and figure out what the parties had in mind. This is a difficult task, and some courts have even devised elaborate "tests" to aid the quest. See, e.g., In re Daulton, 139 B.R. 708 (Bankr. C.D. Ill. 1992) (listing 20 factors). The end result of an exercise of this sort is usually a mixed bag with factors pointing in both directions. Such is the case here. [The wife] has several factors which auger in her favor. But so does [the husband].
142 F.3d at 973 (courtís emphasis). The court concluded that, at best, the factors in the wifeís favor brought her position into a "dead heat" with the factors in the husbandís favor. Id. Thus, the court found that since the wife had the burden of proof she necessarily failed to meet it if the factors in her favor did not trump the factors in the husbandís favor.
For other cases holding that immediate offset pension awards are dischargeable in bankruptcy, see In re Varrone, 269 B.R. 475 (Bankr. D. Conn. 2001) (courtís order to transfer lump sum from husbandís pension to wife constituted a division of marital property and was dischargeable), and In re Key, 1996 OK 130, 930 P.2d 824 (Okla. 1997) (in lieu of dividing husbandís pension, court awarded wife $38,000 payable in monthly installments; obligation was in the form of a property settlement and was dischargeable).
Pension awards made as part of the equitable distribution of marital property are generally not considered dischargeable in bankruptcy. While these pension awards get limited immunity from discharge under 11 U.S.C. 523(a)(15), most courts have eliminated the need to perform the analysis required by this provision by adopting the majority rule that the recipient spouseís interest in the award does not become part of the bankruptcy estate in the first place. The majority rule functions to protect the property interest of the recipient spouse as intended by the final divorce decree. The failure to protect this interest would necessarily result in an inequitable windfall to the debtor spouse. Courts have also reached similar results through the application of other theories, such as finding the existence of a constructive trust or that the pension award was intended as nondischargeable support or maintenance. Although the courts that have applied these alternative theories have reached the correct result, they do so by ignoring the nature of the recipient spouseís issue and, therefore, do not offer the same degree of protection for the recipient spouse as does the majority rule. The superiority of the majority rule is further evidenced by the growing number of jurisdictions that are also embracing this rule when addressing the dischargeability of immediate offset pension awards in addition to deferred distribution pension awards.
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