Collecting Support from a Payor Who Has Filed Under Chapter 11

Pre 2005 Rules

Prior to 2005, as a category, the individual Chapter 11 debtor's post-petition earnings were excluded from the property of the bankruptcy estate. Therefore, the creditor could institute proceedings in state court to collect support arrears from those earnings. In practice, the problem was more complicated. In a Chapter 11 bankruptcy proceeding, the bankruptcy court is interested not only in assets that are part of the property of the bankruptcy estate as of the filing date, but also in the stream of income that the debtor anticipates earning after the bankruptcy filing since, under the bankruptcy plan, that stream of income will be committed, perhaps for several years, to satisfy the debtor's obligations to his creditors. Therefore, in practice creditors had to get permission of the bankruptcy court to proceed in state court to collect support arrears from post-petition income.

Post 2005 Rules

Congress amended the Bankruptcy Code in 2005 by adopting the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). That statute added several features relevant to collecting support in a Chapter 11 proceeding. Congress created the category of 'domestic support obligations' and included within it pre- and post-petition support obligations. Section 362(b)(2)(C) adds an exception to the automatic stay for 'the withholding of income that is property of the estate or property of the debtor for payment of a domestic support obligation under a judicial or administrative order or a statute.' For individual Chapter 11 debtors, new ' 1115(a)(2) broadens the scope of 'property of the estate' to include property 'the debtor acquires' and 'earnings from services performed by the debtor' after the filing of the Chapter 11 petition but while that case is pending. It is important to note here that a Chapter 11 case is pending until the plan is completed, which can take years. This latter provision creates inherent tension in Chapter 11 proceedings between the automatic stay provisions and the definition of bankruptcy estate property.

The support collection exception to the automatic stay permits support creditors to collect out of the debtor's property but not out of the bankruptcy estate's property. Prior to the 2005 amendments, a support creditor in a Chapter 11 case could proceed in state court to collect support arrears from post-petition earnings as those earnings were excluded from the bankruptcy estate. With the broadening of the definition of 'property of the estate' to include post-petition earnings, that remedy and that forum are no longer available. Under current law, if a Chapter 11 debtor owes support, the creditor is required to seek permission of the bankruptcy court to satisfy those arrears even out of post-petition income. If the creditor seeks relief in the state court, the debtor can move to block the proceedings, arguing that the post-petition income is part of the bankruptcy estate and that, therefore, only the bankruptcy court can authorize the use of estate property for personal expenses. Further, the creditor may be subject to sanctions in the bankruptcy court for violating the automatic stay if she even files a state court enforcement proceeding. See, e.g., Altchek v. Altchek, 124 B.R. 944 (Bankr. S.D.N.Y. 1991) (ex-wife forced to defend sanctions motion for seeking enforcement in state court of support obligations). The state court, out of respect for federal law, is likely to direct the parties to seek permission to proceed from the bankruptcy court. Since the barrier to state court enforcement springs from the categorization of the property from which collection is sought and not from the nature of the obligation, this rule applies equally to pre- and post-petition support obligations.

In a similar context under the Bankruptcy Code, there is experience with the tension between the automatic stay and the broader definition of the bankruptcy estate that highlights the ineffectiveness of the support collection exception to the stay. Prior to the adoption of BAPCPA, under Chapter 13, which is commonly used by individuals to 'reorganize' their financial affairs, post-petition earnings were included in the bankruptcy estate. In those situations, the domestic support order exception ”has little or no practical effect ” because '362(b)(2)(B) does not except from the stay actions against property of the estate.' 3 COLLIER ON BANKRUPTCY '362.05[2] at p. 362-52.

Likewise, BAPCPA will have the same effect in Chapter 11 proceedings, particularly since it incorporated into Chapter 11 virtually the same language as had already been in place in Chapter 13.

The support creditor of an individual Chapter 11 debtor seeking 'collection of a domestic support obligation' under ' 362(b)(2)(B) now must go to federal bankruptcy court and request an order authorizing such collection. In the bankruptcy court, the support creditor would be well advised to be prepared to prove her 'need' for the support and that her needs should come before the claims of other creditors. However, she should also understand that she is asserting her position in a legal environment that does not necessarily embrace her claims. See, e.g., Young, 'BAPCPA'S Changes to the Automatic Stay: The 2005 Amendments and Court Decisions,' 2 29^th Annual Current Developments in Bankruptcy and Reorganization 61 Practicing Law Institute 2007 ('It is possible to argue ' that domestic relations creditors are favored unduly at the expense of other creditors'). In effect, these amendments to the Bankruptcy Code federalize the law of support and make bankruptcy court the forum with exclusive jurisdiction to adjudicate the support issues.

'Saving the Day'?

Does the exception in ' 362(b)(2)(C), also adopted as part of BAPCPA in 2005, save the day? It creates a new exception to the automatic stay for the collection of a domestic support obligation 'with respect to the withholding of income that is property of the estate or property of the debtor for payment of a domestic support obligation under a judicial or administrative order or a statute.' Under this exception to the automatic stay, bankruptcy property is used to pay the support creditor. This statute expresses the policy preference for the continuation of the payment of domestic support obligations and, to that extent, provides force for the argument that the bankruptcy court should give great consideration to the support creditor's needs.

At a minimum, the provision permits the continuation of 'withholding' from income that was in place prior to the filing of the bankruptcy petition. Does 'withholding' also include executions? Liens? Whether the statute permits the bankruptcy court to authorize new post-petition 'withholding' is an unresolved question, though at least one court already has found that 'Congress did not intend to automatically stay the collection of a domestic support obligation, whether it arises from a pre or postpetition garnishment action from property of the estate or property of the debtor.' In re Gellington, 363 B.R. 497, 502 (Bankr. N.D. Tex. 2007). In Gellington, the 'withholding' existed before the filing of the bankruptcy petition and post-petition the 'withholding' was expanded. While the statute permits the continuation of existing withholding regardless of the stay, the support creditor may ensure its continuation by getting the endorsement of the bankruptcy court.

It would be prudent for her to get the bankruptcy court's approval prior to sending a new withholding instrument to avoid a motion for sanctions as occurred in Gellington and in Altchek. If the support creditor is not already receiving support pursuant to an existing withholding at the time of the bankruptcy filing, it is not at all clear that she is free to seek a new order in state court without bankruptcy court approval because of the apparent conflict between ' 362(b)(2)(C) and
' 362(b)(2)(B). If a state court proceeding will result in a 'withholding' of post-petition income, such as through the court entering a wage garnishment order requiring that a portion of the debtor's income be 'withheld' to pay support obligations, such 'withholding' appears permissible pursuant to ' 362(b)(2)(C). However, since such 'withholding' also results in 'the collection of a domestic support obligation' from property of the estate, it is outside the scope of the ' 362(b)(2)(B) automatic stay exception and thus apparently statutorily prohibited. In this situation, it is not clear that post-petition income can be lawfully attached. Gellington is not precedent for such a procedure since there the withholding order already existed and the post-petition withholding was issued in error and it was not the result of proceedings instituted to 'collect' support.

Incentive to File

These rules may provide a debtor with an incentive to file a Chapter 11 petition. He may be able to reduce his support payments and postpone collection of arrears, although confirmation of the plan depends upon payment in full of the arrears.
' 1129(a)(9)(B). These advantages, however, come at a price. 'Essentially all property an individual debtor obtains while the Chapter 11 case is pending is now property of the bankruptcy estate.' The debtor can still 'buy bread' and expend money in the ordinary course of business under '363(c)(1), but anything beyond that, including counsel fees for the debtor's matrimonial attorney, requires the bankruptcy court's approval. In re Goldstein, 2007 WL 1970263, 2007 Bankr. Lexis 2325 (Bankr. C.D. Cal. 2007); see also In re Rodriguez, 41 B.R. 774 (Bankr. D. Fla. 1984) (authorizes use of property of the estate in a Chapter 11 case for the payment of personal and dependents' living expenses).

Conclusion

Matrimonial attorneys may believe that the Bankruptcy Code protects support creditors, insuring that they will be able to collect both ongoing support and support arrears. While it may be true that the support obligations cannot be discharged, during the pendency of a Chapter 11 case ' and that could be for years ' collection of support is increasingly a matter of federal law to be adjudicated by a federal court that is concerned with balancing the claims of the support creditor against the claims of all the other creditors, including banks and credit card companies. Garnishment or income 'withholding' within the scope
' 362(b)(2)(C) may not always be an option, such as where the individual debtor lacks a consistent income stream that could be subject to withholding. In such cases, the availability to individuals of Chapter 11 protection can function as a significant barrier to the collection of support, potentially extending the time it will take to collect the support, increasing the cost of collection, and forcing the support creditor to compete with large institutions for the allocation of the debtor's income. Whether this is what Congress intended is unclear.

Elliot J. Wiener, a member of this newsletter's Board of Editors, is the Chair of Phillips Nizer's Matrimonial & Family Law Department. Peter Harutunian is an associate in the Bankruptcy and Restructuring Group at the firm.

Bankruptcy filings under Chapter 7 are generally available to individuals seeking a fresh economic start. A Chapter 7 proceeding involves the appointment of a trustee who collects assets and pays debts, with any unpaid debts subject to discharge unless a particular creditor is entitled to avoid the discharge of the obligation under specific statutory provisions. By contrast, bankruptcy filings under Chapter 11 are generally available to reorganize a business, although filings under this chapter are available to individuals as well. Chapter 11 individual bankruptcy filings typically do not entail the discharge of obligations until all payments under the reorganization plan have been made. In a Chapter 11 'debtor in possession' proceeding, the debtor is appointed as a kind of self-trustee who collects his or her own assets, pays obligations, and during the course of the Chapter 11 proceeding reports to the court, and thereby to the creditors, with regard to assets, liabilities, income, and expenses.

Of primary concern to matrimonial creditors and debtors alike are the concepts of 'property of the estate' and the 'automatic stay.' Upon the filing of the bankruptcy petition, the bankruptcy 'estate' is created. It is comprised of all the 'property of the estate' from which payment will be made to the debtor's creditors and from which assets will be allocated to the debtor's reorganization. Section 541(a)(1) of the Bankruptcy Code provides that 'property of the estate' includes 'all legal or equitable interests of the debtor in property as of the commencement of the case.' Also arising upon the filing of a bankruptcy petition, pursuant to ' 362(a) of the Bankruptcy Code, is an 'automatic stay' of all litigation, lien execution, and other actions involving the property of the estate or the debtor. Significantly for support creditors, the Code carves out an exception to the automatic stay for 'commencement or continuation of a ' proceeding ' for the dissolution of a marriage,' ' 362(b)(2)(A), and for 'collection of a domestic support obligation,' ' 362(b)(2)(B), but only if these proceedings do not seek to collect or determine 'property of the estate.' This latter provision links the automatic stay's support exception to the concept of bankruptcy estate property.

In a Chapter 7 filing, income that was earned or accrued and paid before the filing of the petition is clearly 'property of the estate,' and income that was earned or accrued and paid after the filing of the bankruptcy petition is not 'property of the estate.' This bright line distinction is important because a support creditor is permitted to invoke state law remedies to collect out of post-petition earnings pre- and post-petition support obligations as these earnings are not part of the Chapter 7 bankruptcy estate.

Pre 2005 Rules

Prior to 2005, as a category, the individual Chapter 11 debtor's post-petition earnings were excluded from the property of the bankruptcy estate. Therefore, the creditor could institute proceedings in state court to collect support arrears from those earnings. In practice, the problem was more complicated. In a Chapter 11 bankruptcy proceeding, the bankruptcy court is interested not only in assets that are part of the property of the bankruptcy estate as of the filing date, but also in the stream of income that the debtor anticipates earning after the bankruptcy filing since, under the bankruptcy plan, that stream of income will be committed, perhaps for several years, to satisfy the debtor's obligations to his creditors. Therefore, in practice creditors had to get permission of the bankruptcy court to proceed in state court to collect support arrears from post-petition income.

Post 2005 Rules

Congress amended the Bankruptcy Code in 2005 by adopting the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). That statute added several features relevant to collecting support in a Chapter 11 proceeding. Congress created the category of 'domestic support obligations' and included within it pre- and post-petition support obligations. Section 362(b)(2)(C) adds an exception to the automatic stay for 'the withholding of income that is property of the estate or property of the debtor for payment of a domestic support obligation under a judicial or administrative order or a statute.' For individual Chapter 11 debtors, new ' 1115(a)(2) broadens the scope of 'property of the estate' to include property 'the debtor acquires' and 'earnings from services performed by the debtor' after the filing of the Chapter 11 petition but while that case is pending. It is important to note here that a Chapter 11 case is pending until the plan is completed, which can take years. This latter provision creates inherent tension in Chapter 11 proceedings between the automatic stay provisions and the definition of bankruptcy estate property.

The support collection exception to the automatic stay permits support creditors to collect out of the debtor's property but not out of the bankruptcy estate's property. Prior to the 2005 amendments, a support creditor in a Chapter 11 case could proceed in state court to collect support arrears from post-petition earnings as those earnings were excluded from the bankruptcy estate. With the broadening of the definition of 'property of the estate' to include post-petition earnings, that remedy and that forum are no longer available. Under current law, if a Chapter 11 debtor owes support, the creditor is required to seek permission of the bankruptcy court to satisfy those arrears even out of post-petition income. If the creditor seeks relief in the state court, the debtor can move to block the proceedings, arguing that the post-petition income is part of the bankruptcy estate and that, therefore, only the bankruptcy court can authorize the use of estate property for personal expenses. Further, the creditor may be subject to sanctions in the bankruptcy court for violating the automatic stay if she even files a state court enforcement proceeding. See, e.g. , Altchek v. Altchek , 124 B.R. 944 (Bankr. S.D.N.Y. 1991) (ex-wife forced to defend sanctions motion for seeking enforcement in state court of support obligations). The state court, out of respect for federal law, is likely to direct the parties to seek permission to proceed from the bankruptcy court. Since the barrier to state court enforcement springs from the categorization of the property from which collection is sought and not from the nature of the obligation, this rule applies equally to pre- and post-petition support obligations.

In a similar context under the Bankruptcy Code, there is experience with the tension between the automatic stay and the broader definition of the bankruptcy estate that highlights the ineffectiveness of the support collection exception to the stay. Prior to the adoption of BAPCPA, under Chapter 13, which is commonly used by individuals to 'reorganize' their financial affairs, post-petition earnings were included in the bankruptcy estate. In those situations, the domestic support order exception ”has little or no practical effect ” because '362(b)(2)(B) does not except from the stay actions against property of the estate.' 3 COLLIER ON BANKRUPTCY '362.05[2] at p. 362-52.

Likewise, BAPCPA will have the same effect in Chapter 11 proceedings, particularly since it incorporated into Chapter 11 virtually the same language as had already been in place in Chapter 13.

The support creditor of an individual Chapter 11 debtor seeking 'collection of a domestic support obligation' under ' 362(b)(2)(B) now must go to federal bankruptcy court and request an order authorizing such collection. In the bankruptcy court, the support creditor would be well advised to be prepared to prove her 'need' for the support and that her needs should come before the claims of other creditors. However, she should also understand that she is asserting her position in a legal environment that does not necessarily embrace her claims. See, e.g., Young, 'BAPCPA'S Changes to the Automatic Stay: The 2005 Amendments and Court Decisions,' 2 29^th Annual Current Developments in Bankruptcy and Reorganization 61 Practicing Law Institute 2007 ('It is possible to argue ' that domestic relations creditors are favored unduly at the expense of other creditors'). In effect, these amendments to the Bankruptcy Code federalize the law of support and make bankruptcy court the forum with exclusive jurisdiction to adjudicate the support issues.

'Saving the Day'?

Does the exception in ' 362(b)(2)(C), also adopted as part of BAPCPA in 2005, save the day? It creates a new exception to the automatic stay for the collection of a domestic support obligation 'with respect to the withholding of income that is property of the estate or property of the debtor for payment of a domestic support obligation under a judicial or administrative order or a statute.' Under this exception to the automatic stay, bankruptcy property is used to pay the support creditor. This statute expresses the policy preference for the continuation of the payment of domestic support obligations and, to that extent, provides force for the argument that the bankruptcy court should give great consideration to the support creditor's needs.

At a minimum, the provision permits the continuation of 'withholding' from income that was in place prior to the filing of the bankruptcy petition. Does 'withholding' also include executions? Liens? Whether the statute permits the bankruptcy court to authorize new post-petition 'withholding' is an unresolved question, though at least one court already has found that 'Congress did not intend to automatically stay the collection of a domestic support obligation, whether it arises from a pre or postpetition garnishment action from property of the estate or property of the debtor.' In re Gellington, 363 B.R. 497, 502 (Bankr. N.D. Tex. 2007). In Gellington, the 'withholding' existed before the filing of the bankruptcy petition and post-petition the 'withholding' was expanded. While the statute permits the continuation of existing withholding regardless of the stay, the support creditor may ensure its continuation by getting the endorsement of the bankruptcy court.

It would be prudent for her to get the bankruptcy court's approval prior to sending a new withholding instrument to avoid a motion for sanctions as occurred in Gellington and in Altchek. If the support creditor is not already receiving support pursuant to an existing withholding at the time of the bankruptcy filing, it is not at all clear that she is free to seek a new order in state court without bankruptcy court approval because of the apparent conflict between ' 362(b)(2)(C) and
' 362(b)(2)(B). If a state court proceeding will result in a 'withholding' of post-petition income, such as through the court entering a wage garnishment order requiring that a portion of the debtor's income be 'withheld' to pay support obligations, such 'withholding' appears permissible pursuant to ' 362(b)(2)(C). However, since such 'withholding' also results in 'the collection of a domestic support obligation' from property of the estate, it is outside the scope of the ' 362(b)(2)(B) automatic stay exception and thus apparently statutorily prohibited. In this situation, it is not clear that post-petition income can be lawfully attached. Gellington is not precedent for such a procedure since there the withholding order already existed and the post-petition withholding was issued in error and it was not the result of proceedings instituted to 'collect' support.

Incentive to File

These rules may provide a debtor with an incentive to file a Chapter 11 petition. He may be able to reduce his support payments and postpone collection of arrears, although confirmation of the plan depends upon payment in full of the arrears.
' 1129(a)(9)(B). These advantages, however, come at a price. 'Essentially all property an individual debtor obtains while the Chapter 11 case is pending is now property of the bankruptcy estate.' The debtor can still 'buy bread' and expend money in the ordinary course of business under '363(c)(1), but anything beyond that, including counsel fees for the debtor's matrimonial attorney, requires the bankruptcy court's approval. In re Goldstein, 2007 WL 1970263, 2007 Bankr. Lexis 2325 (Bankr. C.D. Cal. 2007); see also In re Rodriguez, 41 B.R. 774 (Bankr. D. Fla. 1984) (authorizes use of property of the estate in a Chapter 11 case for the payment of personal and dependents' living expenses).

Conclusion

Matrimonial attorneys may believe that the Bankruptcy Code protects support creditors, insuring that they will be able to collect both ongoing support and support arrears. While it may be true that the support obligations cannot be discharged, during the pendency of a Chapter 11 case ' and that could be for years ' collection of support is increasingly a matter of federal law to be adjudicated by a federal court that is concerned with balancing the claims of the support creditor against the claims of all the other creditors, including banks and credit card companies. Garnishment or income 'withholding' within the scope
' 362(b)(2)(C) may not always be an option, such as where the individual debtor lacks a consistent income stream that could be subject to withholding. In such cases, the availability to individuals of Chapter 11 protection can function as a significant barrier to the collection of support, potentially extending the time it will take to collect the support, increasing the cost of collection, and forcing the support creditor to compete with large institutions for the allocation of the debtor's income. Whether this is what Congress intended is unclear.

Elliot J. Wiener, a member of this newsletter's Board of Editors, is the Chair of Phillips Nizer's Matrimonial & Family Law Department. Peter Harutunian is an associate in the Bankruptcy and Restructuring Group at the firm.