Monday, August 31, 2015

What Does Gay Marriage Mean for Bankruptcy?




By Stephen W. Sather
Barron & Newburger, P.C.
Austin, TX

 
The recent Supreme Court decision requiring states to recognize same-sex marriages has generated substantial controversy in the political world, but what does it mean for bankruptcy courts?   The obvious answer is that more people will be able to file joint bankruptcy petitions than before.   However, going from a system where some marriages were legally recognized in certain jurisdictions but not others to one where they must be permitted everywhere is likely to result in confusion for practitioners and courts alike for years to come.    This post will attempt to point out some of the issues involved.

A Short History of Same-Sex Marriage in the United States

For most of the nation’s history, marriage was limited to couples of different genders.   In 1996, Congress passed the Defense of Marriage Act which prohibited the United States government from recognizing any marriage other than one between a man and a woman.   In 2003, the Massachusetts Supreme Court entered a ruling which made that state the first in the nation to recognize same sex marriage.    As a few other states followed suit, it became possible to have a marriage which was sanctioned by a particular state but not by the federal government.


The DOMA era is illustrated by In re Kandu, 315 B.R. 123 (Bankr. W.D. Wash. 2004) in which two women who had been legally married in Vancouver attempted to file a joint bankruptcy petition.   The Court ruled that DOMA meant that the court could not allow the joint filing.   As a result, the women were given the choice to sever their cases or face dismissal.

In 2011, some eighteen bankruptcy judges in the Central District of California signed on to an opinion holding that DOMA was unconstitutional and allowing two men who had legally married in California to file a joint petition.    In re Balas, 449 B.R. 567 (Bankr. C.D. Cal. 2011).   The Supreme Court followed suit two years later.    United States v. Windsor, 570 U.S. ___, 133 S. Ct. 2675, 186 L. Ed. 2d 808 (2013).    At this point in time, Bankruptcy Courts could recognize marriages which were legal in a state but states were not compelled to allow same-sex marriages.   In the case of In re Matson, 509 B.R. 860 (Bankr. E.D. Wisc. 2014), a same-sex couple who had been legally married in Iowa sought to file bankruptcy in Wisconsin, which did not recognize same-sex marriage.   The Court ruled that while Wisconsin was not required to allow same-sex marriage, the Full Faith and Credit clause required it to recognize a legally-binding marriage from Iowa.

Earlier this year, the Supreme Court held that states could not constitutionally withhold approval to same-sex couples to marry.   Obergefell v. Hodges, 135 S.Ct. 2584 (2015).    It also held that states could not refuse to recognize same-sex marriages performed in another state.    Thus, both the federal government and the states were compelled to give same same-sex couples the same access to marriage as opposite-sex couples.    

The Difficult Case of Fred and Barney

The changing nature of marriage over the past twenty years can lead to some difficult issues in bankruptcy.    Take the case of Fred and Barney, a couple who were legally married in Massachusetts in 2004 and moved to Texas the same year.    They formed a limited liability company which opened several fitness centers.    Additionally, Fred opened a practice as an insurance agent on the side which he operated as a sole proprietor.    

One day Barney is leading a cross-fit workout when an overweight man suffers a heart attack.   Distraught, Barney attempts to perform CPR but neglects to call 911.   Tragically the man dies.   His estate sues Barney but not the LLC for negligence.   After a trial marred by gratuitous references to Barney’s sexuality, a Texas jury renders a $7 million verdict in 2013.   Unfortunately, Fred had failed to submit the payment for the LLC’s insurance because he had lost the money gambling at a riverboat casino in Louisiana.   As a result, Barney is liable for the judgment without any insurance coverage. 
In January 2015, Barney files a chapter 7 petition in Texas.   He claims the couple’s homestead, which was purchased 1,200 days before bankruptcy and has equity of $300,000, as exempt.    He also claims $60,000 of personal property as exempt based on the Texas exemption for a family.

The Trustee objects to Barney’s homestead exemption on the basis that the homestead exceeds the cap of $155,675  under 11 U.S.C. Sec. 522(p) and objects to the personal property exemption on the basis that a single person is only entitled to exempt $30,000 worth of personal property.    The judge sustains both objections on June 25, 2015.   The next day Obergefell is decided.   Barney moves for reconsideration on the basis that:  1)  he should be able to claim double the amount of the cap because he and Fred were legally married and 2) he is entitled to the higher personal property exemption for the same reason.

Meanwhile, the Trustee sues Fred for turnover, alleging that Fred’s 50% interest in the LLC and his sole proprietorship are property of the estate.   He also sues Fred for negligence for gambling away the money to pay the insurance premium.    In depositions, Fred and Barney refuse to testify against each other, citing the marital communications privilege.    

Discussion

Several issues depend on when Fred and Barney’s marriage became legally recognized.    If the marriage was valid from its inception in 2004, then Fred and Barney were legally married throughout their time in Texas. On the other hand, if the marriage did not become legal until the Obergefell decision, then they were not legally married on the petition date.    If the marriage was not legally recognized on the date of the petition, but became legal subsequently, does this relate back or does the legal status on the petition date control?

If Obergefell validated a marriage which had always existed, then Fred and Barney acquired community property throughout their time in Texas.   Fred’s interest in the LLC and his insurance practice would probably constitute sole management community property.   Under 11 U.S.C. Sec. 541(a)(2), in a community property state, any community property of the non-filing spouse which is liable for a debt of the filing spouse is part of the bankruptcy estate.   Under Texas law, a tort debt, such as one for negligence, can be collected from the sole management community property of the other spouse.     Thus, if the marriage related back, then the Trustee could force Fred to turn over his sole management community property.   This would give the Trustee control of 100% of the ownership interest in the LLC.   By the same token, if Fred and Barney were legally married on the petition date, Barney could claim the higher personal property exemption for a family.

The homestead exemption is also affected by the couple's legal status.   If they were married on the petition date, then the homestead comes into the estate and is subject to the cap for property acquired within 1,215 days before bankruptcy.   Just like the non-filing spouse in Matter of Kim,  748 F.3d 647 (5th Cir. 2014), Fred stands to lose his interest in the marital homestead.   Not only that, because Fred did not file bankruptcy, the couple is not entitled to double the cap.    On the other hand, if Fred and Barney were not married, then they would each own a one-half undivided interest in the property and Barney's equity in the property would be below the cap.

The Trustee’s suit against Fred poses a different set of problems.    I don’t know if there is anything in Texas family law which prohibits one spouse from suing the other during marriage, although it is common for tort actions to be part of divorce suits.   The Marital Communications privilege would prevent Fred or Barney from being compelled to testify about private conversations between them, but it is not a blanket immunity from testifying such as would apply in a criminal case.    

Conclusion

Marriage comes with benefits and detriments.    In Obergefell, Justice Kennedy described marriage as “essential to our most profound hopes and aspirations.”    However, under the hypothetical posed here, Fred and Barney would have been better off as single individuals.   While this is true for opposite sex couples as well, what makes this situation unique is that, at least for the time being, we don't know when the marriage became legally effective.   I think there are non-frivolous arguments on both sides of the issue.   On the one hand,  the logic of Obergefell dictates that the states never had authority to ban same-sex marriage so that the marriage was always legitimate even if the State of Texas did not know it at the time.   On the other hand, you can argue that because Texas did not recognize the marriage as legal until it was compelled to do so, that the state's community property laws did not affect the couple until the Supreme Court forbade the state from withholding recognition.     I feel sorry for the bankruptcy judges who will have to sort this out.  After Obergefell, same sex couples may know the joy of marriage and the agony of divorce.   They can also reap both the benefits and detriments of having their property joined together.  
(Note:  I have written about community property because that is what we have in Texas and it is what I am familiar with.  There are no doubt a whole different set of issues in non-community property states.   Please don't ask me how this would apply to a tenancy by the entireties.).

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