Business Law

Business Law News 2016, ISSUE 2

The Community Discharge: The Good, The Bad, And The Ugly

Elyza P. Eshaghi

Elyza P. Eshaghi is an associate attorney at Shulman Hodges & Bastian LLP. Ms. Eshaghi concentrates her practice in Commercial Law and Bankruptcy and is experienced in various aspects of litigation, trustee representation, creditor representation, and debtor representation in the insolvency and bankruptcy context.

As the famous saying goes, the Devil himself could receive a discharge if he were married to Snow White.1 What does this mean, exactly? Generally, the rule in bankruptcy is that an individual’s discharge relieves only the "honest but unfortunate" debtor of liability for a debt. Anyone else liable on the debt with the debtor remains liable notwithstanding the discharge received by the debtor.2 The general rule is markedly different in community property states.3 Contrary to the general rule, sometimes a "dishonest" non-filing spouse is able to reap the benefits of a filing spouse’s discharge through what is commonly known as the "community discharge." In order to better understand the impact of a community discharge and how it works, it is important to note how community property is treated in bankruptcy and the basic principles behind a bankruptcy discharge. The best way to examine these concepts is in the context of a voluntary individual chapter 7 bankruptcy.

Once an individual files a voluntary petition under chapter 7 of the Bankruptcy Code, an "estate" is created.4The bankruptcy estate comprises all "legal or equitable interests of the debtor in property," and all "interests of the debtor and the debtor’s spouse in community property," as of the commencement of the case.5 Generally, property interests and liabilities are determined under state law, but federal law determines how those interests are treated in a bankruptcy proceeding. Butner v. United States, 440 U.S. 48 (1979). Thus, we look to state law to determine what constitutes community property, and we look to 11 U.S.C. §§ 541(a)(2)(A)-(B) to determine what items of community property will be included in a married person’s bankruptcy estate. Under 11 U.S.C. § 541(a)(2) (A), all community property under the sole, equal, or joint management and control of the debtor comes into the estate. Under 11 U.S.C. § 541(a)(2)(B), all community property that is subject to recovery for a claim against the debtor, or for a claim against the debtor and the debtor’s spouse, comes into the estate. Thus, even if the debtor files individually, the non-filing spouse’s interest in community property passes into the estate.6

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