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The Phantom Discharge in Bankruptcy

While the Phantom of the Opera was a work of fiction, the phantom discharge is the real deal. If you are collecting a judgment in California, generally all property that is acquired during the course of a marriage belongs jointly to both spouses, even if only one spouse is on the title. This property is called "community property," and it is owned by both spouses as tenants in the entirety. In California, even if only one spouse signed the paperwork for a debt, most debts that arise during the course of the marriage are owed by the community (that is by both spouses). Read more about debt collection and community property here.

What happens if one of the spouses, either the debtor spouse or the non-debtor spouse files for bankruptcy (Chapter 7 or 13) while you are collecting upon your judgment? In California, all community property is included in the bankruptcy estate, even if only one spouse files for bankruptcy. Thus, while the separate property of a non-filing spouse does not become part of the bankruptcy estate, it is crucial for your collections' attorney to assess the effect of the bankruptcy filing as it relates to the creditor's claims and potential recovery against community property.

In a community property state, such as California, even if only one spouse declares bankruptcy, all dischargeable claims by creditors against the community property are discharged. This is sometimes called a "phantom discharge" because it can protect the non-filing spouse against claims against the community property, even though that spouse has not gone through the bankruptcy process. Thus, in the instance where the judgment debtor spouse is also the petitioner on the bankruptcy, the 1439339521_Earnings_wages_wage_takings.pngdischarge order operates as an injunction against collection from the debtor personally and from the debtor's property, and it also enjoins a creditor from collecting -- from the community property of the debtor or the debtor's spouse -- an allowable community claim that is not excluded from the discharge.

In other words, the only community claim that a creditor may continue to collect upon post-discharge is a community claim that is excepted from discharge or that would be excepted from discharge in a case concerning the debtor's spouse. 11 U.S.C. §524(a)(3). This phantom discharge for the non-filing spouse continues as long as both spouses are alive and married.

Another unusual aspect of single-spouse bankruptcy filing is that an adversary proceeding in which an objection is made to the dischargeability of a debt incurred by a debtor's non-filing spouse must be filed within the same time limit as an objection against the debtor. This often is called a "hypothetical discharge." In this instance, counsel for the creditor must properly and timely object to a community property discharge accorded the non-filing spouse by filing an adversary proceeding for a determination that the debt is hypothetically non-dischargeable as to the non-debtor spouse. Once that is determined, the community does not receive a discharge and creditor may proceed against after-acquired community property. As mentioned, the tricky part is making sure to file the adversary proceeding to object to the hypothetical discharge of the non-debtor spouse, within the time limits set by the bankruptcy code. The strict time deadlines generally provide that a complaint filed pursuant to §§ 523(c) and/or 727(a) must be filed no later than sixty (60) days following the first date set for the meeting of creditors. See, Federal Rules of Bankruptcy Procedure 4007(c) and 4004(a)

Otherwise, creditors of either spouse are barred from asserting claims against the after-acquired community property of the debtor and the non-debtor spouse, and attempts to collect a claim from the community property of the debtor and non-debtor spouse would violate 11 U.S.C. Section 524(a)(3). See, In re Kimmel, 378 B.R. 630, 636 (9th Cir.BAP 2007), citing Burman v. Homan (In re Homan), 112 B.R. 356, 360 (9th Cir. BAP 1989).

For more information on collecting a judgment against a bankrupt party, contact commercial collections attorney Ronald P. Slates today.

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