Kelley v. Dahle-Fenske (In re Dahle-Fenske)Kelley v. Dahle-Fenske (In re Dahle-Fenske)
MEMORANDUM DECISION
This case involves the elusive “phantom discharge” that a spouse in a community property state can receive without filing bankruptcy.
Background and Procedural Status
Tina M. Dahle-Fenske (the “Debtor”) filed a Chapter 7 petition on March 13, 2014. On June 16, 2014, Jane C. Kelley (“Kelley”) filed an adversary complaint objecting to the dischargeability of the Debt- or’s debt under 11 U.S.C. § 523(a)(2) and (a)(4). (Adv. No. 14-2309, Docket No. 1.)
The parties later filed a stipulation agreeing to the entry of a nondischargeable judgment against the Debtor in the amount of $396,476.52, consisting of $300,000 in principal and $96,476.52 in interest. (Docket No. 15.) The parties asked the Court to use the February 20, 2015 trial date to decide two legal issues unresolved by the stipulation: (1) whether Kelley is entitled to recover legal fees that she incurred attempting to collect the debt; and (2) whether 11 U.S.C. §§ 524 and 727 prevent Kelley from collecting the judgment from the post-petition marital property of the Debtor and Fenske. The parties filed briefs and affidavits in support of their positions. (Docket Nos. 18, 19, 20, 21, 22.)
Facts
The briefs, affidavits and the Decision of the U.S. District Court for the Eastern District of Wisconsin provide the factual background. See Kelley v. Dahle, No. 11-C-600,
The note provides that in the event of a default, “Holder reserves the right to commence legal action for all unpaid principal, together with costs, reasonable attorneys’ fees and disbursements, after the date of such default, without further prior notice оf any kind.” (Docket No. 18-1 at 3.) The Debtor failed to make any payments on the note. (Docket No. 18 at 2.)
On June 21, 2011, Kelley filed a lawsuit for breach of contract and breach of fiduciary duty against the Debtor, her former law firm, and her malpractice insurer. (District Ct. Dec. at *1.) On July 26, 2012, the District Court granted the insurer’s motion for summary judgment, finding that the obligation owed by the Debtor to Kelley did not constitute “damages” covered by the Debtor’s insurance policy. (District Ct. Dec. at *14.) On December 12, 2013, the District Court entered a dеfault judgment against the Debtor, after she failed to answer an amended complaint. (Docket No. 18 at 2.)
On July 3, 2013, Fenske filed a Chapter 7 case, listing the Debtor as his “non-filing spouse.” (Case No. 13-29119-svk, Docket No. 1.) Kelley’s loan was not mentioned in Fenske’s schedules nor was Kelley listed on the creditor matrix. {Id.) The Court entered an order granting Fenske a discharge on December 31, 2013.
Issues
I. Allowance of legal fees as part of the nondischargeable judgment
Twenty years ago, the Seventh Circuit Court of Appeals held: “Attorneys’ fees provided by contract are part of the debt, and if the principal and (pre-bank-ruptcy) interest on the debt are non-dis-chargeable, so are the other elements of the debt.” Mayer v. Spanel Int’l,
In this case, the Debtor drafted and signed a promissory note that expressly provides for attorneys’ fees and costs in the event of default. The note states: “Holder reserves the right to commence legal action or all unpaid principal, together with costs, reasonable attorneys’ fees and disbursеments, after the date of such default, without further prior notice of any kind.” (Docket No. 18-1 at 3.) The Debt- or was a practicing attorney at the time she signed the note, and Kelley urges this Court to enforce the contract as negotiated and signed — including the provision that requires the Debtor to reimburse Kelley for all reasonable attorneys’ fees upon default. (Docket No. 18 at 4.)
The Debtor responds that when Kelley loaned her the money, Kelley did not negotiate, bargain for or еxpect a possible attorneys’ fee award in the event of a default. (Docket No. 19 at 6-7.) At the time Kelley made the loan, there was no written contract. Instead, the contract was drafted more than a year later and backdated. Thus, according to the Debtor, the default had already occurred and the damage had already been done, so the written contract providing for attorneys’ fees “should not be applicable in this case.” (Id. at 7.) The Debtor citеs no case law to support her argument, and the Court rejects it. The Debtor drafted the promissory note, which provided for reasonable attorneys’ fees on default. The attorneys’ fees provision, like the rest of the promissory note, would be enforceable under Wisconsin law, even though the note was drafted after Kelley advanced the money. Therefore, under Mayer, the attorneys’ fees award is properly included in the nondischargeable judgment.
The Debtor’s second аrgument challenges the amount of the attorneys’ fees. Specifically, the Debtor questions the reasonableness of the fees incurred in suing the Debtor’s malpractice insurer. She contends that she admitted every fact so that Kelley could easily prevail against her in the District Court action, and she tried to advise Kelley’s counsel that the complaint against the insurance company was unlikely to succeed. (Docket No. 19 at 4.) Kelley’s attorney failed to heed these warnings and proceeded with the case, resulting in summary judgment in favor of the insurer and a failed appeal to the Seventh Circuit. (Id.) Kelley’s unsuccessful efforts cost over $90,000 in attorneys’ fees. The Debtor contends that only about $1,000 of legal fees were reasonable under the circumstances. (Docket No. 19 at 8.)
Kelley does not specifically address the reasonableness of the attorneys’ fees in her briefs, but she notes that if the Court determines that Kelley is entitled to reimbursement of attorneys’ fees, she intends to file a motion itemizing the fees to allow
II. Recovery of the judgment from post-petition marital prоperty assets
The remaining question is whether Kelley can collect her judgment from the post-petition marital property of the Debtor and Fenske. The Debtor maintains that 11 U.S.C. § 524(a)(3) limits Kelley to recovery solely from the Debtor’s individual property. Under § 524(a)(3), a discharge enjoins collection efforts against the interests of the debtor and the debtor’s spouse in post-petition community property, “on account of a community claim, except a community claim that is excepted from discharge under § 523 ... or that would be so excepted, determined in accordance with the provisions of §§ 523(c) and 523(d) of this title, in a case concerning the debt- or’s spouse commenced on the date of the filing of the petition in the case concerning the debtor ...”
A. The claim is a community claim
The Debtor argues that Kelley’s judgment cannot reach her community property because the debt was not incurred in the interest of the marriage or family and therefore is not a “community claim” as defined by § 101(7). (Docket No. 19 at 9.) The Debtor fails to cite any authority for her position, and in fact, applicable law provides presumptions that compel the rejection of the Debtor’s argument.
The Bankruptcy Code defines community claim by reference to the property that is liable for the claim. Under § 101(7) a community claim is a pre-petition claim “for which property of the kind specified in § 541(a)(2) of this title is liable, whether or not there is any such property at the time of thе commencement of the case.” Under this definition, if § 541(a)(2) property could be liable for the claim, the claim is a community claim, even if no such property exists. Section 541(a)(2) property includes “[a]ll interests of the debtor and the debt- or’s spouse in community property as of the commencement of the case that is — (A) under the sole, equal, or joint management and control of the debtor; or (B) liable for an allowable claim against the debtor, or for both an allowable claim against the debtor and an allowable claim against the debtor’s spouse, to the extent that such interest is so liable.”
Wisconsin law creates a clear presumption that an obligation incurred during marriage is a community debt for which community property is liable. First, under Wis. Stat. § 766.55(1), “[a]n obligation incurred by a spouse during marriage, including one attributable to an act or omission during marriage, is presumed to be incurred in the interest of the marriage or the family.” The Debtor has advanced no evidence to rebut this presumption. This alone is fatal to her argument. See Schmidt v. Waukesha State Bank,
Specifically, under Wis. Stat. § 766.51(lm), “for the purpose of obtaining an extension of credit for an obligation described under § 766.55(2)(b), a spouse acting alone may manage and control all of the marital property.” Thus, Fenske’s alleged lack of knowledge about the Debtor’s debt to Kelley is insufficient to overcome the presumption that the debt was incurred in the interest of the marriage dr family. See Park Bank-W. v. Mueller,
Under Wis. Stat. § 766.55(2)(b), an obligation incurred in the interest of the marriage or family “may be satisfied only from all marital property and all other property of the incurring spouse.” As a result, all obligations under § 766.55(2), whether incurred by the debtor or the nondebtor spouse, satisfy the definition of “community claim” under § 101(7). Marital Property Law in Wisconsin, supra, at § 6.96. Under the applicable presumptions, and given the lack of any evidence to the contrary, the Court rejects the Debtor’s argument that the debt to Kelley was not incurred in the interest of the marriage or family.
In sum, Kelley’s claim is a community claim because: (1) the Debtor and Fenske were married when the Debtor incurred the debt to Kelley; (2) the debt is presumed to be incurred in the interest of Kelley and Fenske’s marriage or family, and the Debtor has not rebutted the presumption; and (3) such a debt could be satisfied from Fenske’s interest in community property.
B. By оperation of §§ 524(a)(3) and 523(c), the claim is not included in the phantom discharge
The Debtor next argues that Kelley cannot satisfy her claim from post-petition marital property because when Fenske received his discharge on December 31, 2013, the Debtor qualified for the “phantom discharge” of § 524(a)(3). (Docket No. 19 at 10.) Kelley responds that the phantom discharge does not apply because the Debtor’s debt to Kelley is nondischargeable under § 523. She points to the languаge of the statute that says the discharge applies to all community claims “except a community claim that is excepted from discharge under § 523.” (Docket No. 18 at 5.)
Kelley’s' argument ignores the next clause of § 524(a)(3) that dischargeability is to be “determined in accordance with the provisions of §§ 523(c) and 523(d).” Section 523(c) requires creditors to affirmatively seek a determination of the dis-chargeability of certain kinds of debts or they will be discharged. Kelley’s complaint alleges fraud and fraud in a fiduciary capacity, which are among the categories included in § 523(c). Bankruptcy Rule 4007(c) imposes a deadline — 60 days after the meeting of creditors — for filing a complaint under § 523(c). However, simply because a debt fits within the categories listed in § 523(c) and the 60-day period has run does not end the inquiry. Section 523(c) refers to § 523(a)(3)(B) which specifies that if a creditor’s claim is not listed or scheduled in the debtor’s bankruptcy in time to permit the creditor to file a timely request for a dеtermination of dischargeability, the debt is not discharged, unless the creditor had notice or actual knowledge of the case in time to file a complaint.
This Court reviewed § 523(a)(3)(B) in In re Guseck,
By inserting § 523(c) (which incorporates § 523(a)(3)) into the phantom discharge provision, a scheduled creditor with a fraud claim against a non-filing spouse must comply with the 60-day deadline for filing a nondischargeability complaint, or the debt will not be collectible from post-petition community property. Most courts and commentators agree that the 60-day deadline applies to community discharge claims: “[Cjomplaints to determine the nondischargeability of an obligation of the debtor or of an obligation of the nohdebtor spouse in a hypothetical case commenced by such spouse must be filed within the time period set forth in Federal Rule of Bankruptcy Procedure 4007(c). Consequently, creditors must act diligently with respect to both the debtor and the non-debtor spouse to preserve their rights as to the discharge or dischargeability of their claims.” In re Kimmel,
The plaintiffs in Gonzales were either scheduled creditors or had actual knowledge of the bankruptcy in time to file dischargeability complaints. Id. Similarly, in Karber, the court stated: “It was the duty of the scheduled creditors in the Bra-den Jay Karber bankruptcy proceedings to object to the hypothetical discharge of Valerie Karber, as the nondebtor spouse, within the same time limits as their objections to the discharge of Braden Jay Kar-ber. No such objections were filed and thus all community creditors before the Court in that case are now barred from seeking to collect their deficiencies from the after acquired community property of either Braden Jay Karber or Valerie Karber.” Karber,
Conversely, when the creditor is not scheduled, and the creditor does not have actual knowledge of the deadline in time to file a complaint, the phantom discharge does not apply. In In re Sweitzer,
In this case, although Fenske listed the Debtor as his non-filing spouse, he did not include Kelley on his list of creditors, and he did not list the District Court action in his schedule of pending law suits. (Case No. 13-29119-svk, Docket No. 1.) The Debtor’s affidavit states that “[u]pon information and belief, Jane C. Kelley and her attorney’s [sic] received actual knowledge of my husband Trevor Fenskе’s bankruptcy on or before July 10, 2013,” but this unsupported allegation is insufficient to comply with due process requirements. (Docket No. 20 at 4.) If Fenske, the Debt- or or one of their attorneys told Kelley or her attorneys about the deadline, presumably the Debtor would be able to unequivocally state that.
The Seventh Circuit Court of Appeals analyzed the dischargeability complaint deadline notice requirements in Tidwell v. Smith (In re Smith),
If Kelley’s debt had bеen scheduled in Fenske’s bankruptcy case, the result would be different. Kelley overlooks the statutory reference to § 523(c), and suggests that any time a nonfiling spouse has a nondischargeable debt, the phantom discharge does not apply to discharge the community property. But the cases cited by Kelley are readily distinguishable. In In re LeSueur,
Kelley’s citation to Trimble v. Leeuw (In re Leeuw), No. 11-32065,
Kelley also cites Midi Music Ctr., Inc. v. Smith,
The Midi Music court’s rationale does not apply here. Kelley did not file a timely complaint in Fenske’s case, like the creditor in Midi Music. And Fenske’s and the Debtor’s cases did not overlap as they did in Midi Music. In short, while Midi Music, Leeuw and LeSueur support the notion that the community property interest of an innocent spouse will suffer due to the wrongdoing of the other spouse, these cases also require a creditor to be vigilant in protecting itself against the phantom discharge. Here, Fenske did not schedule Kelley as a creditor, and neither the Debtor nor Fenske alerted her to the deadline to object to the hypothetical discharge in Fenske’s case. Therefore, she was not bound by the deadline.
Conclusion
Kelley is entitled to reasonable attorneys’ fees as part of her judgment, and Kelley can collect her judgment from the post-petition community property interests of the Debtor and Fenske. If the parties are unable to agree on the amount of attorneys’ fees, Kelley should file a motion with the supporting invoices; the Debtor may file a detailed objection, and the Court will decide the amount of reasonable attorneys’ fees that may be added to the judgment.
Notes
. The Bankruptcy Code does not use the term "phantom discharge" when referring to the community property discharge available when only one spouse files bankruptcy in a community property state. But the parties have used that term, and the Court will as well.
. All references are to the CM/ECF docket in the adversary proceeding unless otherwise indicated.