The financial strains that drive clients to consider bankruptcy also create difficulties in relationships, and visa versa. I regularly meet with clients who are either separated from their spouses or who are going through a divorce proceeding. In this post and the post to follow, I will touch on the matter of attorneys fees in divorce proceedings, and how they can either be protected or discharged in bankruptcy.
I recently met with a new client who wanted and needed to file for bankruptcy, but who had just paid their divorce lawyer a $5,000.00 retainer to defend a matrimonial action. Despite the pressing need to file bankruptcy, I advised the client to wait at least 90 days from the date that the check to their divorce lawyer cleared.
The basis for this advice arises from an area of bankruptcy law known as “preferences.” Simply stated, Section 547 of the Bankruptcy Code provides that a trustee in bankruptcy may recover payments to “non-insider” creditors paid within 90 days prior to the date of filing when such payments are not in the “ordinary course of business” (for insiders – relatives, business relations, etc. the lookback period is one year). Further, Section 541 of the Code provides that the unused retainer, sitting in the divorce lawyer’s trust account constitutes property of the bankruptcy estate.
In the case of this client, an argument could be made that the $7,500.00 transfer would not be in the “ordinary course of business” since it was a non-recurring (“one-time”) payment. My concern was that if I had filed a Chapter 7 on behalf of this client within the 90 day period, the trustee could demand the $5,000.00 from the divorce lawyer. As you might imagine, this would make for a very unhappy divorce lawyer as well as possibly leaving the client without representation in the divorce action.
Preference issues also arise in other situations. You should ensure that you disclose any “out of the ordinary” payments to anyone made within the one year period prior to your projected filing date.