Employment Contract Is Domestic Support Obligation

Posted by NCBRC - April 13, 2022

An employment contract between the debtor and his ex-spouse where the ex-spouse’s only responsibilities were to assist the debtor in family matters, was in the nature of domestic support and was entitled to priority treatment in the debtor’s chapter 7 bankruptcy. In re Wibracht, No. 21-50477 (Bankr. W.D. Tex. March 31, 2022).

The debtor’s ex-wife, Laura, filed two claims in his chapter 7 bankruptcy one of which was for child support and the other, claim 20, was designated as priority spousal support.

When Laura and the debtor divorced, they had four children between the ages of 3 and 6 and Laura was not working outside the home. Claim 20 was based on an employment contract executed on June 23, 2016, as part of their divorce settlement, Her employee responsibilities began on July 1, 2016 and were to “assist[] Company President with personal family matters as requested.” The contract gave her $7,000 per month for eight years. In addition, any bonuses received by the debtor were to go to Laura to pay off marital debts. The employment agreement was incorporated in the Final Decree of Divorce on June 24, 2016. When the debtor terminated the agreement prematurely, Laura filed suit in state court and obtained a judgment for $652,544.26. The debtor filed for bankruptcy on April 22, 2021, within days of that judgment.

The trustee objected to the claim arguing that it should be disallowed as a priority domestic support obligation and be treated as a general unsecured claim. He also argued that the claim could be avoided as a fraudulent transfer under §§ 502(d) and 548.

Summarizing section 101(14A), the court found that “for the Employment Agreement to constitute a domestic support obligation, it must be (1) owed to or recoverable by a former spouse, (2) in the nature of alimony, maintenance, or support, (3) established by an order of a court of record, and (4) not assigned to a nongovernmental entity.”

The only area of disagreement related to the second factor: whether the employment agreement was in the nature of spousal support.

Citing Milligan v. Evert (In re Evert), 342 F.3d 358, 367 (5th Cir. 2003), the court observed that the term “domestic support,” should be read expansively with an eye to protecting the innocent former spouse who depends on the financial support of bankruptcy debtor. Recognizing the debtor’s incentive to label the debt as non-domestic and dischargeable, courts will look at the substance and intent of the written agreement, and at whether domestic support is treated elsewhere in the divorce decree.

With these concepts in mind, the court found the employment agreement to be ambiguous. Though the agreement contained many terms typical of employment contracts, there were also unique terms including that Laura was to receive the debtor’s bonuses for the benefit of their creditors, that the agreement was binding on any successor entities or other entities in which the debtor was a partner or principal, and that Laura’s duties under the contract were purely family-related. Finally, there was no other provision for alimony or spousal support elsewhere in the divorce decree.

Citing In re Nunnally, 506 F.2d 1024, 1027 (5th Cir. 1975), the court turned to extrinsic evidence to resolve the issue of the parties’ intent. It considered: “(1) the parties’ disparity in earning capacity, (2) their relative business opportunities, (3) their physical condition, (4) their educational background, (5) their probable future financial needs, and (6) the benefits each would have received if the marriage continued.” In addition, the court considered such factors as the duration of the obligation and whether it was assignable, transferrable, or modifiable.

The court found these factors generally favored Laura. She had not worked during their marriage while the debtor finished his schooling and began several businesses, and her understanding of the agreement was to give her a regular income and health benefits through the debtor’s company. Furthermore, the duration of the agreement tracked the typical alimony duration, the contract had limits to its terminability, and the obligation followed the debtor from business to business. Finally, the fact that the employment agreement was merged into the divorce decree suggested its role as domestic support.

The court next addressed the trustee’s argument that the state court judgment was avoidable under section 548(a)(1), as a fraudulent transfer. That section requires the trustee to show that “(1) the debtor incurred an obligation, (2) within two years of the petition date, and (3) the debtor received less than reasonably equivalent value in exchange for the obligation.” The court identified a fourth element which it found could be established in one of four ways: “the Debtor (I) was insolvent at the time the obligation was incurred; (II) was engaged in business or a transaction for which any property remaining with the Debtor was an unreasonably small capital; (III) intended to incur, or believed that it would incur, debts beyond the debtor’s ability to pay; or (IV) made such transfer or incurred such obligation to benefit an insider under an employment contract and not in the ordinary course of business.”

The court made quick work of the trustee’s initial argument that the employment agreement was between Laura and the debtor’s company and therefore the debtor was not a party and did not incur the obligation. The court found the agreement included several obligations imposed directly on the debtor, and to the extent the debtor’s company was a party to the agreement, it was “jointly and severally liable” with the debtor for the obligations incurred.

The trustee argued next that because the state court judgment came within two years of the bankruptcy filing, the second element of fraudulent transfer was met. The court disagreed. The parties executed the employment agreement on June 23, 2016, the Family Court issued the Final Divorce Decree the next day. The court found the obligation was incurred no later than July 1, 2016, when the agreement took effect, almost five years before the debtor’s petition date of April 22, 2021.

The court turned to whether the debtor received “reasonably equivalent value” for the obligation, noting again that the obligation was the employment contract rather than the state court judgment. It observed that federal courts are loathe to unwind fully litigated divorce agreements even where division of marital assets is uneven. The court found Laura’s continued responsibility for the couple’s four young children was sufficient to support a finding that the debtor received value for his obligation.

Next, the court addressed whether the debtor was insolvent at the time he incurred the debt. The trustee offered the debtor’s bankruptcy schedules showing $570,305.00 in assets and over $17 million in debt. The court found that while the schedules supported a claim for current insolvency, they did not establish insolvency at the relevant time: when he incurred the obligation.

The trustee attempted to establish the fourth element of fraudulent transfer by arguing that the transfer was for the benefit of an “insider, under an employment contract and not in the ordinary course of business.”

This argument failed because the agreement was in fact a domestic support agreement rather than an employment contract, and because Laura was not an insider. An insider includes a person related by blood or marriage. At the time the obligation was incurred, Laura was neither.

The court overruled the trustee’s objection and allowed Laura’s claim in the full amount of $652,544.26 as a priority domestic support obligation.

Wibracht Bankr WD Tex March 2022

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