Bankruptcy Code Definition: “Community Claims” – A Distribution Complication For Community Property States

A “community claim” as defined in the Bankruptcy Code “means a claim that arose before the commencement of the case concerning the debtor for which property of the kind specified in section 541(a)(2) of this title is liable, whether or not there is any such property at the time of the commencement of the case.”  Section 541(a)(2) provides that property of the estate includes “[a]ll interests of the debtor and the debtor’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.”   These provisions together are intended to “regulate the treatment of community property under the Code and the rights and remedies of creditors in those jurisdictions that have enacted community property laws.”  Collier Bankruptcy Manual, (4th Ed. 2015), ¶ 101.07[1].  Section 541 governs the types of community property which becomes property of the estate, while the term “community claim” affects the definition of “creditor,” (11 U.S.C. § 101(10)(C), the term “creditor” includes an entity that has a community claim), the parties entitled to receive notice under section 342, and distribution of community property assets under section 726(c).  Id.

Because of the definition, creditors holding claims against the debtor or a nondebtor (typically the debtor’s spouse or former spouse) may participate in the bankruptcy case, as long as that creditor could have satisfied its claim from community property under applicable state law.  Id.  Further, creditors with community claims are protected under the Bankruptcy Code by being permitted to participate in the distribution of community property assets that have passed to the debtor’s estate.  Id.  “Thus, an estate containing community property presents a unique situation under the Code in that its assets will be disbursed to both the creditors of the debtor and to entities who are not creditors of the debtor under state law, but who hold community claims under the Code.”  Id.   

Specifically, § 726(a) provides the general priority scheme for distribution of estate assets.  Section 726(c) provides that if there is community property included in the estate under section 541(a)(2), then such property or proceeds thereof, shall be segregated from other estate property.  Then, after certain administrative claims under 503 are paid as directed by the Court, then community claims are paid first from such property.  See 11 U.S.C. § 726(c).

To have a community claim, the creditor must show that (1) there is a debt owed by one of the spouses, (2) the debt must be satisfiable from community property under applicable state law, and (3) such community property must be included in the estate under section 541(a)(2).  Collier Bankruptcy Manual, ¶ 101.07[2].  States with community property laws generally fall into two categories: (i) those that follow the “community debt” doctrine, where the community is considered to have the capacity to incur debts, and is liable for an obligation of a spouse if the spouse was acting as an agent of the marital community, or (ii) those that attribute a liability to the spouse who incurs it, irrespective of whether or not the debt was incurred for separate or community purposes.  Id.  Each of these types have specific rules for when only community property, or separate property, is subject to the various types of claims.  Id. The Bankruptcy Code preempts some of the intricacies of state community property laws by adopting an all or nothing approach: if a creditor may satisfy any portion of its claim from community property, then that creditor holds a community claim entitled to distributions as set forth in section 726.  Id.  “Any attempt to implement the refinements of liability which exist under the laws of the various community property states would have hopelessly complicated an already difficult distribution scheme.”  Id.  

Patricia B. Fugée
FisherBroyles, LLP
Cleveland/Toledo, Ohio