Money problems are often a large component of marital stress. Especially in the current economy, it is not uncommon for a couple splitting up to have more debt than assets to divide in a divorce.
In some divorces, one or both parties consider filing for bankruptcy as a result of overwhelming debt. Individuals are best counseled to consult with an experienced bankruptcy attorney and a family law attorney when facing a divorce AND considering bankruptcy.
Depending on your circumstances, it may be best to file a joint bankruptcy prior to filing for divorce. Rather than arguing over who is responsible for certain debts, they can be discharged through bankruptcy. Of course, assets (if there are any) will most likely be liquidated to pay joint debts in the process as well.
The elimination of both debts and assets can result in a simplified divorce negotiation process. It can also cut filing costs and attorneys’ fees as well as help a divorcing couple avoid future discord over the discharge of jointly obligated debt.
After one spouse files for bankruptcy, the first thing that happens is that the bankruptcy court issues an automatic stay. The automatic stay prevents creditors from collecting on most debts during the pendency of the bankruptcy proceeding.
The automatic stay does NOT prevent the non-filing spouse from seeking a child support or spousal support order in the family court however. It can cause problems collecting that support until the bankruptcy case has concluded.
The bankruptcy filing may throw a wrench into the divorce works with regard to distribution of marital property. Even if only one spouse files for bankruptcy, in most cases, all the community or marital property becomes a part of the bankruptcy estate and is available to pay debts. The divorce court can only divide the property that is determined by the bankruptcy court to be “exempt.”
Exempt property is not considered part of the bankruptcy estate and is not available for liquidation and distribution to creditors. Exemptions are determined by federal and state law. They can include: a specific amount of equity in the debtor’s residence (in some states, this amount is extremely low; in others, it is high enough that many homes are completely exempt), a specific amount of equity in a single motor vehicle, certain personal jewelry, clothing and household goods and tools of the trade which allow the debtor to work.
As noted above, the automatic stay does not preclude one spouse from obtaining a support order against the other during the bankruptcy. A collection action can even continue if it targets property that is not part of the bankruptcy estate. Unfortunately, the legal definition of the bankruptcy estate is so broad that this is still difficult.
If the bankruptcy filing is a Chapter 7 petition, any income earned by the debtor after the filing of the petition is not part of the estate and is therefore available for collection of support. If the filing is a Chapter 13 petition, post-petition earnings of the debtor are part of the bankruptcy estate. Because those funds are needed to pay claims, the court must issue a specific order granting payment of any support arrearage until the case is closed and the stay is lifted.
The good news is that all debts – child support, spousal support or property settlement – owed to a former spouse are excepted from discharge in bankruptcy. They will NOT be wiped clean after a bankruptcy. Debts for support are even entitled to priority payment from the bankruptcy estate.
Prior to the most recent bankruptcy reform legislation passed in 2005, debts related to a divorce property settlement were presumed to be “nondischargeable” in bankruptcy but there were exceptions. The debt could be discharged if the debtor showed that he could not pay the debt and still take care of himself, his dependents, and his business, or that discharging the debt would result in a benefit to the debtor that outweighs the harm that would be caused to the former spouse or child by non-payment.
Now, all obligations between former spouses as set forth in a divorce decree or settlement agreement are considered non-dischargeable in bankruptcy without exception. This includes an award of attorneys’ fees.
Even if your ex-spouse cannot wipe out his or her obligations to you in bankruptcy anymore, they still might not voluntarily pay. Support obligations can be enforced with the help of the court and/or state agencies.
Property settlements though might be more difficult to collect. You may want to consider placing a lien against your ex-spouse’s property to secure the debt.
If your ex-spouse assumes a joint debt in the divorce and later takes bankruptcy while your name is still attached to the debt, the creditor may look to you for payment regardless of the divorce decree or settlement agreement. You should consider requiring, via the settlement agreement, any joint debt to be refinanced into your ex-spouse’s name alone as soon as possible after the divorce. The agreement should include a “hold harmless” or “indemnity” clause, requiring your ex-spouse to pay certain debts or repay you if a creditor makes you pay the debt.
In any event, the intersection of bankruptcy and divorce can be sticky. It is always best to consult an attorney about your specific needs.