BANKRUPTCY AND DIVORCE
When it comes to marriages, few things have the magnetic ability to drag down a relationship like the gravitational pull of debt. Given that debt is a major contributor to marital disenchantment, it is no wonder that bankruptcy and divorce seem to intermingle like old friends. Though divorce and bankruptcy often meet, both actions are entirely separate from each other and often create problems due to the nature of each action. If you are considering bankruptcy and divorce—regardless of the order—be sure to consider how bankruptcy and divorce cross paths.
How does bankruptcy interact with debt and property division in a divorce?
To answer this question, the first step is to understand that a final judgment and decree of divorce divides all property and marital debt between the parties. The court can do this in a multitude of ways, but the end result is that the court allocates specific property and specific debts to each party. While this sounds straight forward, it is wise to remember that divorce actions bind the parties to the divorce decree, NOT the creditors.
For example, assume that Husband and Wife reach an agreement on the division of their marital debt. Husband agrees to retain any debt incurred solely in his name and Wife agrees to retain any debt incurred solely in her name. Prior to the divorce, Husband and Wife co-signed a loan to finance their house, and the house was used collateral for the loan (a basic mortgage). Their divorce decree orders that Wife retain the home and that Husband transfer his interest in the home to Wife. Wife is to hold Husband harmless on any debt still owed on the loan. Husband transfers his interest in the property to Wife. Subsequently, Wife misses a few monthly payments on the home loan and decides to file a Chapter 7 bankruptcy. Wife does not reaffirm the house loan debt. Wife’s Chapter 7 bankruptcy is successful, and she receives a discharge of the debt associated with the house loan. Is the house loan debt fully extinguished since Wife’s debt was discharged through bankruptcy and Husband’s debt was removed in the divorce decree? NO!!!
The divorce decree does not affect a creditor’s right to collect a debt. Since Husband co-signed the loan, he is still responsible to the creditor for the debt. Even though the home was likely sold by the trustee as a result of Wife’s bankruptcy, the creditor will still be able to collect any remaining deficiency from the husband. The language of the divorce decree DOES NOT affect the creditor’s right to seek repayment of the debt.
However, Husband may be able to take Wife back to the court that granted the divorce since Wife was to hold Husband harmless on the debt. This presents a problem for Wife because, even though her debt was discharged in bankruptcy, she has an obligation in another court to hold Husband harmless on the debt. Essentially, Wife may still have to repay the debt, but her obligation could only be to Husband, not the creditor, since Wife’s debt to the creditor was discharged in her chapter 7 bankruptcy.
On the other hand, if the decree of divorce did not order Wife to hold Husband harmless on the debt, then Wife could discharge her debt through the bankruptcy without any obligation to Husband. Husband would remain responsible for the debt on the loan, and the creditor could still seek a judgment against Husband for the debt.
The lesson: The possibility of Bankruptcy should always be considered in divorce because divorce alone does not severe a party’s obligation to a creditor. Divorce binds parties, not creditors.
Can bankruptcy discharge spousal support, child support, attorney fees, or property settlements that were ordered in a divorce decree?
Domestic support obligations are not dischargeable in bankruptcy. Spousal support and child support are considered domestic support obligations. Support obligations will remain after a chapter 7 or chapter 13 discharge. Even though these obligations are not dischargeable in bankruptcy, trustees in a Chapter 13 bankruptcy may allow these obligations to be paid outside of a chapter 13 bankruptcy plan.
In general, attorney fees awarded as a result of a large disparity in income between the two parties are considered support obligations. However, there are circumstances where attorney fees are not for the purpose of support. Such instances are factually driven and may result in a discharge of the debt through bankruptcy.
As for property settlements, these are dischargeable through bankruptcy if the property settlement is not for the purpose of support. For example, if Husband is to pay Wife $200 every month for ten months as part of a property settlement to compensate Wife for a car that Husband retains, then that $200 per month is dischargeable in bankruptcy. On the other hand, if Husband is to pay $200 per month for ten months by way of spousal support, then that obligation is not dischargeable due to its classification as a domestic support obligation.
Should bankruptcy be filed prior to a divorce?
Filing for bankruptcy prior to a divorce may be beneficial. Prior to a divorce, parties have the option of filing a joint bankruptcy as well as individual bankruptcies. In the event that both parties owe creditors jointly, a joint bankruptcy may be a beneficial option. If a divorce or separation action has not been filed, then bankruptcy can function as a mutual friend to eliminate joint debt. This often aids in the distribution of property inherent to divorce actions. Though bankruptcy does not distribute marital property, it can often eliminate substantial amounts of marital debt. Accordingly, this simplifies the debt distribution in divorce. Also, spouses can save filing fees and attorney fees by filing a joint bankruptcy.
Yet, filing jointly requires joint decisions. If both parties are unable to agree upon a bankruptcy plan, then filing jointly is certainly not an option. Once a divorce case is filed, there is a high probability that both parties will not be able to agree upon issues relating to the bankruptcy. For example, both parties may disagree as to the length of their chapter 13 plan or as to whether to reaffirm certain debts in a chapter 7. Further, bankruptcy attorneys are prohibited from representing clients with adverse objectives. Thus, divorce often limits the ability of spouses to file jointly.
If one spouse does not want to file for bankruptcy, then the other spouse may still file for bankruptcy. A divorce action does not prevent either spouse from filing a joint bankruptcy, prior, during, or after a divorce.
What happens when bankruptcy is filed during a divorce?
Many times a divorce action is filed prior to a bankruptcy. In the event that one spouse files a bankruptcy after the filing of a complaint for divorce, the court hearing the divorce must abide by the bankruptcy court’s automatic stay. However, the court hearing the divorce may still equitably divide property once a motion for relief of the automatic stay is filed and granted in the bankruptcy court.
Though a relief from stay may be granted, it is still important to remember to address bankruptcy issues in the final decree of divorce to avoid unexpected obligations relating to marital debt. Even if a court of equity divides marital debt, creditors may assert claims against parties based on their rights as creditors. Often times, a failure to properly address bankruptcy issues in divorce decrees leads to post decree motions for compensation because one spouse must hold another spouse harmless on certain debts. This creates an obligation in a domestic relations court that is not consistent with the obligations of creditors and debtors. Thus, one spouse could potentially be forced to reimburse a spouse for a debt discharged in bankruptcy if not properly addressed.
Image from Flickr user Rusty Clark
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