Bankruptcy and Divorce

I frequently tell new bankruptcy clients — often college-educated, middle- to upper-middle class people who never dreamed they’d be in this position — that bankruptcy is the new divorce. Long ago, divorce was extremely rare and resulted in a social stigma. No one marries planning to divorce; we make the best decision we can, with the information we have, and plan for a long and happy marriage.

But, sometimes, despite our best efforts and intentions, divorce does happen, and it may be the only way out of an unbearable situation. These days, divorce is commonplace, and most people understand that when a friend, family member or colleague goes through a divorce, they’ve done the best they could to make the marriage work.

Likewise, in this disastrous economy, bankruptcy is more and more commonplace and shouldn’t be a source of shame or humiliation. We all make financial decisions throughout our lives, and we do so generally with the best of intentions, thinking that those decisions and the related obligations will work out for the best. And sometimes, our financial circumstances deteriorate to the point that a bankruptcy is the only way to move out from under debts and move on.

So what about bankruptcy AND divorce?

Once the decision is made to separate or divorce, the marital relationship should be viewed as a business transaction that includes the untangling and allocation of the couple’s assets and liabilities. Our discussions with clients who are contemplating a separation or divorce, or have already separated or divorced, may include these considerations.

Married couples can file for bankruptcy, even if they are separated

Advantages to a joint filing include that there is one filing fee, not two, because the couple can file a joint petition instead of two separate petitions. The filing fee goes to the bankruptcy court; as of this writing, the filing fee for a Chapter 7 petition is $299.00. Generally there is a savings on the attorney’s fee as well, because the attorney attends one meeting of creditors, not two; files one petition, not two; etc. Further, there is a certainty to what debts are discharged (meaning, wiped out) in the bankruptcy, and what, if any, are not.

However, a joint filing may be impossible where estranged spouses are unable or unwilling to communicate, or where there is an actual conflict of interest that cannot be resolved in order to allow one attorney to represent both spouses in a bankruptcy.

Further, household income and expenses are a factor in bankruptcy planning; if the household income, including both spouses, is too high such the couple is disqualified from a Chapter 7 bankruptcy but must instead file a Chapter 13 involving monthly payments, then it may be preferable to delay until the spouses are in different households. And one can easily imagine that it’s simply untenable for estranged spouses to endure a Chapter 13 bankruptcy, in which monthly payments are made to the bankruptcy trustee for a period of five years.

Obviously, an experienced bankruptcy attorney can help weigh these factors to determine what’s best in any set of circumstances.

Domestic support obligations are not dischargeable in a Chapter 7 bankruptcy

They will survive the bankruptcy filing. Domestic support obligations include — but are not limited to — spousal maintenance (or alimony), child support, equitable distribution, indemnity provisions relating to marital debts, guardian ad litem fees, and some attorney’s fee awards in the context of a domestic case. However, equitable distribution and property settlements may be dischargeable for less than full value in a Chapter 13 case. Again, this is a complicated area, and one that ought to be explored with a competent bankruptcy attorney.

Where there are joint marital debts, the parties may agree (or the divorce court may order) that one spouse will assume responsibility for payment of certain debts. Common examples are provisions in which one spouse shall “hold the other harmless from,” or “indemnify against,” credit card debts, the mortgage(s) on the marital residence, etc. While these provisions are enforceable by one spouse against the other, they are not binding on the original creditor. For example, John and Jane had a joint Visa account, and the divorce settlement requires John to pay the debt in full, and to hold Jane harmless on that debt. If John stops paying the debt, then Visa can try to collect from Jane, including obtaining a judgment against her for the full amount. Visa doesn’t care whether John pays or not. Where there is significant marital debt without a great ability to pay it, bankruptcy — eliminating the Visa debt altogether — is something to consider as part of the divorce plans.

Divorce planning should consider debt and property issues

Section 541(a)(1) of the Bankruptcy Code provides, among other things, that property of the debtor’s bankruptcy estate includes any interest in property that could have been property of the estate as of the date of the filing of the bankruptcy petition, when the debtor acquires or becomes entitled to acquire such property within 180 days from the date of filing as a result of a property settlement agreement with the debtor’s spouse, or any interlocutory or final divorce decree.

In other words, if the debtor receives or becomes entitled to receive property as a result of a property settlement agreement with the spouse, within six months of the filing, then the bankruptcy trustee can and likely will use those proceeds to pay creditors.

In the past year, we’ve had to explain to more than one recently divorced person that bankruptcy is no longer an option, even though they are saddled with debt that would be dischargeable, because they wouldn’t want to give up their share of the marital property as part of the filing. Consideration of debt and property issues as part of divorce planning can be critical.

All too often money problems lead to divorce, and visa versa. Be sure to include a competent bankruptcy attorney on your legal team alongside your family law counsel.