Bankruptcy and Divorce Go Together Like A Carriage and Horse

By Kelly M. Walsh

Divorce and bankruptcy often go together for several reasons. First, financial problems are a common cause of relationship problems, so the couple that has had a breakdown financially may also have reached a breakdown in their relationship that makes them want to divorce.

Second, divorce involves dividing the parties’ assets and debts through a process called Equitable Distribution. There are cases in which the parties just have debts, or mostly just have debts, to divide. In those cases, the easiest way to handle the Equitable Distribution may be for the parties to file bankruptcy to discharge their debts.

Third, when parties are divorcing, one party may choose to file bankruptcy strategically to gain certain advantages in the divorce. A divorce judge is not allowed to assign a debt in equitable distribution to a party who discharged that debt in bankruptcy, so filing the bankruptcy could potentially improve your equitable distribution outcome. In some divorce cases, such as where the assets that existed at the date of separation no longer exist or have lost a lot of value by the date the divorce court issues the order distributing the assets, a divorce judge may order one of the divorcing parties to pay the other “equitable reimbursement payments.” Equitable reimbursement payments are payments from one ex-spouse to the other in the nature of property distribution rather than support or alimony. Although alimony and other domestic support obligations are not dischargeable in bankruptcy, equitable reimbursement can be discharged in a Chapter 13 bankruptcy. The party who is ordered to pay equitable reimbursement might file Chapter 13 bankruptcy to reduce or eliminate the equitable reimbursement payments, or to pay them on a schedule that is more feasible.

Fourth, divorce is very challenging financially. It is difficult to go from a two-income household to a one-income household and adjust your lifestyle down from the standard of living to which you were previously accustomed to the standard of living you can afford after separation. Usually the parties selected their house based on what they could afford with both of their incomes, and maybe neither of them can afford to maintain that house alone and still stay afloat on other expenses. Court costs and attorney’s fees in divorce add to the financial difficulty. Typically, divorcing parties build up a lot of debt while they are going through the divorce process. They may find themselves needing to file bankruptcy to dig themselves out of the financial trouble they ended up in due to divorce.

What do you file first -- Bankruptcy or divorce?

The timing depends on the circumstances. If you are filing to simplify equitable distribution, discharge joint debts with your spouse, or limit what debts can be assigned to you in your divorce, it makes sense to file bankruptcy before divorce or at least before the divorce is finalized. If you are filing to dig yourself out of the financial mess in which your divorce left you, you want to file bankruptcy after the divorce is completed.

Should you file a Chapter 7 or a Chapter 13?

A Chapter 7 bankruptcy is what most people think of when they think of bankruptcy. It is a pretty quick process in which the debtor discharges their dischargeable debts without payment. Any assets that are outside the exemption amounts that can be protected in bankruptcy may be liquidated by the Trustee. Typically, though, you only file Chapter 7 if your assets can definitely all be protected. Chapter 7 also includes some income qualifications. Not everyone can qualify. This is what you want to qualify for and file if you have a lot of credit card or medical debt, and you are current on secured loans you want to keep. It does not provide a way to catch up arrears on secured loans, taxes, and domestic support obligations, though.

A Chapter 13 bankruptcy is a payment plan. People typically file Chapter 13 if they want to bring arrears current on a secured debt for an asset they want to keep, if they make too much money to qualify for a Chapter 7, or if they want to protect assets that would be liquidated in a Chapter 7. Also, if they want to discharge equitable reimbursement obligations as discussed earlier, they would have to do that through a Chapter 13. In order to qualify for a Chapter 13, though, you must have enough income to cover all of your basic living expenses plus enough left over to pay what you are required to pay to the Trustee.

Should you file Bankruptcy Jointly or Individually?

The parties can limit their bankruptcy court costs and attorney’s fees by filing a joint bankruptcy, but must do so while they are still married. If they file a joint bankruptcy before a divorce, the ideal point in time to file bankruptcy is likely after they have moved into separate households, so they can account for the increased expenses of living separately. However, what is best for one party in that situation is not necessarily what is best for the other. There are cases in which one of them gets a better deal by filing a joint bankruptcy and the other gets a better deal filing separately. They may need to consult with bankruptcy attorneys separately to decide if they want to file a joint bankruptcy or file bankruptcy separately.

Given the relationship issues involved, it probably only makes sense to file bankruptcy jointly if the couple can qualify for a Chapter 7 bankruptcy filing together. A Chapter 13 bankruptcy is a five-year process during which the parties have to make regular payments to a Trustee. That probably requires more time and cooperation with your soon-to-be-ex-spouse than you would ideally like.

Are there any problematic interactions between Divorce and Bankruptcy?

Your bankruptcy and your divorce could have different strategies for valuing assets, and it is important to consider how those strategies impact each other. Both divorce and bankruptcy require you to list all of your assets. Theoretically, there is a true and accurate value that you would honestly list in both places. Realistically, though, there is a range of value that different reasonable experts would attribute to a given asset. In divorce, the parties typically use experts at either end of that range and litigate the value of assets. Typically, one party in divorce wants the value to be higher and the other wants the value to be lower for strategic reasons. Your asset schedules in bankruptcy and your inventory in divorce are filed under oath, so if you file both you should make sure you are consistent between the two of them. If you are inconsistent, you risk penalties for perjury and bankruptcy crimes, as well as your spouse using one of the values you swore to against you.

Domestic support obligations are another important consideration. Divorce is often accompanied by the need for one party to pay child support, spousal support, and/or alimony. In bankruptcy, those are called domestic support obligations. Domestic support obligations are not dischargeable, and the bankruptcy court will require you to pay them and keep them current if you want to receive a discharge of other debts. If you do not pay all of your child support, spousal support, or alimony, your support case could cause your bankruptcy to fail.

Additionally, although most adverse actions by creditors are stayed by the automatic stay in bankruptcy, most family law matters are not stayed. You can be pursued for support and custody during your bankruptcy, and your divorce can be finalized. The only family law proceeding that is stayed during bankruptcy is equitable distribution.

What do you do if your spouse or ex-spouse files bankruptcy?

If your spouse files bankruptcy, you should have their bankruptcy petition reviewed by an attorney who is familiar with both bankruptcy and divorce. It is possible there is nothing adverse to you, but there are a lot of ways in which their bankruptcy could potentially harm you. Are they attempting to discharge obligations they owe to you? What about debts on which you are also obligated? Are they surrendering the car you drive or the house you live in? Did they list any assets or debts you did not know about? Did they omit assets or debts you do know about? Is there anything in their bankruptcy you can use in your divorce? What impact will their bankruptcy have on your divorce given your specific circumstances? Should you file bankruptcy, too?

If your spouse’s bankruptcy is adverse to you, you may be able to appear in their bankruptcy case as an interested creditor or as a co-debtor and take certain actions to protect yourself. You also might be able to use information they listed in their bankruptcy against them in your divorce or support case. You should talk to an attorney about what options you have available and what they would recommend.