Divorce is one of the leading reasons individuals give for filing for bankruptcy. Likewise, financial woes often cause tension in relationships. Due to this relationship, many individuals who go through a divorce file for bankruptcy during or after their divorce.
As explained below, divorce and bankruptcy laws have many complex interactions affecting property rights.
When you or your spouse files for divorce, the court must split your property according to your state’s divorce laws.
Suppose you live in a community property state. All property received by you or your spouse during marriage, other than by gift or inheritance, or acquired using funds or property obtained before marriage, is typically deemed community property. Other property, with some exemptions, is considered separate property.
Upon divorce, each spouse is typically entitled to 100% of their separate property and 50% of the community property.
If you live in a non-community property state, upon divorce, the court will split your property between you and your spouse in a manner it deems fair.
Your property becomes part of the bankruptcy estate when you file for bankruptcy unless you can exempt it under the bankruptcy laws. The bankruptcy estate is the collection of assets the bankruptcy trustee uses to pay creditors. Most individuals who file for bankruptcy use statutory exemptions to keep as much property as possible out of the bankruptcy estate, allowing them to keep it:
In some states, property owned by you and your spouse as tenants by the entirety is excluded from the bankruptcy estate if only one spouse files.
If you file for bankruptcy jointly with your spouse, normally, all of your non-exempt property and all of your spouse’s non-exempt property will be included in the bankruptcy estate.
Some states authorize joint filers to double the amount of the exemptions to keep more property out of the bankruptcy estate. But if you do not live in a state that authorizes you to double your exemptions and you have more property than you can exempt, it may be more advantageous to file individually rather than jointly.
Because filing jointly needs collaboration, it may not be possible if you are currently getting divorced or are contemplating divorce shortly.
Read more about the legal impact if only one spouse files for bankruptcy.
Filing for bankruptcy triggers an automatic stay. The automatic stay stops lawsuits or debt collection relating to your property unless approved by the bankruptcy court. Typically, actions taken in violation of the stay are invalid.
While the automatic stay does not stop a spouse from filing for divorce, the stay does stop the family court from splitting property in the bankruptcy estate or ordering support to be paid out of the bankruptcy estate.
Because of the automatic stay, to continue with a divorce case after a bankruptcy case has been filed, either you or your spouse may need to request an order from the bankruptcy court to modify the automatic stay.
Bankruptcy courts generally grant relief from the automatic stay to allow the family court to determine each spouse’s property rights. Still, the bankruptcy court may retain jurisdiction over community property in the bankruptcy estate.
Child custody and domestic violence proceedings are exempt from the automatic stay. A family court may also order or enforce a support order so long as it does not affect the bankruptcy estate’s property.
Filing for bankruptcy before divorce permits you and your spouse to share both the legal expenses of the bankruptcy and both of your exemptions (double exemptions, which some jurisdictions allow) that can be claimed on property in a bankruptcy.
This can be financially advantageous for both spouses. This action plan will be better if the spouses are still on reasonable terms. It can also simplify divorce proceedings if the bankruptcy proceedings are already handled.
It is more straightforward to file for bankruptcy either before or after divorce. Nonetheless, suppose you file for bankruptcy during your divorce case. In that case, all of the non-exempt marital property not yet divided in the divorce case will be pulled into the bankruptcy estate. To continue with the divorce case, you or your spouse may need to seek relief from the automatic stay before the family court can determine property rights and split the marital property.
If you file for bankruptcy in the middle of a divorce case, you should give notice of the bankruptcy case to the family court and notice of the divorce case to the bankruptcy court.
If you and your spouse use the same lawyer for your divorce, then file bankruptcy, you will need to get separate lawyers because this will create a conflict of interest for the lawyer (representing both of your financial interests).
Filing for bankruptcy after a divorce can lead to unique problems involving the division of assets.
The trustee of the bankruptcy court, who is liable for administering property in the bankruptcy estate, may examine the way the property was split in the divorce case. In some cases, the trustee may seek to undo certain transfers in the divorce case to pull property into the bankruptcy estate, thereby making it available to pay creditors.
This is especially true if your divorce was resolved by settlement and the settlement terms appear more favorable to the other spouse or when the non-exempt property was awarded to the spouse not filing for bankruptcy.
Additionally, suppose you file for bankruptcy after the divorce. Even if you obtain a complete discharge, you may be potentially liable to the non-filing spouse for some debts if your divorce judgment included an indemnification agreement. Moreover, you may be precluded from discharging other obligations in your divorce judgment.
Also, it is essential to mention that the simplest type of bankruptcy, a Chapter 7 bankruptcy, requires that you be below an income limit. If you and your spouse jointly surpass that limit, it may be better to wait until after the divorce to file bankruptcy.
There are many different Chapters of bankruptcy that a debtor may file for, such as Chapter 7, Chapter 13, Chapter 9, and Chapter 11. The Chapter of bankruptcy that a debtor or entity chooses to file will depend on the requirements provided by the U.S. Bankruptcy Code.
Chapter 7 is the most common type of bankruptcy filing. It is ideal for debtors with low income, who have high unsecured debt, and need quick relief. Those who successfully file for Chapter 7 bankruptcy and obtain a discharge will be permanently released from having to pay their debts.
Both bankruptcy and divorce can bring out highly complicated legal matters. If you are contemplating divorce or bankruptcy, you should strongly contemplate contacting a local divorce lawyer to protect your interests.
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