Bankruptcy & Divorce (Part One)

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Sometimes couples find themselves not only in marital trouble but financial trouble. Indeed, studies show that serious financial trouble can precipitate a divorce. However, the two remedies for these situations – bankruptcy and divorce – do not always work well together, and pursuing one path before another could create real problems a couple did not anticipate. We want to try and provide some guidance.

If a couple finds they have too much debt to repay with current income together, and the debt is jointly owned, divorce will likely make the financial situation more difficult.

Why? Divorce only adds to individual spouse’s expenses and reduces overall income. The longer a divorce drags on, the more likely it will be that one spouse defaults on obligations during the divorce, which will impact how the court divides marital property. Also, the court could order one spouse to pay child support, or maintenance, or both during the pendency of the divorce. The failure to pay these sums could put the spouse in contempt, and in all likelihood, will create a debt that will only accrue interest and require repayment over time.

What happens when a couple with present income cannot cover their joint debt? First, the spouses should see if additional or different employment would be possible to cover the shortfall. With a divorce under consideration, neither spouse will find that option appealing as they may think that will hurt their legal position with regard to spousal or child support.

Second, the spouses would consider bankruptcy. To understand the pros and cons of bankruptcy, it first helps to understand some basics of the federal bankruptcy law.

A couple can seek one of two types of bankruptcy filings – Chapter 7 or Chapter 13.

Chapter 7 seeks to discharge all debt allowed by law, whereas Chapter 13 seeks to reorganize debt so it can be repaid. Both forms have a negative impact on each spouse’s credit rating, but Chapter 13 will do far less damage because the debtor continues to pay the full balance owed in most cases, whereas Chapter 7 becomes a “do over” and cleans the slate – something creditors and credit agencies do not like.

Also, when thinking of discharge and a clean slate, not all debts are dischargeable. Critically, in the divorce context, alimony, child support, court fees, penalties, and certain attorney fees would not be dischargeable – explaining why handling the bankruptcy first might make sense for some couples looking to maximize fairness of debt distribution.

How does bankruptcy work? The couple files a petition in the bankruptcy court that includes a list of all income, assets, and liabilities, and choose either discharge or reorganization.

Discharge happens rather quickly. After the filing of a petition and the appointment of a trustee, creditors have a chance to weigh in and the trustee will issue a report that the court usually accepts. An important consideration will be the marital home – the parties will want to be careful about its discharge as it will lead to forfeiture, but protection will require continued payment.

Reorganization takes much longer because it keeps the case open until all debts have been satisfied.

It is not easy to choose under which Chapter to proceed – each couple should think carefully about their financial situation and consult with a bankruptcy or divorce attorney and perhaps a financial advisor before choosing to file for bankruptcy.

In our next post, Bankruptcy & Divorce (Part Two), we will examine how different bankruptcy paths affect the potential outcomes of divorce.

If you have any questions about bankruptcy and divorce, contact us – we can help.

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