How does bankruptcy affect divorce?

bankruptcy and divorce

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 their financial situation worse. 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 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? Spouses should consider filing for 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 to file a Chapter 7 or a Chapter 13 bankruptcy. 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 cleans the debtors’ slate – something creditors and credit agencies do not like.

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 guardian ad litem 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 chooses 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.

When the timing of divorce is important, and the parties would prefer to get divorced sooner rather than later, Chapter 7 is the quicker and cleaner option. It will discharge all debt legally allowed and leave both spouses on a cleaner slate, albeit with a troubled credit rating. Chapter 13 will take much longer, perhaps as long as five years, and that may simply be too much for a couple to handle.

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

On the other hand, if the couple can agree to a legal separation after the issuance of the reorganization, and wait until discharge to complete the divorce, it will allow the couple to save more assets and their credit rating.

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 and a divorce attorney before choosing to file for bankruptcy.

Why does the timing really matter?  Bankruptcy filings trigger an automatic stay on current finances – no other court can begin to allocate assets and no party can access assets once the freeze of the stay takes place. So, a bankruptcy ties the hands of a divorce court and complicates jurisdictional issues. In short, avoid doing both at the same time.

Which should come first? If the couple has predominantly marital debt, it makes sense to discharge all of that marital debt collectively at once in advance of divorce, so the parties have a clear picture of their actual assets and liabilities before they seek a divorce. In essence, bankruptcy assures that each spouse gets an equal benefit from the discharge of marital debt.

Should you need the advice of a divorce and family law attorney or have questions or concerns about your situation, know that we are here to help and discuss those issues with you.