Bankruptcy and Its Impact on Divorce

This past week, I attended a two-day training by the American Academy of Matrimonial Lawyers on a variety of topical issues in our profession. Programs like this are always great to refresh memory regarding issues we don’t necessarily deal with in every case. One of the refresher courses dealt with the intersection of bankruptcy and divorce, so I figured I would share some key points from this fresh reeducation.

Bankruptcy and Divorce.  A basic education on bankruptcy is a good start.  Bankruptcy is the legal mechanism to dispose of debt at a time when paying it off in full has essentially grown beyond your reach.  Bankruptcy is federal law, whereas divorce is state law, yet the two are often interwoven.  There are three types of bankruptcy that individuals typically utilize. By far, the most popular is Chapter 7, a liquidation bankruptcy. This is the type of bankruptcy in which an individual’s property is liquidated, with the exception of a handful of protected property types, and used to pay off debt. This is the quickest type and does not include a payment plan.  Alternatively, a Chapter 13 case requires a 3 to 5 year payment plan, most of which fail at some point before they conclude.  Most Chapter 13s eventually convert to chapter 7’s. Chapter 11 bankruptcy is typically relegated to businesses, but if an individual’s debt or income is high enough, there may be a reason to put an individual debtor through and 11.

Financial Strain on Marriage.  Taking a step back, we know financial difficulty is a common hardship faced in marriages.  We also know from our other discussions about divorce, that equitable distribution requires a fair allocation of all assets and debt of a marriage.  So, before we go further, consider the importance of timing between a bankruptcy and a divorce.  There are all sorts of situations that require a strategic approach, particularly focused on the timing and cooperation of the spouses, as they pertain to the filing of a bankruptcy.

Bankruptcy can Make Divorce Unfair.  Let’s take an example to illustrate the point. Let’s say for this example that the marriage is irretrievably broken and that the divorce would be inevitable whether bankruptcy was filed or not.  So, let’s say in this example that the parties have $50,000 in joint credit card debt, another $50,000 in a personal loan to the husband only, and non-exempt assets valued at $50,000. If there is no bankruptcy, a logical distribution would be to distribute the non-exempt assets, $25,000 each to each the husband and the wife. Then, distribute the $50,000 in credit card debt to the wife and the $50,000 in personal loan to the husband. Let’s assume the interest rates were comparable, making the distribution a fair one. So each spouse has $25,000 in assets and $50,000 in debt. Now, let’s say the husband files a Chapter 7 bankruptcy. The bankruptcy trustee, who oversees the bankruptcy, takes possession of the $25,000 in non-exempt assets. Then, the husband’s personal loan is paid with the proceeds of the $25,000 and the remaining balance is discharged.

In that example, the husband’s result is that he has no exempt property and no debt. He is at net zero. The wife, on the other hand, is still at negative $25,000 net. Considering the bankruptcy, is that a fair result in the divorce? Maybe a better question is, if the parties had collaborated on the best possible outcome for both parties, given the divorce and bankruptcy, was a better result available?

Why Not Work Together to Maximize the Bankruptcy in the Divorce?  Now, you may be thinking, why not just give all the debt to the husband and all the assets to the wife? Then 100% of the debt would have been discharged and the wife would have received the maximum assets without any detriment to the husband. Makes sense, right?  Well… Yes and no.

First, there may be a limitation on a distribution’s effectiveness if they debt is in both parties’ names.  While one party may discharge debt in bankruptcy, if the other party is also responsible, the creditor may still pursue him or her, regardless of what’s in the divorce agreement.  You will also recall from a couple paragraphs ago, a trustee oversees the bankruptcy estate. That is an experienced bankruptcy lawyer, trying to find assets for the bankruptcy estate, overseeing the administration of the process.  Part of the trustee’s job is to identify questionable or fraudulent transfers.  In certain circumstances, the trustee can force money transferred, even for a long period leading up to the bankruptcy filing, back into the bankruptcy estate.

That does make sense. Logically, people who know their assets are going to be taken away and liquidated are likely to try to transfer them out of their names prior to this occurring. The bad news for those individuals is the bankruptcy trustee will be looking for this. The good news is, there are certain types of transfers that cannot be reversed. One such type is when money is transferred for the payment of what is called a DSO.

A DSO is an obligation the spouse has to pay support, such as alimony or child support. So, when the divorce lawyers understand the limitations of the bankruptcy code, they may be creative in crafting an agreement that best benefits their clients, reducing the risk of transfers reversed through the bankruptcy. Aside from DSO transfers, there may be additional opportunity to maximize the marital estate through an agreement on alimony, child support, and/or equitable distribution. Getting too ambitious in these areas can be risky as there is an entire body of federal common law devoted to whether a transfer is in the nature of support or whether it is in the nature of a property transfer, the latter of which would make it more likely to be taken by the bankruptcy trustee. The expression “pigs get fat, hogs get slaughtered” it’s fitting here.

Every practice area has its complexity and it is uncommon for an attorney to be well experienced in both divorce litigation and bankruptcy law. It is important, therefore, that you choose a divorce lawyer with a thorough understanding of how divorce law in bankruptcy law intersect. If you have a heavy debt load and are contemplating bankruptcy in addition to divorce, bring these issues up in your divorce attorney consultation.

To schedule a free, confidential divorce attorney consultation with our office, call 978-225-9030 during our regular business hours or complete the contact form here and we will contact you back when we are back in the office.

Bankruptcy and Divorce in Massachusetts

Many divorces occur due to the financial stress a couple experiences, so it should come as no surprise that many couples considering divorce are also thinking about bankruptcy. The intersection of bankruptcy and divorce is examined in this post. In many cases, it makes sense to pursue a bankruptcy prior to a divorce. It is often less costly for couples to file for bankruptcy together, and often the bankruptcy eliminates property and debt that would otherwise have to be addressed in the property settlement agreement.

If both parties agree that a bankruptcy is inevitable and can work together through the bankruptcy process, it may make sense for the couple to pursue bankruptcy proceedings prior to divorce. It is important to understand that if one party chooses to enter bankruptcy proceedings, those debts may then fall upon the other party if they were entered into mutually. The court can assign that debt to an individual, but that does not change the agreement entered into with the creditor. The only way for both parties to release the debt is through a joint bankruptcy.

Although much debt can be discharged through bankruptcy, it will not affect child support or spousal support obligations. Individuals should not enter into bankruptcy in an effort to get relief from support orders. That does not mean that divorce is a bad option, however, especially if both parties carry significant debt and few assets.

Individuals considering a bankruptcy and divorce should understand that any debt they assumed as part of the divorce cannot be discharged through a Chapter 7 bankruptcy. It can only be discharged through a Chapter 13 bankruptcy, in which an individual assumes some of the debt through a payment plan. That’s why it is important for both parties to set aside their differences and work together, especially if they intend to pursue bankruptcy.

Will I Be Responsible for My Spouse’s Debts if I Do Not Declare Bankruptcy?

Many individuals rightfully fear that they will be held responsible for their spouse’s (or former spouse’s) debts if they do not file for bankruptcy. If the debts were incurred during the marriage, even if they solely benefitted your spouse, you may be held responsible. That’s why it is critical to hire an experienced Massachusetts divorce attorney to represent you legally and manage the financial implications you may face.

My Spouse Makes More Money, So We Cannot File for Chapter 7 Bankruptcy. What Can I Do?

In some cases, you and your spouse may, combined, not qualify for Chapter 7 bankruptcy. Separately, however, you may be able to pursue a Chapter 7 filing. If your spouse earns significantly more than you, and you want to file for Chapter 7 bankruptcy, it may make sense to wait until after your divorce is complete. It is important to speak with a bankruptcy attorney to determine your best method of filing.

We Started to File for Divorce, but Now We Are Pursuing Bankruptcy. What Should We Do?

Filing for bankruptcy puts an automatic stay on the divorce proceedings. That does not mean, however, that the court cannot establish support payments or that the support can be put on hold. It simply allows for a period of time during which the couple can proceed with the bankruptcy and then revisit the divorce proceedings at a later date.

When a couple seeks divorce and one or both parties believe that bankruptcy may be in their future, it’s critical to meet with an experienced Massachusetts divorce attorney right away.

Couples pursuing or even considering both bankruptcy and divorce should meet with both an experienced family law attorney and a bankruptcy attorney prior to proceeding with either. Since no two cases are exactly the same, it is critical to seek advice from practitioners who understand how bankruptcy and divorce can affect each other. The advice and guidance may save you thousands! Contact Damian Turco today for a free consultation to learn more about how bankruptcy may affect your divorce case.