It’s not a match made in heaven, but bankruptcy and divorce often pair up hand-in-hand. Many people who go through divorce end up in poor financial condition and find no other alternative but to declare bankruptcy for a fresh start. Likewise, some couples who file or are on their way to filing bankruptcy have suffered the inmesurable toll and stress of being deep in debt and marriages are strained beyond reconciliation.
If you are in the midst of a divorce and bankruptcy is being contemplated, it is highly advisable to seek the advice of a bankruptcy lawyer before finalizing the divorce because the divorce settlement agreement or court order equivalent will likely affect what you can and can’t do in your bankruptcy. It is important to understand how assets, debts and obligations that are the subject of a divorce will be treated in a bankruptcy case.
The Debt You Can’t Get Rid Of: the DSO
In bankruptcy, how debt is characterized determines, in part, if it is subject to “discharge” (the obligation to pay back the debt is extinguished in bankruptcy). The bankruptcy code, 11 U.S.C. 523(a)(5) exempts from discharge a “domestic support obligation” or “DSO.” Pursuant to 11 U.S.C. 101, a DSO includes debts that are characterized as alimony, maintenance or support as created by a divorce decree, property settlement agreement or other similar court order. Thus, the way that obligations are distributed in a divorce will dictate whether that obligation will be “dischargable” in the bankruptcy. Simply put, if the obligation arises due to support, it won’t; if it arises due to property settlement, it has a better chance of being dischargable.
In a divorce, the law of the state in which you live and file will dictate how a divorce court should go about distribution of marital assets. If however, a bankruptcy is filed while the divorce is in progress, the bankruptcy court will determine the equitable share of property and has the power to “stay” a divorce court from proceeding on any determination of the division of property that is owned, in whole or in part, by the person who filed for bankruptcy relief – the debtor. This means that timing is, again, key to knowing when it is best to file bankruptcy when a divorce is involved because it will greatly affect the distribution of property under the divorce.
In the divorce court setting, the husband and wife may chose to work something out amicably among themselves; if bankruptcy is filed by either party while the divorce is still in progress, it will be the bankruptcy court, not the parties, that makes the determination as to the division (and potential seizure and liquidation) of jointly held property.
Like a lion in wait, so is the bankruptcy Trustee stalking assets
Another reason to make sure the divorce is finalized before filing bankruptcy is the implication of assets vesting into the bankruptcy estate. When a bankruptcy case is filed, all of that individual’s legal and equitable interest in property is placed in the hand’s of a court-appointed bankruptcy Trustee. In Chapter 7 bankruptcy, the Trustee serves to determine if any non-exempt assets exist for liquidation for the benefit of the bankruptcy debtor’s creditors. Similarly, in Chapter 13 bankruptcy, the Trustee is interested in knowing if any non-exempt assets exist for the purpose of determining if the debtor has proposed a repayment plan that meets the “best interest of the creditors” test pursuant to 11 U.S.C 1325(a)(4). Under either chapter of filing, if a divorce is pending and there are likely to be assets involved, the bankruptcy Trustee may hold open the Estate for the final divorce decree to see how the assets were distributed. This would mean, of course, prolonging the time the bankruptcy case is open. It could also result in the loss of assets awarded by the divorce court if those assets are not exempt under the applicable bankruptcy law.
When you’re in a bad situation, the natural instinct is to get out of it as soon as possible. Following this line of thought, some people who are divorcing and in need of bankruptcy try to get both done and over with in one setting. The well-informed person should realize that trying to do both at the same time will likely throw in unforseen consequences – some of which are detrimental to your best interests; it is therefore the best practice to finish one before the other.
You will survive the process, but you need to realize and accept that it is a process – don’t put the cart before the horse. If in doubt, always consult a local attorney for advice.