Often, a married couple’s decision to divorce comes when they are already considering filing for bankruptcy. In other cases, bankruptcy is used by one divorcing party as a strategy to discharge some of the financial burdens of the dissolution action. Because bankruptcy operates under federal law and dissolution is mostly governed by the laws of specific states, their intersection is rarely simple.
If you are considering both divorce and bankruptcy, timing is everything. Under Chapter 11, § 362 of the United States Code, a petition to begin bankruptcy proceedings freezes attempts by creditors to assert claims against the debtor’s estate – a legal operation known as an “automatic stay.” The stay only applies to a dissolution action when “such proceeding seeks to determine the division of property that is property of the [filer’s] estate,” but most dissolutions seek to do just that. Although committee notes to the statute indicate that divorces which “bear no relation” to the bankruptcy should not be stayed, dissolution property division proceedings stop when bankruptcy begins.
If the bankruptcy filing occurs after dissolution, the parties also must consider the effects of the bankruptcy on asset division and debt allocation. If the parties to the dissolution are both named on indebted accounts, such as vehicle loans or credit cards, one party’s bankruptcy may not discharge the debt for their ex-spouse. Creditors could seek to recover some or all of the amount owed from the remaining debtor.
If the parties choose to file for bankruptcy before dissolution, their respective negotiating positions will be much clearer because they will know which debts were discharged. Bankruptcy proceedings can be lengthy, however, and may result in unnecessary delay if the parties could otherwise have reached a favorable settlement.
11 U.S.C. § 523 outlines exceptions to the discharge of debt which occurs when bankruptcy is completed. Among those exceptions are fraudulently obtained moneys, some court judgments, and student loans. Other well-known exceptions are “domestic support obligations,” including spousal maintenance and child support payments.
The fact that domestic obligations are not dischargeable may provide a false sense of security, however, because non-support components of the dissolution decree could still be discharged. Negotiated property settlements, for example an equalization payment for the value of a business or a waste claim, may result in money that is due to the other party. Because this obligation may or may not be classified as a “domestic support obligation,” it could potentially be discharged in the bankruptcy. The bankruptcy court’s determination of whether an obligation in the dissolution decree is support-based is discretionary and requires specific findings by the judge.
A complex dissolution/bankruptcy scenario can be full of legal hazards to avoid and obstacles to overcome. Attorneys for each legal action must be willing and able to work together in order to secure the most favorable outcomes for their clients after considering every option. A family law attorney with inadequate knowledge of bankruptcy law could even run afoul of the statutes if they advise their client to assume additional debt during the dissolution with a planned bankruptcy in the future.