BANKRUPTCY AND DIVORCE

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Divorce and bankruptcy often go hand-in-hand.  Many divorces are attributed to overwhelming financial debt, a job layoff by either party, or other significant reduction in income.  Also, it is inevitable that the financial pressure only increases upon the separation of the parties, as now the same income must support two separate households instead of just one.  The addition of child support and/or alimony being levied against one party may also contribute to that party’s overall inability to meet their financial obligations.

Absent a bankruptcy filing, the creditors’ legal rights are not directly affected by a divorce.  Joint debts owed to creditors survive intact, and creditors can continue to pursue either or both spouses, including pursuing all available state law remedies such as foreclosure, wage and bank garnishments, repossession, liens, or levies.   This is true even if one spouse agreed to pay the other spouse’s bills in the divorce, because the creditor was not a party to the divorce action and thus, such an arrangement remains strictly  an agreement between the parties themselves.  The harmed party’s sole remedy then lies with enforcement through the family law court, which is often costly and time-consuming.

Consequently, divorcing spouses often consider filing bankruptcy, either individually or as a joint Petition.  However, due to the nuances contained in the Bankruptcy Code, it is important for spouses and family law attorneys to consider the implications of divorce orders and settlements in advance – BEFORE they are finalized by the divorce court.  Otherwise, short-sided debtors may find themselves in the precarious position of having to pay debts that they can ill afford, and which might have been dischargeable but for the divorce proceedings themselves.

Most people are aware that domestic support obligations — alimony / spousal maintenance and child support obligations — are not dischargeable in bankruptcy.  11 U.S.C. 523(a)(5).   However, few people are aware that other debts, which would normally be dischargeable if a Debtor files a case before a divorce is entered, can be made non-dischargeable simply by way of the divorce settlement or court order.   11 U.S.C. 523(a)(15) controls the Chapter 7 dischargeability of “property division” obligations and other non-domestic support obligations, and states that the general discharge does not apply to a debt owed “to a spouse, former spouse, or child of the debtor and not of the kind described in [Section 523(a)(5)] that is incurred by the debtor in the course of a divorce or separation or in connection with a separation agreement, divorce decree or other order of a court of record, or a determination made in accordance with State or territorial law by a governmental unit.”  In layman’s terms, this means that if one spouse either agrees in a divorce settlement, or is otherwise court-ordered to pay a particular debt or debts, and is to indemnify and hold the other party harmless thereon, then those debts then become non-dischargeable in a subsequently filed bankruptcy case filed by that party.  This is true even if the ex-spouse is not personally liable for the debt and was not directly damaged by the non-payment.  Courts have held that the indemnification provision in the parties’ marital settlement agreement creates a new debt that runs between the spouses. See In re Harn, 208 WL 130914 (Bankr. C.D. Ill. 2008).

This is why planning is of vital importance!  Under most circumstances, it is advisable to file a bankruptcy case before obtaining a divorce judgement.  The divorce can have been filed and still be pending at the time of filing of the bankruptcy case, as long as the final judgment concerning property and debt allocations have not yet been entered.   Once a bankruptcy has been filed by a party, the divorce Judge is prohibited from assigning the filing party any of the debts that were included in the bankruptcy.  (Therefore, for single filing cases, it is important that all marital debts are included in the bankruptcy filing – even those that may be in the other spouse’s individual name.  The other spouse can be listed as a co-debtor for those and any other joint debts.) This does not keep the divorce court from ordering a filing spouse to pay alimony and/or child support, but said obligations would be non-dischargeable in bankruptcy regardless of when they were incurred, so this is not really an issue with regards to the timing of the filing of a case.

As explained, there is generally no distinction in a Chapter 7 regarding the dischargeability of different types of the two different types of family law obligations.  However, a Chapter 13 could not be more different.  Chapter 13 discharges are divided between the uncommon “hardship” discharge of Section 1328(b) and the common general discharge of Section 1328(a). Chapter 13 debtors who are granted a “hardship” discharge are NOT discharged from debts relating to property division obligations. However, the court’s entry of a general chapter 13 bankruptcy discharge after the successful completion of a confirmed chapter 13 plan DOES discharge an individual debtor’s debts relating to property division obligations. See Section 1328(a)(2) by omission.  Therefore, for debtors who did not plan ahead and now owe debts that they agreed to take on in a divorce but can no longer pay, this may be a way out.  However, Chapter 13 is much more onerous than a Chapter 7 when it comes to traditional domestic support obligations: if a debtor owes an arrearage for alimony or child support, this usually must be paid in full in the Plan unless the debtor can show that this would pose a hardship, and then is payable only to the extent the debtor is able, but any unpaid amounts still would remain non-dischargeable.  What’s more, a precondition to a chapter 13 general discharge  requires a debtor to pay all domestic support obligations that have come due AFTER filing the bankruptcy case, and to certify under penalties of perjury that all domestic support obligations owed as of the date of the certification have been paid, (including amounts due before the case was filed, but only to the extend provided for by the plan).   Thus, if the Debtor can successfully complete a 3-5 year bankruptcy plan, and pay all alimony and child support obligations during this time, they would be able to discharge their other debt obligations.

However, an ounce of prevention is better than a pound of cure, and thus, a little pre-planning can eliminate this costly mistake that is made by debtors everyday – debtors who simply do not know the perils of their decisions.  What is even worse though is that there are family law attorneys that fail their clients miserably by not knowing the intricacies of bankruptcy law and how the two fields interrelate.  More family law attorneys need to understand the consequences of the wording routinely espoused in settlement agreements and  divorce decrees, and advise their clients appropriately.  More widespread knowledge of these laws will help divorce clients make more informed decisions when it comes to their cases, and the eventual outcome will not come as a surprise to those who find that they cannot meet their financial obligations post-divorce.

www.manuelassociates.com  or Call Us : 217-344-3400

 

 

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