Bankruptcy During Divorce

If you think you're headed for divorce and have a lot of debt between the two of you, it might make sense to file for bankruptcy before starting a legal divorce proceeding. Filing bankruptcy first can simplify the divorce by clearing out some of your debt. This can make it easier to negotiate how the remaining debts should be divided, and protect you from your soon-to-be-ex's bankruptcy filing down the road. It's also cheaper to file a joint bankruptcy than doing it separately.

Effect of Bankruptcy On Divorce

When one or both spouses file bankruptcy, all the community property becomes a part of the bankruptcy estate and is available to pay debts.

When you or your spouse file a bankruptcy, an automatic stay immediately prevents creditors from collecting on most debts. But the automatic stay doesn't prevent you from asking a divorce court to order your spouse to pay child support or alimony. Some family courts will require you to get an order from the bankruptcy court stating that the bankruptcy court doesn't have authority over support matters.

Once a bankruptcy court decides property is "exempt" (not available to be sold to pay debts), a divorce court can then divide that property.

Property Settlements and Bankruptcy

Negotiating a property settlement in the midst of bankruptcy is complicated. Debts related to a property settlement are presumed to be "nondischargeable" in bankruptcy, meaning that the person who files bankruptcy can't have those debts wiped out and must still be responsible for them. But the bankruptcy court will wipe out those debts if the person filing for bankruptcy can show that:

• he or she can't pay the debt and still take care of him or herself and any dependents, or
• that wiping out the debt would result in a benefit to the person filing the bankruptcy that outweighs any harm done to his or her former spouse or child by nonpayment.

So if you think your spouse is contemplating bankruptcy after your divorce is final, you'll want to word your property settlement in such a way that your soon-to-be-ex's obligation looks and acts as much as possible like a support obligation instead of a property settlement.

How do bankruptcy courts decide what's support and what's property settlement? It varies greatly by state, but courts have based their decisions on such questions as:

• Does the obligation terminate or reduce with the occurrence of certain events, like remarriage or a child turning 18?
• Is the obligation in installments or a lump sum?
• Are there minor children?
• What is the relative health and education of the parties?
• Was there a need for support at the time of the divorce?

Property Liens

One way to protect yourself in a divorce negotiation if you think your spouse may be contemplating bankruptcy in the future is to take a security lien as a backup to debts your spouse is to pay you after the divorce. The lien should be on property your spouse is to be awarded in the divorce, preferably property that means a lot to your spouse. That way, if your spouse later asks the bankruptcy court to discharge the debt he or she is supposed to pay, you can seize the property to pay the debt.

Indemnity Clauses

Another precaution in the face of a soon-to-be-ex talking about bankruptcy is to have a "hold harmless" or "indemnity" clause written into the divorce decree, requiring your spouse to pay certain debts or repay you if a creditor makes you pay the debt. If your ex bankrupts, you can go to bankruptcy court and ask the judge to enforce the indemnity agreement. While an indemnity agreement won't guarantee you'll get paid, it's one more factor for the bankruptcy judge to consider.

As you can see, the issues of going through divorce and bankruptcy at the same time are confusing at best, and highly damaging at worst. If you find yourself in this position, it makes sense to find a bankruptcy lawyer who can help you with all the issues.

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