Divorce is one of the top reasons people give for filing for bankruptcy. Similarly, financial woes often cause stress in relationships. Due to this connection, many people who go through a divorce end up filing for bankruptcy during or after their divorce.
Divorce and bankruptcy laws have many complex interactions affecting property rights, as explained below.
How Divorce Affects Your Property
When you or your spouse files for divorce, the court must divide your property according to your state’s divorce laws.
If you live in a community property state, all property obtained by you or your spouse during marriage, other than by gift or inheritance, or obtained using money or property acquired before marriage, is generally considered community property. Other property, with some exemptions, is considered separate property.
Upon divorce, each spouse is generally entitled to 100% of his or her separate property and 50% of the community property.
If you live in a non-community property state, upon divorce, the court will divide your property between you and your spouse in a manner it deems fair.
How Bankruptcy Affects Your Property
When you file for bankruptcy, your property becomes part of the bankruptcy estate, unless you can exempt it under the bankruptcy laws. The bankruptcy estate is the pool of assets the bankruptcy trustee uses to pay creditors. Most people who file for bankruptcy use statutory exemptions to keep as much property as possible out of the bankruptcy estate, allowing them to keep it.
- In a Community Property State: If you are married and you live in a community property state, the bankruptcy estate will include all of your non-exempt separate property, and generally includes all of the non-exempt community property.
- In a Non-Community Property State: If you are married and you live in a non-community property state, the bankruptcy estate includes all of your non-exempt separate property, and half of the non-exempt property jointly owned by you and your spouse.
In some states, property owned by you and your spouse as tenants by the entirety is excluded from the bankruptcy estate if only one spouse files.
Filing Bankruptcy Jointly vs. Filing Separately
If you file for bankruptcy jointly with your spouse, generally all of your non-exempt property and all of your spouse’s non-exempt property will be included in the bankruptcy estate.
Some states allow joint filers to double the amount of the exemptions to keep more property out of the bankruptcy estate. But if you do not live in a state that allows you to double your exemptions, and you have more property than you can exempt, it may be more advantageous to file individually, rather than jointly.
Because filing jointly requires cooperation, it may not be feasible if you are currently getting divorced or are contemplating divorce in the near future.
Read more about the legal impact if only one spouse files for bankruptcy.
How the Automatic Stay Affects Your Divorce
Filing for bankruptcy triggers an automatic stay. The automatic stay prevents lawsuits or debt collection relating to your property, unless authorized by the bankruptcy court. Generally, actions taken in violation of the stay are void.
While the automatic stay does not prevent a spouse from filing for divorce, the stay does prevent the family court from dividing property in the bankruptcy estate or ordering support to be paid out of the bankruptcy estate.
Because of the automatic stay, in order to continue with a divorce case after a bankruptcy case has been filed, either you or your spouse may need to request an order from the bankruptcy court modifying the automatic stay.
Bankruptcy courts commonly grant relief from the automatic stay to allow the family court to determine each spouse’s property rights, but the bankruptcy court may retain jurisdiction over community property in the bankruptcy estate.
Child custody and domestic violence proceedings are exempt from the automatic stay. A family court may also order or enforce a support order, so long as it does not affect property of the bankruptcy estate.
Filing for Bankruptcy Before Divorce
Filing for bankruptcy prior to divorce allows you and your spouse to share both the legal costs of the bankruptcy, and both of your exemptions (double exemptions, which some jurisdictions allows) that can be claimed on property in a bankruptcy.
This can be financially beneficial for both spouses. This plan of action would be a better idea if the spouses are still on good terms. It can also simplify divorce proceedings if the bankruptcy proceedings are already handled.
Filing for Bankruptcy during Divorce
It is easier to file for bankruptcy either before or after divorce. However, if you file for bankruptcy during your divorce case, all of the non-exempt marital property not yet divided in the divorce case will be pulled into the bankruptcy estate. In order to continue with the divorce case, you or your spouse may need to seek relief from the automatic stay before the family court can determine property rights and divide the marital property.
If you file for bankruptcy in the middle of a divorce case, you should give notice of the bankruptcy case to the family court and notice of the divorce case to the bankruptcy court.
If you and your spouse use the same attorney for your divorce, then file bankruptcy, you will need to get separate attorneys, because this will create a conflict of interest for the attorney (representing both of your financial interests).
Filing for Bankruptcy after Divorce
Filing for bankruptcy after a divorce can lead to unique issues involving the division of assets.
The trustee of the bankruptcy court, who is responsible for administering property in the bankruptcy estate, may scrutinize the way the property was divided in the divorce case. Under some circumstances, the trustee may seek to undo certain transfers in the divorce case in order to pull property into the bankruptcy estate, thereby making it available to pay creditors.
This is especially true if your divorce was resolved by settlement and the terms of the settlement appear to be more favorable to the other spouse, or when non-exempt property was awarded to the spouse not filing for bankruptcy.
Additionally, if you file for bankruptcy after the divorce, even if you obtain a full discharge, you may be potentially liable to the non-filing spouse for some debts if your divorce judgment included an indemnification agreement. Moreover, you may be prevented from discharging other obligations in your divorce judgment.
Also, it is important to note that the simplest type of bankruptcy, a Chapter 7 bankruptcy, requires that you be below an income limit. If you and your spouse jointly exceed that limit, it may be better to wait until after to divorce to file bankruptcy.
Should I Contact a Bankruptcy Attorney?
Both bankruptcy and divorce can bring out highly complex legal issues. If you are contemplating divorce or bankruptcy, you should strongly consider contacting a local bankruptcy attorney or family law attorney to protect your interests.