Do You File Bankruptcy Or Divorce First?
The journey to divorce… financial disasters.
You hear it all the time…
Finances are the #1 cause of divorce.
The tighter money is for the household, the more you argue. Normally you have someone who is a saver and someone who is the spender. The balance is good in a healthy marriage and disastrous in a bad marriage.
If you are at the point where bankruptcy might be the only way to fix your finances, then there is likely another reason you found yourself in such trouble… a job loss, a major medical event, and in this time period, the devastation brought by COVID on our economy and our lives. All of this stress can break even the strongest of bonds. All your energy is put towards keeping your head above water. Who has time for romance? Who has the energy to take time to tell your Spouse how much you appreciate them? The greater the stress, the less the sex. It can be the perfect storm to tear apart your marriage and leave it in shreds.
Warning: This is going to be a bit technical… not expecting you to truly grasp everything… but it it meant for you to see how complicated this issue is and convince you that you need legal advice. I promise, this is not really of the level of “ambulance chasing”… it truly is complicated!
As a divorce and bankruptcy attorney, I see people who try to file bankruptcy as an effort to save their marriage. Sometimes it works, other times it is too little too late. Other times I have people end up in bankruptcy out of the divorce because they simply can’t make it. As a mediator, I often walk people through the idea that they may need to file bankruptcy. Again, I can’t say this enough…this article is a brief overview of a very complicated subject.
How do you know if you should file bankruptcy or divorce first?
- Talk to a bankruptcy attorney first by yourself.
- Talk to a divorce attorney.
- Talk to your Spouse.
There is a reason that it needs to be in this order. There are very few bankruptcy attorneys that can represent both Parties in a bankruptcy case when divorce is on the horizon. Some of this depends on if you are filing a Chapter 7 or a Chapter 13 simply because of the different timelines each case will take. Chapter 7 is normally a 3–4 month process after you file while Chapter 13 is a 3–5 year process. If the attorney represents both Parties, there is an inherent conflict of interest between the two individuals 90% of the time. What that means is that your interest and what you need is not the same as your Spouse’s and the attorney cannot advise each of you because it puts the two in direct competition with the other. There are times that the conflict can be waived with everyone being on the same page of how to move forward and other times when it cannot. When a conflict comes up, this might mean that the attorney cannot represent EITHER person and you both would have to start over with a new attorney. This is the reason you want to talk to the attorney on your own first. You can always bring in your Spouse later.
Another reason you need to talk to the bankruptcy attorney first is to protect your property. Each State has “Exemptions” which allow you to keep a certain amount of property free from your creditors. If both Parties own the property, sometimes you can “stack” the “Exemptions” and sometimes you can’t. If only one Party files, then if the property is owned jointly then they only legally are entitled to 1/2 of the equity in that property.
Let’s use an example of your home. In Missouri, you are only allowed $15,000 of equity in your home free from your creditor. If the Parties own the home jointly, they do not get to stack the exemption and the total exemption is $15,000 or $7,500 each. Let’s say that you have $20,00 in equity in your home… over the limit. But if only one Spouse files, it is $10,000 to them and under the bankruptcy limit. If you set the house aside to the Spouse who needs to file bankruptcy, you have a problem because they have the entire $20,000 which means they would need to file a Chapter 13 case and pay creditors $5,000. If you set aside the house to the Spouse who will not be filing bankruptcy, then it might not be a problem unless they should have received funds coming out of the divorce (maybe).
The opposite could also be true… you don’t have any equity in your home and in fact, you might be able to dump your second mortgage or not pay 100% of your car loan if you are too upside down. This is beyond the scope of this article, but it would definitely help one Spouse and hurt the other.
Child Support and Maintenance
If you are delinquent on your child support or maintenance, you are not eligible for a discharge of your debts. This might require you to file a Chapter 13 to give you time to pay back child support so you can receive a discharge of your debts in bankruptcy. So there are ways that you should deal with child support and maintenance payments that do not force you into a Chapter 13 just because you did not do it right. Most divorce attorneys don’t know anything about bankruptcy and have no idea this is an issue. Direct payments are the way to go rather than wage withholding only because it takes the State several months to get your child support order into the system and then for the wage withholding to kick in. You have to pay direct anyway. Without bankruptcy issues, you could save up and then make a direct payment to catch up. The best way, when bankruptcy is on the horizon, if you can trust your Co-Parent, is to make payments direct to the Co-Parent and have then sign the State forms acknowledging payments. Then the Acknowledgment of Payment gets filed in your divorce matter so the State does not show you as delinquent. Do it right, and you are safe in both cases.
What about the budget?
Another big issue for Parties is the budget after separation. Bankruptcy is all about what the Debtor has available to pay their creditors. In some cases, it might be 100%. For other people, it might be $0.00. Whether the divorce is first or second can impact this number. Would you be throwing away money if you file bankruptcy before the divorce (or separation)? If you know divorce is likely, but you are not ready to throw in the towel just yet, you should still understand what happens if divorce comes down the road.
There is a trick with Chapter 13 that your divorce attorney doesn’t know about… you get 5 years max to pay. So the car payment could be less per month or the payment on taxes could be less. This might make the structuring of who gets what property and what debts are paid by each a bit more complicated, but a way better financial decision in certain circumstances. Again, this is another reason you need to talk to the bankruptcy attorney first.
Automatic Stay in Bankruptcy Court
One little known fact… you CANNOT finish the divorce and divide property without getting relief of the automatic stay by the bankruptcy Judge. Ok, so what does that mean exactly.
- You can set child support and maintenance without an Order from the Bankruptcy Court.
- You cannot divide the assets and debts without an Order from the bankruptcy court.
- The Automatic Stay protects BOTH Parties.
Why can’t you divide the assets? Because technically the assets are assets of your bankruptcy estate. You can’t sell without permission or in any way encumber the assets because this is against the rights of the creditors. Further, although only one Spouse might be in bankruptcy, the other Spouse is protected by the Co-Debtor “Stay” as well. It is all kind of technical, but super easy to fix. There needs to be a Joint Motion For Relief of Stay filed with the Bankruptcy Court. Normally, this is no big deal; however, you may need to pay a filing fee for the Motion and mail it out to all the creditors.
Common misconception… just because a JOINT debt is set aside to one person does not mean the other person is off the hook.
If you owe a creditor, you are responsible for the debt to your creditors if your Ex does not pay. You can still be sued and end up with a garnishment against you. Your only recourse is to go back to the Divorce Judge and ask for an Order of Contempt and reimbursement for funds you had to pay for the debt.
The bigger problem is not just that you are open to lawsuits, but that you might not qualify for bankruptcy yourself or you might have to file a Chapter 13 case if you have a higher amount of income.
As a divorce attorney, I always recommend that we think through this process carefully. It is hard enough to make it after divorce… but to be thrown into bankruptcy because your Ex does not hold up their end of the bargain is yet another betrayal. Before you set aside the house to your Spouse, make sure they can make the house payment AND pay their other debts. If there is some equity in the property, maybe the Spouse needs to refinance and pay off debts or give you funds out of the refinance to pay off debts. This is the reason it is so important to talk to the divorce attorney before you file for bankruptcy as well.
Not Playing Fair… filing for bankruptcy before the divorce.
Another important concept to understand… if your Spouse files bankruptcy before the trial date on your divorce, the Divorce Judge cannot set debt aside to them other than for secured property they will keep in the bankruptcy (like the house or a car). This means it is 100% on you… all the credit cards, all the medical debt. It really does not matter if it is a Chapter 7 or Chapter 13 — it is on you. The good news with a Chapter 13 is that anything that is paid to unsecured creditors (credit cards and medical bills) is money you don’t have to pay. Plus, you do get the benefit of the co-Debtor stay which means the creditor has to go to the Bankruptcy Court to get permission to sue you individually in the Civil Court. There are plenty of ways to structure this in a positive way in the divorce. Only an attorney with knowledge about bankruptcy and divorce and truly walk you through this process.
Do I have to file bankruptcy with my Spouse?
I think we have answered that question, but to be sure the answer is “No”. You can file by yourself while you are still married. In fact, if the debt is primarily your debt, this might be helpful. What can hurt you is your Spouse’s income. Technically, being married and not separated, the marital income of your Spouse is “marital income” and not their sole and separate income. However, I have had cases which have successfully discharged their debts despite the income of the husband when the income was always kept separate and each paid separate debts. This seems to pop up more in second marriages where you have non-marital homes, cars owned separately, etc. Everyone comes into the marriage with their own debt and it was not joint debt. The Bankruptcy Court will not penalize you for having a bad Spouse who won’t help you. This does make you vulnerable to allegations of fraud so you need to tread lightly and disclose everything to your attorney.
Working together to help BOTH Parties
Not every divorcing couple wants to hurt the other. They may have different needs and how they move forward might not be the same… but it does not mean that they don’t have a common goal to both come out of this as healthy as possible.
The attorneys can help you figure this out… which to file first. The Parties can only file together while they are married. They can be separated already, just not divorced before they file. In a Chapter 7 case, it normally might be good to have the divorce on file if you need separate budgets to qualify for a Chapter 7 due to your inability to pay. However, if the budget is not there in the circumstances before your separation, filing a Chapter 7 at that time before the divorce might be best especially if you have children and will have issues of child support. In a Chapter 13 situation, you can get divorce in the middle of your case no problem. You would need to figure out who pays which portion of the Chapter 13 Plan Payment or if it is appropriate to separate the cases and one Spouse move to a Chapter 7 case. The good news is that if you do need to file separate cases, often the bankruptcy attorney will give you a discount since some of the work is duplicated in each case.
What about filing divorce first and then only one Party files bankruptcy after?
You might think this is black and white and the Bankruptcy Debtor is home free, but this is not always the case. This is a question to ask both your bankruptcy and divorce attorney as the answer might be different depending on your State. This all goes to the concept of “in lieu of maintenance”. What this mean is that the Divorce Judge could have ordered maintenance to be paid if the Spouse had not taken the debt set aside to them.
Still legal babble to you? Let’s try an example…
Husband makes more money and all the debt is set aside to him. Now he wants to come back and discharge it all and Wife is stuck. Now what?
Wife has the option to file bankruptcy. Sometimes that is the best option despite it being stuck on her. But what if she received the house and it has too much equity? What if she simply does not want to file because it is husband’s fault? What can she do?
First, it is always prudent to file an Objection to Discharge, participate in the 341 meeting, and if a Chapter 13, Object to the Chapter 13 Plan. However, is some States, you might not even be required to do this. You might be able to go back to Divorce Court for a Motion to Compel or Motion for Contempt. If there is any chance that the Divorce Judge could have Ordered the Spouse to pay maintenance to the other to help make payments on the debt, then they cannot simply file bankruptcy and walk away. But you have to fight it!
Just like I mentioned above, you really do need to think this through before you finalize your divorce (maybe before you file it in the first place). Don’t make the mistake of being naïve and thinking you can make it on your own after your divorce. Do you homework… how much will it be to live on your own, what is your health insurance payment on your own, what about car insurance without the bundle discount, etc. Is your Spouse going to just pay the minimum amount due and your credit is hurt in the process. What if you get in a wreck and don’t have GAP insurance… or what if that happens to your Ex? Remember, if you are going to be a renter, your credit score can keep you from finding a decent apartment even if you have the ability to pay the rent… especially if you are just getting back into the work force. Another factor is that after a person has their debts discharged in bankruptcy, they still might not be able to refinance the house for another 2–3 years even if they can afford the payment. The mortgage lender might not sign off on it just because of the bankruptcy.
As you can see, there is a ton to think about and talking to an experienced attorney will help you avoid the potholes in the road of divorce and bankruptcy. You want an attorney who does divorce and bankruptcy if you can find one. I find that most bankruptcy attorneys don’t know much about divorce and most divorce attorneys don’t know much about bankruptcy. If you can’t find someone who does both, the bankruptcy attorney is a bit more important in this scenario to be honest. Getting the two attorneys to work together would be crucial to making sure you proceed in the best way possible. Talk to attorneys, do your homework, and then you will have the best foundation necessary to talk to your Spouse in a way that does not come across as you are only concerned about yourself and you are leaving them to the wolves.
If you think you might need to file bankruptcy, I suggest that you take my Fix My Finances Quiz. While it does not deal with the divorce complication, it can tell you if you even would need to file for bankruptcy in the first place.