If you're facing a divorce and you have significant debt, filing for bankruptcy could be a stress-reducing option. But timing can be critical. In this article, you'll learn about the benefits and issues associated with filing for bankruptcy before or after a divorce.
While filing for bankruptcy won't stop divorce, custody, or support actions, it can delay the distribution of assets until after you complete the bankruptcy case. Here's why.
Most people choose to file for Chapter 7 bankruptcy when possible. It's quick, taking three to four months to complete, and it wipes out qualifying debt without the need to pay creditors through a repayment plan. You'll also be able to keep or "exempt" the property needed to work and live. The primary way a bankruptcy case will affect a divorce is that it can delay the distribution of assets. The bankruptcy trustee assigned to administer your matter will hold most assets in the bankruptcy estate and sell any property that you can't protect with a bankruptcy exemption. The trustee will then distribute the funds to your creditors.
The Chapter 13 process works differently. If a married couple files for Chapter 13 bankruptcy, you'll both responsible for the three- to five-year Chapter 13 repayment plan. It's unusual for a couple to plan to file for Chapter 13 before a divorce, so only Chapter 7 is addressed in the remainder of the article.
If you and your spouse are on good terms, a joint Chapter 7 bankruptcy filing while you're married is often a great idea. You'll eliminate qualifying debts—like credit card balances, past-due utility and medical bills, and personal loans—leaving you less to divide in the divorce. Bankruptcy will also eliminate contracts that neither one of you want to keep, like an expensive car loan or a home mortgage that's entirely underwater. You might also be able to increase your exemption amounts and protect more property. And you can reduce court costs and attorneys' fees by filing jointly before a divorce, as opposed to filing two bankruptcy matters after divorce. Overall, when it works, filing for Chapter 7 while married makes for a much simpler, cleaner dissolution.
One of the issues you'll have to address is whether your combined income is low enough to qualify for Chapter 7. It's not uncommon for the two spousal salaries combined to exceed the maximum amount allowed under the Chapter 7 means test. If that happens, you might not have a choice but wait to file until after the divorce. But there are ways around this problem. For instance, if you're separated and living apart, you'll be able to reduce your income by deducting household expenses for both residences.
By contrast, if one spouse makes all the money, filing before the divorce will increase the chance of qualifying for a Chapter 7 for that spouse (both of you will be included as part of the household for purposes of the means test). Assisting the income-earning spouse by reducing debt through bankruptcy should make it easier for that spouse to pay support obligations, a win-win for all involved.
Filing for divorce first might make sense if your joint income is too high to qualify for Chapter 7 bankruptcy. Sometimes both spouses qualify individually after a divorce even if they could not do it jointly. If you make significantly less than your spouse, you might be able to qualify for Chapter 7 after your divorce, too.
Proper planning in a divorce could also move certain assets outside of the trustee's influence. For example, if one spouse takes a house in the divorce, a proper judgment and transfer of the title and mortgage can protect the ex-spouse from your creditors. Just be sure to stay above board. A bankruptcy trustee has the power to undo certain transfers using clawback procedures, and you don't want to find yourself accused of committing bankruptcy fraud.
If you file for divorce knowing that you or your soon-to-be ex-spouse will file for bankruptcy, you'll want to be sure to hire a family law attorney who is savvy about bankruptcy law (many aren't). While your case could have any number of issues that could affect a bankruptcy, here are a couple of things to consider:
The issues that can arise in cases involving both family law and bankruptcy tend to be numerous and complicated, and the hearings that can ensue are often vengeful and fraught with emotion. It's highly advisable to prepare accordingly by seeking counsel knowledgeable in both areas and by familiarizing yourself with common family law issues.