The interplay of divorce and bankruptcy

For many, debt leads to both a divorce and a bankruptcy filing.

Financial strain could lead some couples to divorce; constant bickering about money can upset even the strongest of marriages, resulting in partners who choose to go their separate ways. If unmanageable debt is the cause of financial woes that led to the divorce, one or both spouses might be better off filing for bankruptcy. The question then is to determine if the bankruptcy should be filed before the divorce or vice versa.

Possible considerations

At first glance, it may not seem like it will make a big difference if the bankruptcy is filed before the divorce or after. You may even assume that the outcome will be the same regardless. If you think that, however, you could be in for a rude awakening.

As with many things in life, when both a bankruptcy and a divorce filing are on the proverbial table, timing is key. If the divorce is finalized before the bankruptcy is filed, then the debt relief may be incomplete for one or both spouses. This is perhaps best illustrated with an example.

Joe and Jill decide to end their 10-year marriage after a lengthy period of unhappiness. The divorce is filed and finalized. In the divorce settlement, Joe assumes half of the couple's marital debt, which includes tens of thousands of dollars in joint credit card bills and personal loans for which both he and Jill signed. Under the divorce decree, each spouse is responsible for paying half of the joint debts. Afterwards, Joe files for bankruptcy. His bankruptcy discharge will grant him relief from his unsecured debts, including the marital ones he assumed as part of the Marital Settlement Agreement. Legally, this means that Jill is now responsible for the entirety of the joint debts, because creditors cannot collect from Joe; since the creditors aren't a party to the divorce, they are not bound by the terms of a family court action. In that situation, Jill's only recourse would be to file a civil suit against Joe to collect his half of the funds.

Perhaps a better option in this example would be for both parties to file for bankruptcy as a couple prior to the divorce. This would grant them both relief from their joint unsecured debts without leaving either party "on the hook" for the entire amount. An important consideration about filing for bankruptcy prior to the divorce being finalized, though, is that one spouse could inadvertently undo the assistance offered by a bankruptcy by accepting debt in the divorce settlement. If a bankruptcy filing had legally discharged a debt, later agreeing to pay it could "revive" it for collection purposes.

Another important point about the interplay of divorce and bankruptcy involves the assumption of debt and how it could affect the type of bankruptcy relief available. If, as part of the couple's Marital Settlement Agreement, one party agreed to assume the joint debt (while indemnifying the other spouse), then the debt would be legally considered a "Domestic Support Obligation," which would limit the bankruptcy relief later available. Domestic Support Obligations are only dischargeable through Chapter 13 bankruptcy, not through Chapter 7. Since there are pros and cons to which type of bankruptcy relief is sought, the marital debt - and how its treatment could potentially influence an upcoming bankruptcy filing - must be carefully considered during the divorce negotiations.

Neither bankruptcy nor divorce should be entered into lightly, and each should be carefully considered before action is taken. If you have already divorced and entered into a Marital Settlement Agreement, make sure to bring that to the attention of your bankruptcy attorney as soon as possible in the bankruptcy process to get a better idea of your rights and obligations. To learn more about how bankruptcy and divorce intersect - and which you should do first if you are considering both - contact the Law Office of Paul L. Ulrich, P.A. by calling 407-896-3077 or sending an email.

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