FindLaw KnowledgeBasePublished: 2010-01-15
Even though divorce rates have stayed lower than expected in the current economy, couples who are deciding to part ways are finding that their divorces are complicated by the amount of debt they carry. For example, rather than using the funds from the sale of the family home to finance their new separate lives, spouses instead must decide what to do with a home worth less than what is owed on it. Will one spouse stay in the home? Can either spouse afford the house on his or her own? How will joint mortgage debt be divided?
Filing for bankruptcy before, during or after the divorce is one way spouses may decide to deal with their debt.
Bankruptcy Before Divorce
Generally, filing for bankruptcy jointly before divorce is a simpler process, although this is not practical in all cases.
If it is an option, finalizing the bankruptcy before filing for divorce will allow the spouses to discharge some or all of their debts. The divorce court then can decide how to divide any remaining assets and debts between the two parties, according to New York law.
Bankruptcy During Divorce
Handling the bankruptcy during the divorce is likely to complicate the entire process and slow down the divorce, but it may be necessary.
Either spouse can file for bankruptcy during the divorce. Regardless of whether the filing is joint or separate, assets of the marital estate — for example, the property acquired by either spouse during the marriage — could become part of the bankruptcy and subject to liquidation to pay some or all of the spouses' debts.
Once the spouse files for bankruptcy, the bankruptcy court will issue an automatic stay, which prevents creditors from continuing to try to collect any unpaid debts. The automatic stay also prevents the divorce court from proceeding any further, with important exceptions. The automatic stay does not apply to any actions to establish, modify or collect support obligations, including spousal maintenance and child support, or to actions to determine paternity. In addition, the automatic stay does not apply to child custody or visitation decisions. In some cases, however, the automatic stay may make it difficult for a spouse to collect court-ordered support, particularly if the assets the other spouse would use to pay those obligations are considered part of the bankruptcy estate.
Likewise, the divorce court will not be able to divide property between the spouses until the bankruptcy court has made a determination of which property is exempt from the bankruptcy. Exempt property cannot be sold by the bankruptcy trustee to pay off debts.
New York has opted out of the federal property exemptions available under the U.S. Bankruptcy Code. Instead, debtors are limited to using the exemptions available under state law. Some of these exemptions include:
- Homestead exemption up to $10,000 in equity for joint filers
- Automobile exemption up to $2,400 in equity for a single car
- All qualified retirement account funds
- Personal use and household items
Federal benefits, like Social Security and veteran's benefits, also are exempt from bankruptcy. Once the bankruptcy court has sorted the exempt property from the non-exempt property, then the divorce court can divide the exempt property equitably between the spouses.
If the couple has any non-exempt property, it will be used to pay off secured creditors first, like the bank holding their mortgage, followed by any unsecured creditors, like credit card companies. Generally, however, most people filing for bankruptcy have little to no non-exempt property and the majority of their secured and unsecured debts are discharged.
Bankruptcy After Divorce
Some ex-spouses may decide to file for bankruptcy after the divorce in hopes of discharging some or all of the debts they were ordered to pay as part of the divorce order. Certain types of debts, however, are not dischargeable in either a Chapter 7 or Chapter 13 filing. Specifically, support obligations, including child support and alimony, are not dischargeable in bankruptcy and must be paid.
Property settlements may be dischargeable. Non-support obligations, such as debt included in a property settlement, are not dischargeable in a Chapter 7 bankruptcy; they may be dischargeable in a Chapter 13 filing, however, unless the court finds that the debt is actually a support obligation.
If an ex-spouse is able to discharge a joint debt in a Chapter 13 filing, the creditor may decide to come after the other spouse for repayment of the debt. This can create a real financial burden for a former spouse who believed that he or she was protected from repaying the debt by a property settlement.
There are ways for individuals to protect themselves in their property settlement agreements if they believe there is a possibility their former spouse will file bankruptcy after divorce. These include:
- Indemnity agreements: It is a wise idea to include an indemnity clause in the property settlement agreement that permits one spouse to seek repayment from the other if the other spouse fails to repay certain debts.
- Property liens: One spouse can take a security lien against some of the property awarded to the other spouse in the property settlement, allowing the spouse to seize the property for repayment of any unpaid debt.
- Support obligations: Debts included in a property settlement should be structured as support obligations to prevent discharge in bankruptcy.
- Title changes on joint debts: Jointly owned debts that must be repaid by one spouse should be put only in that spouse's name after the divorce.
Should a bankruptcy court discharge debt that was part of a settlement agreement, the other spouse also has the option of seeking a modification to the support amount. While it can be difficult to get a modification of a property settlement, it may be possible to seek an increase or decrease in support based on the discharge of debt and new financial obligations of either spouse.
Contact an Experienced Attorney
If you are contemplating divorce and have a heavy debt load, bankruptcy may be a good option for you and your spouse. While filing bankruptcy before the divorce can simplify the process, it is not feasible for every couple. In some cases, filing during or after the divorce makes more sense for the individuals involved.
To learn more about divorce and your financial planning options, contact an experienced attorney. Because a bankruptcy near the time of divorce can be complex, the advice of an attorney is valuable in determining the proper course of action.