As a bankruptcy attorney, I'm here to shed light on an often-overlooked aspect: Chapter 13 bankruptcy can offer unique benefits in discharging certain non-support obligations stemming from divorce, which are typically non-dischargeable in Chapter 7 bankruptcy. Let's emphasize this point: Any marital settlement agreement or court judgment that stipulates future payments or indemnities between spouses may become vulnerable if the obligated spouse files for bankruptcy later on. The intersection of bankruptcy and divorce can indeed be volatile. Therefore, it's imperative to plan and draft agreements with the potential for bankruptcy in mind. This blog discusses some of the things that you should be looking out for if you are going through a divorce and there’s a possibility that your ex-spouse may file for bankruptcy.
Eliminating Divorce Obligations in a Bankruptcy
The Bankruptcy Code, Section 523(a)(15), designates debts incurred during divorce as non-dischargeable in Chapters 7 and 11. However, Chapter 13 bankruptcy offers broader relief, encompassing the debts outlined in Section 523(a)(15)[1]. Any obligation for future payments to equalize the division of property (equitable distribution) or to hold a former spouse harmless from marital debts can be discharged in Chapter 13. Importantly, any agreements that attempt to prevent the filing of bankruptcy are unenforceable.
The sole recourse for a creditor-spouse seeking to prevent this discharge is to challenge the confirmation of a Chapter 13 plan, either for non-compliance with the law or lack of good faith. Such challenges are risky and expensive. This is why preventing bankruptcy-related complications is often the more reliable approach.
Bankruptcy-Proofing a Divorce
Strategies to shield the division of assets and debts from potential disruption by a former spouse's Chapter 13 bankruptcy do not have to be overly complex. Here are some key steps:
1. Eliminate Existing Debts:
a. Utilize Marital Assets: One of the most effective ways to ensure that debts do not linger post-divorce is to use marital assets to pay them off. This approach eliminates the need for ongoing payments, reducing the risk of future financial complications. By allocating joint funds for this purpose, you can close joint accounts and extinguish shared obligations.
b. Cancel Open Accounts: Even if debts are paid off during the divorce process, it's crucial to close open accounts and revoke any authorized user status. By doing so, you prevent the possibility of your former spouse accumulating new debts that could complicate matters down the line. This step helps maintain financial independence after divorce.
2. Assign Debts to the Responsible Spouse:
a. Understanding Legal Liabilities: To effectively assign debts to each spouse, it's essential to comprehend their legal liabilities to creditors. Identify which debts are in each spouse's name or for which they are legally responsible. By dividing these debts accordingly, you ensure that the spouse who incurs them takes full responsibility.
b. Joint Debts: Joint debts can be particularly tricky. It's advisable to pay off these obligations entirely or refinance them into one person's name to begin with. This prevents the other spouse from being exposed to potential bankruptcy consequences arising from the joint debt. Meaning – if one person files for bankruptcy after a divorce and there is joint-debt remaining, the creditor will come after the non-bankruptcy filing ex-spouse for payment of the debt (regardless of what may have been agreed to in the divorce settlement).
3. Ensure an Equal Division of Assets:
a. Timely Division of Marital Home: Address the division of the marital home promptly during divorce proceedings. If it remains classified as community property, the entire property could become part of the bankruptcy estate, possibly leading to its sale to benefit creditors (and not the non-filing spouse). Carefully consider whether one spouse will retain the home or if it will be sold and the proceeds divided equitably.
b. Avoid an Unequal Distribution of Assets: Where one spouse is slated to make future payments to equalize the division of martial assets – these future payments will be highly at risk if the non-paying spouse files for Chapter 13 bankruptcy because these payments are susceptible to discharge in Chapter 13.
4. Secure Future Performance with Liens:
- Bankruptcy-Resistant Liens: Understand that bankruptcy “generally” doesn't affect liens securing debts; these liens tend to survive bankruptcy proceedings. To secure future performance obligations, consider a lien on collateral to secured the equitable distribution payments. This lien acts as collateral, providing additional protection for the recipient of future payments.
- Valuation Considerations: Keep in mind that the effectiveness of these liens will largely depend on the value of the asset available to secure them. Ensure that the assets being used as collateral are adequately valued, the value of the asset is enough to cover the lien, and the lien documentation is legally sound.
5. Reserve for Support:
- Protecting the Non-Bankrupt Spouse: After a bankruptcy discharge, the family court's hands are tied when it comes to revisiting the division of assets and debts. However, it still has the authority to award support to the spouse who suffered financial setbacks due to the ex-spouse's bankruptcy. By reserving the option to seek support, the non-bankrupt spouse gains a valuable tool to seek relief and maintain financial stability.
- Adapting to Changing Circumstances: Life circumstances can change after divorce, and this reserved support option provides a safety net. It allows the family court to address the evolving financial needs of both parties in light of the bankruptcy discharge.
What's Not at Risk in Bankruptcy
It's essential to understand that bankruptcy by an ex-spouse does not jeopardize support payments. Whether it's family support, child support, alimony, spousal support, or maintenance, these obligations remain non-dischargeable in any form of bankruptcy. Additionally, the automatic stay triggered when someone files for bankruptcy does not impede proceedings related to custody, visitation, paternity, changes in status, or the collection of support from assets that aren't considered "property of the estate."
Additional Resources
The following links can provide you with more information about bankruptcy and divorce:
- https://www.experian.com/blogs/ask-experian/how-to-handle-bankruptcy-and-divorce-at-the-same-time/
- https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics
Conclusion
Understanding the intricate relationship between divorce and bankruptcy is paramount for anyone navigating these challenging waters. As a bankruptcy attorney, I've highlighted the potential advantages offered by Chapter 13 bankruptcy in discharging specific non-support obligations originating from divorce. By taking proactive steps, such as eliminating existing debts, assigning debts responsibly, ensuring an equal division of assets, securing future performance with liens, and reserving support when needed, individuals can better safeguard their financial interests in the face of potential bankruptcy by an ex-spouse. Remember, while bankruptcy may introduce complexities, it's possible to navigate these waters successfully with careful planning and professional guidance, ensuring a more stable financial future post-divorce.
If you need bankruptcy guidance, and need someone to explain how bankruptcy can affect your divorce, we are well qualified as a full-service law firm for people in this county and other New Jersey counties: Passaic County, Hudson County, Essex County, Bergen County, Morris County, Union County, and Sussex County. Call us today at 973-554-9827 or toll free 973-696-8391.
[1] https://www.law.cornell.edu/uscode/text/11/523
