Divorce and Bankruptcy of Ex-Spouse

A divorce decree typically outlines who gets specific property and who is responsible for paying specific debts. However, when an ex-spouse files for bankruptcy, the marital debts you thought you no longer had to worry about may come back to haunt you. Depending on the type of bankruptcy filed, you may find yourself the target of a creditor seeking to collect from you on a debt your ex-spouse agreed to pay. Therefore, Bankruptcy and divorce can be complex.

First, the good news. Any debt owed to you by a former spouse for child support or alimony, also referred to as spousal support or maintenance, cannot be discharged in bankruptcy. In fact, a person cannot successfully complete a bankruptcy if child support payments are not kept current. Similarly, if the court ordered your ex-spouse to pay a portion of your attorney fees, that debt cannot be eliminated in bankruptcy.

You are also shielded from paying any debts that were acquired solely in the name of an ex-spouse. If your former spouse had a credit card, contract or loan only is his or her name, filing bankruptcy will ultimately discharge that debt without any collection action aimed at you.

The bad news results from debt on a joint credit card, loan or account. A divorce decree does not take priority over a bankruptcy filing. Creditors don't care who pays the debt on a joint account as long as they get paid. The decree may specify who is responsible for paying a joint debt, but if one source of payment dries up, the creditor will usually go after the second option.

Chapter 13 vs. Chapter 7 Bankruptcy

If your ex-spouse files a Chapter 13 bankruptcy, you will be protected at least for awhile. In a Chapter 13 filing, the debtor agrees to restructure debts into a long-term payment plan which usually requires three to five years to complete. At the end of that term, most debts are then discharged. During the repayment period, the creditor is prohibited from going after any cosigners on the account. If there is a balance owing on the joint debt after the repayment period ends, a creditor might seek to collect from you as a cosigner.

If your ex-spouse files a Chapter 7 bankruptcy, you may have creditors contacting you much sooner. A chapter 7 filing results in collecting any property owned by the debtor above certain limits and liquidating it to pay off creditors. Even if the debts are not fully paid, the ex-spouse will be released from further liability to pay those debts with certain exceptions. A chapter 7 bankruptcy can usually be completed within four months. This is the most common scenario which will result in creditors seeking payment from you for debts the family court allocated to your ex-spouse.

Hold Harmless Provisions

Once a divorce decree is entered, courts are generally hesitant to reopen the case to revisit the distribution of property and debt. However, if the decree includes a hold harmless provision, family courts are more likely to take action.

Hold harmless language is included as a boiler plate provision in many divorce decree forms. Unfortunately, this requires time and expense to both prepare for and appear in court to enforce such a provision.

Federal bankruptcy courts are split on whether the existence of a hold harmless provision in the divorce decree creates, in effect, a new debt owed by one spouse to another which cannot be discharged in bankruptcy. If the bankruptcy court allows the debt of the ex-spouse to be discharged and the creditor turns to you for payment, reimbursement will have to be sought via the family court.

Steps to Protect Yourself with Bankruptcy and Divorce

Rather than having to rely on a hold harmless provision, the better course is to prevent any possible liability for an ex-spouse's future bankruptcy either prior to or at the time the divorce decree is entered. Ideally, any joint debt should be eliminated. These steps may not be financially feasible in all cases but should be taken whenever possible.

1. Consider bankruptcy before divorce. If bankruptcy is being contemplated by either spouse, consult a bankruptcy attorney prior to finalizing the divorce. This may help determine whether filing for bankruptcy is more advantageous before or after the divorce. Filing a joint chapter 7 bankruptcy prior to divorce may be the surest way to eliminate debts and prevent them from creating later problems.
2. Refinance property. Any property jointly held and financed should be refinanced in the name of the person who will be awarded the property. This includes the family home and vehicles. If this can't be done prior to entry of a decree, at least include language in the order requiring refinance within a set number of days from entry.
3. Sell property. Consider selling any jointly held property and dividing the proceeds. In many cases, the finances of both parties following a divorce are negatively impacted. It may make little financial sense for one party to take the family home and assume responsibility for the mortgage payment if income after the divorce will be insufficient to keep up the payment.
4. Payoff joint credit card accounts. Once the divorce is contemplated, the parties should obtain and begin using separate credit accounts.
5. Avoid equalization payments in lieu of property. When assets are divided unequally between divorcing spouses, one spouse will often agree to pay the other a specific sum to make up for the difference in asset value. This is called an equalization payment in that it seeks to make the property division equal by substituting a future payment for the actual property. However, equalization payments can be discharged in bankruptcy. The more prudent course is simply to divide assets equally. Alternatively, categorize the payment as spousal maintenance in the decree rather than a property equalization payment.
6. Reserve spousal support. In theory, this works similarly to a hold harmless provision. Include a clause in the divorce decree reserving the right to amend any spousal support payment until all non-support obligations have been fulfilled. This allows the family court an added method to revisit the divorce decree and provide future financial assistance to the non-bankrupt spouse.
7. Contact creditors. Review your credit report to be sure you are aware of all creditors to whom you may be liable. Notify joint creditors by certified mail immediately after the decree is entered that you will no longer be responsible for any future debt incurred on the account after the date of the decree.

Other than spousal or child support obligations, spouses generally hope to minimize financial entanglement with each other once a divorce decree is entered. When one spouse files for bankruptcy after divorce, both may discover their finances will remain intertwined for months or years to come. A proactive approach once divorce becomes a real possibility can minimize that risk and help ensure financial independence once the divorce becomes final.

If you have a bankruptcy and divorce issue and would like to speak to an experienced divorce attorney, call the Law Offices of Peter Van Aulen today at (201) 845-7400 for a free initial consultation.

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