Bankruptcy and Divorce: Which Comes First?

If you're facing a divorce and you have significant debt, filing for bankruptcy could be a stress-reducing option. Eliminating debts in bankruptcy means you won't need to divide them in the divorce matter. Not only does it minimize issues of contention during the divorce, but it leaves both spouses in a much better financial situation afterward.

Filing for bankruptcy before divorce rarely works for high-earning couples, but it can work for many others. In this article, you'll learn about the benefits and issues of filing for bankruptcy before or after a divorce.

How Can Bankruptcy and Divorce Affect Each Other?

Most people choose to file for Chapter 7 bankruptcy when possible. It's quick, usually taking three to four months to complete, and 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.

A bankruptcy case could affect a divorce by delaying the distribution of assets, but not typically. Although the bankruptcy trustee assigned to administer the case "holds" assets in the bankruptcy estate, the trustee only takes physical possession when selling property not protected by a bankruptcy exemption (the sales proceeds are used to pay creditors). Before filing, you would know which property you would lose, so property division shouldn't be impacted significantly.

The Chapter 13 process works differently. When married couples file for Chapter 13 bankruptcy, they're both responsible for the three- to five-year Chapter 13 repayment plan. Because it would be unusual for a couple to plan to file for Chapter 13 before a divorce, the remainder of this article only addresses Chapter 7.

Why File for Chapter 7 Bankruptcy Before Divorce?

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 want to keep, like an expensive car loan or an underwater home mortgage.

Also, you can reduce court costs and attorneys' fees by filing jointly before a divorce instead of filing two bankruptcy matters after the divorce. When it works, filing for Chapter 7 while married makes for a much simpler, cleaner dissolution.

Passing the Chapter 7 Bankruptcy Means Test Before Divorce

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 to wait to file until after the divorce. But there are ways around this problem. For instance, if you're separated and living apart, you can 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 that spouse's chance of qualifying for a Chapter 7 (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.

Learn about qualifying for Chapter 7 and other expenses that can help you pass the means test.

Why File for Divorce Before Bankruptcy?

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. Also, sometimes, it's possible to protect more property by filing for bankruptcy separately after divorce. For instance, some states allow the same exemption amount regardless of whether the filing is individual or joint. In such states, you'd essentially double some exemption amounts after bankruptcy.

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 can undo certain transfers using clawback procedures, and you don't want to find yourself accused of committing bankruptcy fraud.

Marital Settlement Agreements and Bankruptcy

If you file for divorce knowing that you or your soon-to-be ex-spouse will file for bankruptcy, you'll want 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:

• You might not want to agree to pay debt in your ex-spouse's name. Assume that bankruptcy will discharge (wipe out) only debt in your name (because that's often the case). No one wants to file for bankruptcy and later find out they're still responsible for paying an ex's debt under a family law order.
• Know the difference between a support order and an amount owed due to a property division. Child or spousal support assists an ex-spouse with everyday living expenses. A property division settlement occurs when one spouse takes more property in exchange for an agreement that the other will pay its value over time. For instance, one spouse might take the car, house, or business in exchange for payment later. A debtor can't discharge either order in Chapter 7, but that's not the case in Chapter 13. Although support obligations aren't dischargeable in Chapter 7 or 13, a debtor can eliminate a property division settlement in Chapter 13. So payments characterized as "support" tend to be safer than "property division" payments.

Speak with an Experienced Bankruptcy and Divorce Lawyer

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 familiarizing yourself with common family law issues.