When Is The Best Time To File For Bankruptcy During A Divorce?
It does make a difference whether to file for bankruptcy before or after a divorce, and it varies case by case. In general, it makes sense to file bankruptcy before the divorce and there are a couple of reasons for that, but there are a limited set of circumstances where it might make sense to do the divorce first and then file bankruptcy. Typically filing bankruptcy before divorce makes sense if both spouses are on-board with the bankruptcy because there are debts in both spouses’ names, either they each have approximately half of the total amount of debt in each of their names or most of the debt is held jointly by both of them. That way you can discharge the debts with one single bankruptcy case. You can file a joint bankruptcy, while you are still married, which is going to save you money because you are filing one case as opposed to two separate cases with two separate attorneys’ fees and two separate court filing fees. So you are going to save money on the bankruptcy and you are probably going to save money on the divorce, because if you retain a divorce attorney, part of what you are paying the divorce attorney at an hourly rate for, is negotiating is who pays what debts. If the debts are discharged before the divorce, there is less to negotiate and less divorce attorney services for which to pay.
Another reason why filing bankruptcy before divorce often times makes sense is because when debts are resolved through a divorce decree, each spouse is required to hold the other spouse “harmless” from collection of the debt. Oftentimes, the approach by the couple or the court is to split the debts. If each spouse’s income is approximately equal and let us say we have $50,000 worth of debt, for example, and it is jointly held, most of it is in both of their names, then the court will hold that each spouse be responsible for half of the debts and hold the other spouse harmless on the portion that you are going to pay.
That hold harmless language spouse 1 to pay his/ her $25,000 in debts and ensure that the creditors do not collect against spouse 2 for those particular debts. Essentially, it just means each spouse has to ensure that they get their portion paid off. If you have that worked into your divorce decree and then one of the spouses goes and files for bankruptcy, it can create problems. Because bankruptcy does not erase debt. It simply insolates the filer from the collection action of the creditors, so your liability is discharged, but the debt does not disappear. If there is somebody else on that debt who is jointly responsible, like a former spouse, the credit card company is just going to turn their collection action against the former spouse. The credit card company is not bound by the divorce decree, they don’t care what a family court judge said was going to resolve the debt. If they have a contract with both former spouses names on it and one has filed for bankruptcy, they will be going after the other spouse for the debt.
If you have a divorce decree that has “hold harmless” requirements in it and you file bankruptcy after that divorce decree was issued, then your former spouse can go back in the family court and request the judge enforce the divorce decree against you to hold the former spouse harmless on these debts. If Spouse 1 filed bankruptcy after the divorce, the bankruptcy would not protect Spouse 2. If Spouse 1 was ordered to pay this debt and hold Spouse 2 harmless under the divorce decree, the family law judge will order Spouse 1 to resolve the debts s/he was order to pay through the divorce decree. Bankruptcy is federal law. Bankruptcy operates under the U.S. District Courts of the Federal Judicial System. Divorce is a creature of state law – in Minnesota it is adjudicated under the family court systems of each county. The bankruptcy court would have jurisdiction between Spouse 1 and his/ her creditors. The family court would have jurisdiction between Spouse 1 and Spouse 2. Because bankruptcy doesn’t erase debt, and if Spouse 2 was liable on some of the debts Spouse 1 was ordered to pay by the family court, the divorce decree can essentially do an end-run around the bankruptcy laws if you’re not careful.
When you are divorced, the parties to the divorce to which the judgment and divorce decree apply are the spouses, not the creditors. The creditors are not a party to the divorce decree. It does not matter what the family court judge says who is going to pay what. If both spouses are liable on the debt, the creditor says you are both responsible. The creditors just want their money. They do not care where it comes from. The creditors are not bound by the divorce decree at all, but the divorce decree does bind the spouses and if they are ordered to pay the debt and hold the other spouse harmless, but then later go into federal bankruptcy court, bankruptcy court binds the creditors only as to the person who has filed for the bankruptcy.
That is why most of the time, bankruptcy before a divorce makes the most sense. Another reason why bankruptcy before divorce makes a lot of sense is a lot of times there can be asset transfers through the divorce.
You are going to get the house or car, and once you file bankruptcy, they look at all those assets, and usually nine out of ten times it is what we call a quid pro quo arrangement. Meaning, the asset division between the spouses is roughly equivalent. In those situations, there is no problem in the subsequent bankruptcy. But if the divorce was a little bit one-sided and one spouse got the house that had $20,000 of equity and got half of the other spouse’s 401(k), that was another $40,000 of value, but in return did not have to give away any other assets, well then that spouse just got $60,000 worth of assets without really giving up anything for reasonably equivalent value.
Once that bankruptcy is filed, that could actually cause an issue. There are ways we can deal with it but in general, we prefer that if you are looking at a divorce and potentially a bankruptcy as well, sit down with the bankruptcy attorney for a free consultation before you finalize anything through the divorce. Make sure that the lines of communication between the bankruptcy attorney and the divorce attorney are open so that you can avoid potential big problems later on down the line.
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