People often ask about the intricacies of bankruptcy, or they call about the procedures regarding a divorce. But what happens when a divorce is looming and bankruptcy is in the works? The collision of these two events can be complex and confusing for everyone involved. The attorneys must understand how a Chapter 13 or Chapter 7 bankruptcy is likely to affect the financial lives of their divorcing clients and be comfortable with the many variables that may come into play. 

For instance, will the bankruptcy occur before or after the divorce is final? How will it affect the division of the property? Which type of bankruptcy is best for the situation? Are third-party claims involved? 

It’s nearly impossible to address all of the possible variants and outcomes in a blog format, so instead, we’ll simply address the laws as they stand. If you are in this unique situation, we recommend that you seek legal advice from a professional family law and bankruptcy attorney. 

Bankruptcy & Divorce Basics 

• Spouses can (but are not required to) file bankruptcy jointly.

• Only spouses can file a joint case.

• The administration of a bankruptcy case may continue beyond the recording of the debtor’s discharge.

• The right to file bankruptcy cannot be blocked by a family court order.

Several clauses in bankruptcy law outline what happens when bankruptcy and divorce coincide.

The Supremacy Clause:  Bankruptcy law is written in Title 11 of the US Code, which is federal law. Generally speaking, however, state law determines the debtor’s property rights. (The debtor is the person who has filed bankruptcy.) 

The Supremacy Clause relies on federal law to determine how those property rights are impacted (or possibly altered) by bankruptcy. One of the potential changes addresses the bankruptcy court’s ability to re-label financial obligations from property division to support. Courts have found the following can be characterized under support:

● Non-filer’s attorney fees

● Child’s guardian ad litem

● Mortgage payments for the ex’s residence

● Debts of the ex

● Education expenses of children, even beyond the age of majority.

Property of the Estate: Another statutory force that impacts the divorce proceeding is “property of the estate.”  

An estate is created when a bankruptcy case is filed; Bankruptcy Code Section 541 defines what assets become the bankruptcy estate property.

Bankruptcy defines “property” as “all legal or equitable interests of the debtor in property as of the commencement of the case.” In a dissolution combined with a bankruptcy, all of the community property becomes property of the estate. If the community property has not been divided in the divorce, a bankruptcy filing by one spouse or ex-spouse brings all of the community into the bankruptcy estate.

Exemptions:  Exemptions define the value in assets that are untouchable to the trustee and the creditors. Exemptions become final 30 days after the first meeting of creditors. There is nothing about the division of exempt property between spouses in bankruptcy law. If the exempt property was community property, it remains community property.

The above is just a brief overview explaining the potential issues and complexities when divorce and bankruptcy collide. As we recommend you don’t undergo either proceeding on your own, navigating both of them at the same time absolutely requires legal guidance. Protect yourself and call Richard V. Ellis today.