It is not at all uncommon for bankruptcy to follow divorce, or vice versa. A budget that works on two incomes may not work when there is only one, especially if the budget was tight to begin with. In fact, it is so common that sometimes divorce decrees resolve issues of marital debt by advising or requiring the parties to file bankruptcy. If you are going through a divorce, and have even considered the possibility of a bankruptcy, you owe it to yourself to talk to both your divorce lawyer and a bankruptcy lawyer about your options before you have to go to court.
Here’s the important thing to understand about divorce and bankruptcy. The divorce court can change the nature of your debt, and how bankruptcy will affect the debt. In effect, a divorce decree, or a property settlement, or a division of property order, or even a custody order, can change debt that you can get rid of in bankruptcy to debt that you can’t. That’s why I said you should explore your options “before you go to court” and not “before your divorce is final.” Although the process may differ from state to state, once a judge has made a final decision and ordered you to pay debt, that order will affect your bankruptcy outcomes. It doesn’t matter whether the order comes at an early stage or a final decree. Once the issue is decided, your options may be limited.
This issue comes up in lots of ways, so lets just take an example. Lets say Harry and Sally have separated, and things are pretty amicable. They are trying to avoid spending a lot on attorney fees, so they decide that they will go to a mediator to try to work out who gets, and pays, for what. They are able to work things out, and agree that Sally is going to stay in the marital home. She is supposed to pay the mortgage, and within a year she is supposed to refinance the home to buy out Harry’s equity in the property, and get the mortgage out of his name. The Family Court blesses this agreement and incorporates it in a final order–all of which is totally routine in such cases.
However, what Harry and Sally don’t take into account in their agreement is that, because of their split and the credit card debt they have been carrying, Sally can’t qualify on her own to refinance the house. So, not only is the mortgage still in both names, she can’t pay Harry his equity. Harry is forced to continue to rent, because he doesn’t have the money for a down payment on a new home, and the existing mortgage affects his debt to income ratio. Then, as a result of all these issues, Sally makes a mortgage payment late, and that affects Harry’s credit score, too. So Harry takes her back to court. The Family Court issues another order that says that Sally has to either refinance the house or sell it in 90 days, and if she doesn’t (or can’t, because she is unable to conjure up a buyer out of thin air) the court will hold her in contempt of court, and may jail her as a result. (The jail part is rare when the only issue is a property settlement like this, but not unheard of, especially if the judge thinks that Sally is dragging her feet.)
Now Sally is in a pickle. If she files a Chapter 7 bankruptcy, she can discharge her debt to the credit card companies and the mortgage company, but she can’t discharge her obligation to Harry. She still owes it to Harry to continue to pay the mortgage and pay him the equity in the house, and even get the mortgage out of his name. The Chapter 7 doesn’t change that dynamic, and won’t protect her from a contempt citation. If not for the Family Court order, Sally could file a Chapter 7 and walk away from the home, or continue to make the payments on it, or try to sell it to pay Harry. But because the order makes her responsible for that debt to Harry, Chapter 7 no longer solves her problem. Chapter 13 may help–she can file a Chapter 13 and, as long as she pays her creditors, including Harry, as much as she can afford to pay over the life of her Plan, she is protected from the Family Court’s contempt citation. But a three-to-five year payment plan is vastly different from the clean break of a Chapter 7, and may well cause Sally hardship. It will certainly affect her ability to make a fresh start after her divorce.
So what should Harry and Sally have done instead of the agreement they entered into? First, an honest and open look at their debts and their credit history would have helped. Competent divorce lawyers (assuming each party has a lawyer) will review this early on, and will help the parties recognize the effect separation and divorce is going to have on their finances. If it is clear that one or both parties is going to have trouble meeting those obligations, divorce attorneys may advise a client to file bankruptcy, or may refer them to bankruptcy counsel for a review of their situation. It is not unusual at all for a divorce lawyer and a bankruptcy lawyer to confer on a case, and it is not unheard of for one lawyer to handle both matters, if they have the expertise to do so.
One of the disadvantages of going through a divorce without a lawyer, or with only one lawyer, is that this step may be overlooked or avoided altogether. If you have a lawyer and he suggests that you consult bankruptcy counsel, that’s a pretty good indication that you ought to do so. If you are proceeding without a lawyer, and you have anything other than trivial debts, you probably ought to do so on your own.
Second, Harry and Sally would have been better off if they had made provision for something going wrong with their plan. Had Sally been able to qualify for a new mortgage, their plan would have worked out just fine. The problem was that, once that option was off the table, they had no clear direction. If their agreement had provided that the house would be listed for sale and the proceeds split between them if Sally couldn’t refinance, there would have been a better chance that the house could be sold in a reasonable time for a reasonable price, and their relationship might have remained more amicable. If it were up to me, I would also include a marketing plan in the agreement, and specify who lives in the house (and is therefore responsible for showing it) and who pays the mortgage in the meantime, or even plan for both to move out and share the expenses. The agreement could even specifically provide that, in the event that the property proves difficult to sell, that neither party is responsible to the other for the detrimental effects of the mortgage debt. And, as I’ve said, the agreement can even contemplate that one or both parties will file bankruptcy to get rid of that debt.
Harry and Sally started out pretty amicably. The situation can be even worse when the parties are anything but amicable. And that can happen. Take Alice and Mel. Their separation was emotionally fraught from the outset. Alice was convinced of two things: Mel was hiding money or assets from her, and he would never willingly give her what she was due. (The truth of those assumptions matters not one whit.) Therefore, when Mel and Alice reluctantly agreed to attend a mediation, Alice was quick to conclude that Mel was not being truthful with the mediator, and that the mediator was either credulous to the point of imbecility, or on Mel’s side. All the mediation did was confirm her in her assumptions, and make her even madder. So, immediately after the mediation, her attorney made a motion for an emergency hearing to determine issues of support and property division. (In lawyer world, “property division” includes “debt division”) At the emergency hearing, the court ordered Mel to pay the mortgage payments on the marital home so that Alice and the kids could stay there. The judge also ordered Mel to pay all the joint credit card debts, to prevent any negative impact on Alice’s credit report. By the end of that hearing, about 50% of Mel’s income was committed to paying that debt.
Now, assuming that Alice was right and Mel has more income and property than he admits to, that may not be such a big problem. But, if she’s wrong, or if Mel’s business suffers and his income drops, he may be in serious trouble. Even if he files a Chapter 7 bankruptcy, he can still be held in contempt of court for failing to pay the mortgage and credit cards for Alice. He is effectively prevented from taking advantage of a bankruptcy discharge, unless he is able to fund a Chapter 13 payment plan. Again, by allowing the family court to rule on those issues first, his options are limited.
Had Mel filed a Chapter 7 case before his divorce, he would have been able to discharge both his obligation on the credit cards, as well as any obligation to Alice to hold her harmless. And, because the trade-off for bankruptcy relief is full disclosure, he might have been able to convince Alice, or the Family Court judge, that he was not hiding assets. In the right circumstance, a bankruptcy can save a lot of trouble, and might even save a ton of litigation in the Family Court.
If you were struggling to pay all your debt before you and your spouse separated, it is especially important to explore your options before you get to the Family Court. If you are struggling to take care of everything after you separate, it is still a good idea. Even if you just aren’t sure, know your options before they are curtailed by a Family Court order.