Adding Bankruptcy to a Divorce May Not Grant You the Relief You Are Seeking

Obermayer Rebmann Maxwell & Hippel LLP
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Obermayer Rebmann Maxwell & Hippel LLP

Times are tough and you may be motivated to make a change, however, it is important to note that you cannot transform your whole life at once. While there is nothing that legally precludes a spouse from filing for bankruptcy during a pending divorce, generally, overlapping the two just complicates and delays both processes. You may think you are killing two birds with one stone, but as you may have heard in the past, slow and steady wins the race.

When filing for bankruptcy, a majority of your assets become part of the bankruptcy estate. Once you do file for bankruptcy, an automatic stay is placed on all of the assets and property in the bankruptcy estate. This stay not only creates a freeze on all assets, but it halts creditors from attempting to collect, thus enabling the bankruptcy court to determine your debt-to-asset ratio and decide which of your assets may be used to compensate for some of the debts in the estate.

Generally, bankruptcy takes precedence over divorce. A Chapter 13 Bankruptcy action normally takes three to five years to complete, while a Chapter 7 Bankruptcy action will often be finalized in approximately three months to six months. Therefore, if your divorce is pending or if you plan on filing for divorce in the near future, expect to factor in the automatic stay which was placed on those assets. This is an important issue to consider because the stay can make it extremely difficult for the family court to access and divide your assets until the bankruptcy action is completed.

Usually, bankruptcy courts do not discharge an individual from any debt that is considered a “domestic support obligation.” These types of obligations include debts for alimony, support and maintenance that accrued before, on, or after the date of the order for relief in the bankruptcy case. Support and maintenance obligations derived from property separation agreements, divorce decrees and orders of court are all included under the scope of a domestic support obligation. A bankruptcy court is not bound by the way a domestic support obligation is characterized in a divorce decree or settlement agreement, and, oftentimes, what a court determines to be an obligation is not always immediately obvious. For example, the obligation to pay the mortgage, the costs to divide a marital asset, or even attorney’s fees for the marital action may all be considered domestic support obligations, as their function is to provide a form of support for a dependent spouse. Whether these items are considered domestic support obligations also depend on your specific circumstances.

Another thing to consider if you plan on filing for bankruptcy during a divorce is that bankruptcy action creates a conflict of interest, which precludes the divorce attorney from representing both spouses. Though generally, the divorce action itself creates a conflict between the spouses and using the same attorney in a divorce action is strongly discouraged. The reverse also applies if you hired the same attorney to represent the both of you in the bankruptcy action; if you have the same bankruptcy attorney and file for divorce, that attorney may have to withdraw due to the opposing interests of each party in each separate action.

Now that you are aware that it is not preferable to attempt to manage both actions at the same time, how do you decide which action to file first? There is no set answer. The benefit of filing for divorce first may be that your joint income is too high to qualify for a Chapter 7 Bankruptcy case, but you might be able to qualify individually after the divorce is final. Additionally, if the divorce is handled properly, it may result in the ability to move certain assets outside of the bankruptcy estate, protecting those assets from your ex-spouse’s creditors.

The benefit of filing for bankruptcy first may be that filing jointly will address all debts under one bankruptcy and may also increase your exemption amounts. The bankruptcy action will also help eliminate debt that neither spouse wants so that it does not become an issue in the divorce action. Additionally, it also makes it easier for you and your spouse to split costs and attorney’s fees.

Filing for bankruptcy and divorce are both big steps. To determine which step to take first depends on your own individual circumstances, and the benefits which each provides to those circumstances. To help determine this, it may be a good idea to consult an attorney who will advise you as to which way to proceed that would be best for your individual situation.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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