Bankruptcy and Divorce: Which Should Come First?

Bankruptcy is a messy business. Divorce is often another. When they come together, it can be as disastrous as the Titanic meeting the iceberg.

The aim of bankruptcy from the debtor’s point of view is not the bankruptcy itself but the discharge from bankruptcy, which comes later. Bankruptcy and subsequent discharge is a useful way for someone in over her or his head to wipe the financial slate clean and start again, free of debt. The coincidence of bankruptcy and divorce arises more often than one might think, and someone faced with both may ask themselves the question: should I file for bankruptcy before divorce? Divorce before bankruptcy? Or both at the same time?

To get the answer to that question right takes careful thought. Here are some of the things to be considered.

Which Chapter?

The Bankruptcy Code allows bankruptcy to happen in a number of ways and each has its own chapter of the Code.

A Chapter 7 bankruptcy is available to individuals, partnerships, corporations and other business entities. There is no need to file a repayment plan. The bankruptcy trustee sells the debtor’s non-exempt assets and uses the proceeds to pay creditors. The debtor can keep certain “exempt” property but the remaining assets will be liquidated. At the end of that process it is likely that not all debts will have been paid in full and the liabilities that remain will be written off at the time of discharge. Where an individual whose debts are primarily consumer rather than business debts applies for Chapter 7 bankruptcy, the court may refuse the application on the grounds that to grant it would be an abuse of Chapter 7.

A Chapter 11 bankruptcy allows the debtor to seek an adjustment of debts, either by reducing the debt or by extending the time for repayment, or a more comprehensive reorganization.

Chapter 13 bankruptcies give debtors time to avoid foreclosure on their homes by allowing them to “catch up” past due payments through a payment plan.

Relative Income

If one party has most of the debt and the other party makes most of the money, the court will take into account total household income and may refuse to grant the bankruptcy petition. In such circumstances, filing for divorce before filing for bankruptcy may be the way to go.

Do Both Parties Agree to File Bankruptcy?

If one spouse refuses to join in a filing for joint Chapter 7 bankruptcy, the application cannot go ahead and even a divorce proceeding cannot force the matter. One party may still file individually, but that will not discharge the other party’s debts. Whether or not the bankruptcy filing should precede the divorce filing is a matter to be decided on examination of the relative positions of each party.

Distribution of the Debt

Where one party has substantial separate assets, those assets may prevent the other party’s discharge from a Chapter 7 bankruptcy, in which case it would likely have been better for divorce to take place before bankruptcy.

Property of the Estate during a Divorce

Once a bankruptcy petition has been filed, jointly held property cannot be divided in a divorce property settlement without permission from the bankruptcy judge or until the bankruptcy has been discharged. In this case, the parties must consider whether they are prepared to accept such a delay in a post-bankruptcy divorce settlement.

This is just a short summary of a complicated matter.  If you’re facing a divorce or need legal help on other matters related to family law, please get in touch with Lyttle Law Firm today for assistance. Call 512-215-5225 or fill out the form on the website for more information or give us a call. 

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