Bankruptcy Assisted Divorces

Marx was right! “Love flies out the door when money comes innuendo.” Unfortunately for some, money problems keep some couples together who’d rather be divorced. The issues become who pays the debt versus who keeps the couch, cat and castle. Bankruptcy can help divorcing couples get two fresh starts; marital and financial. Thanks to Congress, the Bankruptcy Code Amendments of 2005 made this possible.

The “sea change” was: (a) changing domestic support obligations to first priority in payments to unsecured creditors; and (b) making or presuming, as non-dischargeable,³ all claims and property distributions arising from domestic support obligations (“DSO”).⁴

This means, to some degree, bankruptcy cases’ primary beneficiaries are the debtor spouse and the spouse with the DSO. The Debtor spouse gets their debts discharged. The spouse with the DSO gets their debt paid through the liquidation of non-exempt property. Where debts are joint, owned by both spouses, a joint bankruptcy case may be necessary.

The strategy generally puts the divorce before the bankruptcy case, chronologically. The divorce’s DSO order: (a) divides the spouses’ property among them; and (b) sets the support and child-support payments, if any.

The bankruptcy court is bound by the DSO to the extent its terms are supported by the spouses’ intent. Thus, the spouses can divide their marital property to take maximum advantage of federal and state law exemptions, prior to the bankruptcy. Where property is jointly owned with a right of survivorship, leaving the interests in place may be wiser for protecting it from creditors in the bankruptcy.

The bankruptcy will discharge the dischargeable debts. This leaves future income to pay support, child-support and avoid the serious repercussions of not paying these non-dischargeable debts. Non-dischargeable debts remain. However, the bankruptcy case will make resources more available to pay them. The bankruptcy case can help contest or discharge claims previously thought not dischargeable.⁵

With proper planning, the spouses get two fresh starts. Parties may disagree about selling jointly owned property. Retaining that property can freeze resources or commit revenues to a needlessly expensive endeavor. Consider the terms “house poor,” “under water,” and “house as anchor.” After considering factors of fairness and necessity, the bankruptcy court can permit selling the jointly owned property.⁶

The sale’s proceeds are distributed based on the spouse’s ownership interests. Life goes on. I’ve lectured about this around the country. So far no complaints in its use. As always, we’d love hearing your questions, comments and experiences.

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