The effect of bankruptcy on divorce

Money is one of the biggest stressors in a marriage, and some couples come to the process with considerable debt. It’s important to consider whether there are sufficient resources to pay down the debt so that each party can support themselves and the children after the divorce, or whether bankruptcy should be considered.

Bankruptcy is governed by federal law. Divorce is governed by state law. It takes planning to coordinate these two legal systems. Federal law imposes a “stay” on the assets and debts of people who file bankruptcy. This means that creditors cannot collect debts and that the bankrupt cannot dispose of property. If you file for bankruptcy during divorce, your case will be “stayed” or put on hold as to property. In Michigan, the divorce cannot be final until property issues are completely dealt with in the bankruptcy.

Two forms of consumer bankruptcy

  1. Chapter 7 means that all debt is cancelled. This is beneficial for people who do not have the financial resources to pay off debt because of loss of jobs, illness or some other major downturn in their lives.
  2. Chapter 11 reorganizes your debt. You develop a plan to pay off a portion of your debt over 3–5 years. If you follow the plan, your creditors will accept less than full payment on your debt. If you don’t comply with the plan, your creditors can begin collection proceedings again and Chapter 11 protection is lost. Chapter 11 appeals to people who feel an obligation to pay off their debt, but cannot manage to pay more than of a portion of their debt. However, Chapter 11 requires cooperation between the parties for many years. Many divorcing couples don’t want to be financially connected for years and meet the requirements of the plan.

Generally, people getting a divorce who need bankruptcy protection choose Chapter 7.

Should couples file for bankruptcy as a married couple or separately? If there is substantial joint debt, it’s usually better to file together. If just one party files without the other joining in, the party who files will have his/her debt discharged, and the other party will be solely liable for all this debt. If the couple does not have the resources to pay off joint debt, it’s highly unlikely that just one party will be able to pay this debt alone. In most cases the parties file together.

To avoid conflict, both parties must communicate honestly with each other about their plans for managing their debt. If one person files secretly—only to have the other spouse find out that they will be solely liable for their marital debts—understandably creates acrimony. The fees for a married couple are less than having two people file separately.

Filing for bankruptcy requires detailed knowledge of the federal procedure, so divorcing couples should also hire a bankruptcy lawyer. This attorney will guide them through the application process and help them organize their debt reporting so that all of their debt is discharged. If you forget to report a debt on the application, that debt will not be discharged. You cannot omit certain debt because you want to repay that debt but not others. However, there are ways to protect important debt, such as mortgages and car payments, so you can retain these assets.

The divorce court should receive notice of the bankruptcy filing so they can enforce the stay. When the discharge is granted, the divorce court should receive a copy. The stay will then be lifted and the divorce can be completed.

While the bankruptcy proceedings are underway, other divorce issues such as custody, parenting time and support can proceed. The parties can mediate these issues, so that when they know what property and debts remain after the bankruptcy, they can finalize the divorce.