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Bankruptcy and Divorce

Money is one of the biggest stressors in a marriage that can lead to a breakdown of the relationship.  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 with the resources that they will have at the end of the marriage, or whether bankruptcy is necessary.

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

There are two forms of consumer bankruptcy.

  1. Chapter 7 means that all debt will be cancelled. This chapter is attractive 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 means that you reorganize your debt. You develop a plan to pay off a portion of your debt over 3-5 years.  If you meet the plan, your creditors will accept less than full payment on your debt.  It the debtors do not comply with the plan, the creditors can begin collection proceedings again and the protection available to the debtor is lost.     This debt forgiveness appeals to people who feel an obligation to pay off their debt, but cannot manage more than payment of a portion of their debt.

Chapter 11 requires cooperation between the parties for many years.  Many divorcing couples do not wish to be or cannot be connected financially for years and meet the requirements of the plan.

Generally, people who divorce who need bankruptcy protection, will opt for Chapter 7.

The next question is whether the couple should file together as a married couple or separately.  If there is a lot of joint debt, it is 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 fighting or high conflict, it is important that the parties communicate with each other about their plans for managing their debt.  Having one person file secretly only to have the other party find out that they will be solely liable for their marital debts, can create a lot of acrimony.  The fees for a married couple are less than having two people file separately.

Filing for bankruptcy requires specific knowledge of the federal procedure.  It is recommended that the couple 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 certain debt and 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 case can be completed.

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



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