Divorce and bankruptcy are two areas of the law that can often overlap, affecting each other in many ways. Depending on which Chapter of the bankruptcy code a debtor files for relief may affect obligations granted in a divorce decree or settlement.

When a person files for bankruptcy, “automatic stay” provisions come into play and most creditors must stop collection methods. Under a Chapter 7 bankruptcy, the debtor’s assets are collected by the trustee and sold to pay the creditors. Only “exempt” property is protected under a Chapter 7 bankruptcy.

Under a Chapter 13 bankruptcy, the filing party’s debts are reorganized and paid off in three-to-five years. The filing party keeps all property under a Chapter 13 bankruptcy; Chapter 11 bankruptcies are less common for individuals and are more complicated reorganization bankruptcy procedures for companies or extremely high net worth individuals.

To address some of the overlap between divorce and bankruptcy, the U.S. Congress passed revisions to the bankruptcy code, including The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), which, as it relates to divorce, is that the automatic “stay” does not apply to spousal support or child support — so these will continue to be collected.

In addition, unsecured property settlement debts (debts owed to you by your spouse in your property settlement) are not subject to “discharge” in bankruptcy. When a debt is discharged, the creditor is legally forbidden to take any action “to collect, recover or offset any such debt.” (See Section 524 (a)(2) of the Bankruptcy Code.) The goal of most consumer bankruptcy cases is to discharge all debts, or as many debts as possible.

Financial support awarded in divorce decrees is a “first priority claim” that generally cannot be discharged. (Other examples of claims entitled to a priority are certain taxes, employee wage claims earned within 90 days before the bankruptcy filing, up to a certain dollar amount, alimony, etc.) Other debts that generally cannot be discharged include student loans.

Furthermore, your spouse’s filing for bankruptcy should not affect your right to receive wage garnishment for the support owed to you. Generally, your spouse’s filing of bankruptcy will not affect your collection of his or her past-due support, but under some bankruptcy plans the past-due payments may be discharged.

In some instances, your spouse’s filing of bankruptcy may be helpful as he or she will disclose income, real property and personal property when filing. You may be able to use property that was exempt from discharge to collect what support or property settlement obligations are owed to you.

A bankruptcy can, however, delay divorce proceedings. The State court handling the divorce will have no authority to make orders regarding marital property until either the bankruptcy is concluded or the automatic stay is lifted.

A money settlement is most likely to be property exempt from discharge in a bankruptcy if it appears to be a support arrangement, although with the passage of BAPCPA, it is generally no longer necessary to characterize money settlement as “support” in order to avoid discharge.

The court will look at the schedule of payments (one-time payment or installment payments), whether a major life event (like remarriage) affects the payment, whether there was a need for support, and other indicators that the payment was intended as support. Ultimately, the bankruptcy court is not bound by what you call the money settlement in your divorce.

A Difference of Note: Chapter 7 vs. Chapter 13 Discharge

Under Chapter 7 or “straight bankruptcy,” most debts are discharged, but there are exceptions: You may choose to continue making payments on your vehicle loan in order to keep that vehicle, so you might voluntarily choose not to discharge that loan. The kinds of debts that can’t be discharged in a Chapter 7 case are mostly the same kinds that can’t be discharged in a Chapter 13 “adjustment of debts” case, including child and spousal support, most student loans and recent income taxes.

However, there is one major kind of debt that can’t be discharged under Chapter 7 but can be discharged under Chapter 13: non-support divorce debts. So, if you owe a large amount of this kind of debt, you should seriously look into filing Chapter 13 bankruptcy instead of Chapter 7.

What are “Non-Support” Divorce Debts?

They are usually obligations in your divorce decree related to the division of property and the division of debts between you and your ex-spouse. As to the division of property, if in your divorce, your ex-spouse received fewer assets than you did, your divorce decree may have required you to pay your ex-spouse a specific amount of money to make up for the difference.

As to the division of debts, your divorce decree may have required you to pay certain debts so that your ex-spouse would not have to do so. This created a new and separate obligation by you to your ex-spouse to pay those debts, over and beyond your initial obligation to the creditor(s).

In a Chapter 7 case, your obligation to pay your ex-spouse the money to make-up for you getting more of the marital assets cannot be discharged — you would continue owing your ex-spouse that debt.

The divorce-created obligation to pay the designated debts would also not be discharged in a Chapter 7 case — you may be able to discharge your obligation to the initial creditor(s), but you would still be required to pay the debt(s) because of the requirement to do so in your divorce decree.

Discharged Only Under Chapter 13

However, both obligations to your ex-spouse, and all other non-support divorce debts, would be discharged in a Chapter 13 case. That’s part of the Chapter 13 “super discharge.”

That doesn’t mean that it could be discharged in a matter of months as in a Chapter 7 case. Rather, in a Chapter 13 case, it means non-support obligations would be treated like all other “general unsecured” debts. Outstanding non-support obligations would all be put into one pool of debt, and then to the extent you pay down that pool of debt is based on a number of factors, including:

• The amount of your other legally higher priority debts (such as back child or spousal support, recent income taxes and such), all of which must be paid in full before other debts are paid anything;
• The amount of the other “general unsecured” debts in that pool — the more other debts there are, the less your ex-spouse will receive;
• How much your plan must pay in administrative expenses: the Chapter 13 Trustee fees and whatever attorney fees you did not pay before your case was filed —which must be paid ahead of the general unsecured creditors;
• Whether your Chapter 13 plan lasts three years or five years — determined by your income when your case is filed, and;
• How much you can afford to pay all your creditors per month, now and throughout the length of the case.

As stated in the beginning, divorce and bankruptcy are complex and overlapping areas of the law. The best advice is to seek good counsel before undertaking either action.

For more information on bankruptcy and divorce overlap, contact Carina Kraatz at Resnick Law or call her at (248) 642-5400.