The Effect of Bankruptcy on Divorce Planning
| Publication year | 2001 |
| Pages | 30-36 |
| Citation | Vol. 70 No. 3 Pg. 30-36 |
70 J. Kan. Bar Assn. 3, 30-36 (2001). The Effect of Bankruptcy on Divorce Planning
70 J. Kan. Bar Ass'n, March 2001, 30-36 (2001)
I. Introduction
Divorces and consumer bankruptcies are rising in tandem. As a result, the divorce practitioner needs to be aware of potential bankruptcy issues at all stages of representation - counseling the divorcing client, drafting separation agreements, protecting the record at the trial level, and advising a client who may have a claim as a creditor in his or her former spouse's bankruptcy. What steps can the divorce lawyer take to protect the integrity of the division of net worth and orders for support, in the event the client's former spouse files for bankruptcy relief in the future? A general familiarity with the basic principles of bankruptcy law will help the divorce lawyer to: 1) protect clients from the ramifications of a former spouse's future bankruptcy; and 2) create opportunities for the divorcing parties to take advantage of pre-bankruptcy planning options.
This article sets out options and strategies for divorce lawyers to consider under various bankruptcy and divorce scenarios. We address the various bankruptcy filing options, outline the differences between the relief provided by Chapter 7 as opposed to Chapter 13, and compare filing jointly versus filing individually.
The first option, and perhaps the cleanest, is for the parties to file for joint bankruptcy relief. The second option involves either or both parties filing a separate bankruptcy action.
Bankruptcy law is a complicated and often confusing blend of federal and state law. In the family law context, the most frequently encountered issues with bankruptcy ramifications are the treatment of support related obligations and the net worth division. Whether you are representing a client who contemplates bankruptcy or a former spouse who is trying to collect unpaid divorce related debts, as a divorce lawyer you are well advised to become conversant with at least the elementary aspects of bankruptcy law.
II. Pre-Divorce Planning
When you are retained to represent the husband or wife in a divorce action and are preparing the financial history of the parties, it may become apparent that once they set up separate households they will be unable to maintain their current debt obligations. This is an opportune time to explore the pre-divorce bankruptcy options with your client.
A. The Best Option: File The Bankruptcy Jointly
If you can convince your client, and the opposing party, to file a joint bankruptcy then it is usually possible to discharge and thereby eliminate most, if not all, the unsecured debt for both parties (as opposed to discharging the debt for only a single party who files for bankruptcy protection). A global discharge of marital obligations simplifies the divorce because the parties do not have to divide that debt. It also minimizes post-divorce conflict, because the parties will not remain obligated to indemnify each other when one of them fails to pay an obligation assigned to him or her in the divorce.
Generally, two chapters are available for consumer debtors: Chapter 7 for liquidation bankruptcy, and Chapter 13 for reorganization bankruptcy. If divorcing parties file for bankruptcy protection before the divorce is final, they can file jointly and thus minimize attorney fees, filing fees and costs. If the parties file for bankruptcy protection after the divorce is final they must file separate cases. But decisions about joint filings for divorcing parties are fraught with other difficulties, such as whether the same chapter serves the best post-divorce interests of each person, and whether one lawyer can represent both parties in a joint filing. These difficulties are discussed later. For purposes of this section of this article, it is assumed that the parties can act together and with only one attorney.
If the parties decide to file a joint Chapter 7, then the issue as to which debts will be discharged is generally resolved by having each party pay the secured obligations on the property awarded to that party in the divorce, and then discharging all unsecured obligations. It is important for the divorce practitioner to remember that paying secured obligations does not necessarily mean the bankrupt should reaffirm those secured obligations. Reaffirmation obligates the bankrupt to potential deficiency obligations, because it binds him or her to the original terms of the note. If obligations are not reaffirmed, and the obligor later defaults on a secured obligation post bankruptcy, the creditor's remedy is in rem and the deficiency obligation is discharged.[1]
Reaffirmation is not always necessary during a bankruptcy and is generally advisable only if obligations are in default at the time of filing, or if default occurs during the pendency of the Chapter 7 action. If the parties file Chapter 7 while their secured obligations are current, then they have the option to keep the secured property while avoiding reaffirmation, thus discharging any post bankruptcy deficiency debt(s) and maximizing post divorce and post bankruptcy financial recovery.
If the divorce practitioner is aware that the parties will file for bankruptcy protection, then secured obligations on any property that will be retained by one of the parties to the divorce should be kept current. For example, assume that the parties to a divorce agree that the wife will keep the house and pay the mortgage indebtedness. In a joint Chapter 7 filing, if the obligations on the house are current when the parties file, and are kept current during the bankruptcy, the bankruptcy can end with the wife in possession of the home and without her having signed a reaffirmation agreement. Later, if the wife defaults on the mortgage obligation, no deficiency judgment may be taken against her because she did not reaffirm the obligation in the bankruptcy.
When the parties to a Chapter 7 bankruptcy have non-dischargeable debt to pay, such as income tax, child support, maintenance or student loans, it will survive the bankruptcy and there is simply nothing for the divorce practitioner to do except allocate that debt.
Joint Chapter 13 filings for parties who are divorcing are more difficult, because the debtors must remain in the joint bankruptcy for three to five years.[2] Problems can arise if the parties do not remain amicable and in agreement regarding the course of their bankruptcy case; and the lawyer can develop a conflict of interest.[3]
But benefits not available in Chapter 7 are open to the Chapter 13 debtor: (1) the debtor can reduce secured debt to the value of the collateral securing the obligation and reamortize the payments based on the reduced value, with reduced interest rates;[4] (2) the Chapter 13 debtor can protect his or her co-debtors on consumer debts, so long as the co-signed obligation is paid in full in the Chapter 13 plan;[5] (3) the Chapter 13 debtor can protect against liquidation of non-exempt property (unlike Chapter 7), by paying the unsecured creditors the value of that property in the Chapter 13 plan;[6] (4) Chapter...
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