Divorce and bankruptcy tend to go hand in hand. Either the financial stresses that led to bankruptcy also break down the marriage, or ex-spouses use bankruptcy as a way to clean-up and get a fresh start after divorce.
However, the issue of divorce can weak havoc on bankruptcy, and vice-versa. So it’s good to revisit some of these themes. Particularly when you’re trying to decide which to do first: file for divorce or file for bankruptcy, and whether to file joint or individual. Many of these themes have circular reasoning, so there really was no linear way to present these, other than randomly…
- Filing a joint bankruptcy before a divorce is finalized is almost always the preferred route. It’s cheaper to file one joint petition rather than two separate individual petitions. Both debtors benefit equally from the discharge, neither one has to rely on the “phantom discharge”, and it renders most “hold harmless” clauses in divorce papers moot.
- On the other hand, some debtors don’t want to file joint because of impact on credit scores, because bankruptcy causes the revelation of certain financial information that could give one of the spouses leverage in divorce proceedings, or because the income potential of one debtor disqualifies both debtors – as a married couple – from Chapter 7.
- For reasons beyond my comprehension, creditors are not required to abide by the terms of divorce orders. Which means that a bankruptcy filed after divorce may not be as effective as a bankruptcy filed before divorce. Divorce orders usually contain “hold harmless” clauses. Which means if one spouse gets a debt discharged in bankruptcy that was assigned to him or her in the divorce, and the creditor then pursues the other spouse for payment, the second spouse can go into family court and get a non-dischargeable support order from the first spouse for damages resulting from their failure to pay the debt assigned to them in divorce. So, if you do file divorce before bankruptcy, make sure that your attorney knows of your intent to file for bankruptcy and that your divorce papers do not include “hold harmless” clauses. (DO NOT FILE FOR DIVORCE WITHOUT AN ATTORNEY! Most divorcees who have done so will tell you that it was a mistake.)
- Get rid of the mentality that you and your spouse split everything 50-50, or that credit cards in one spouse’s name are not the responsibility of the other spouse. Wisconsin is a community property state, which means that married spouses are deemed a single legal entity, and each spouse is presumed to own a whole and undivided interest in all assets (and share a whole and undivided liability in all debts).
- Consequently, a bankruptcy petition must disclose the assets of both spouses (if the divorce is not yet finalized), even if one spouse is filing without the other spouse. Assets of the non-filing spouse that are not disclosed (even if it is due to the non-filing spouse’s lack of cooperation) cannot be taken as exempt, which means the trustee can seize and liquidate unreported and non-exempt assets of the non-filing spouse. While the filing spouse might not care, this adverse impact on the non-filing spouse could hurt the filing spouse when it comes time to settle the divorce.
- Additionally, in a non-filing spouse scenario, only the filing spouse can claim exemptions (which are generally half of the exemptions available to joint filers), often creating non-exempt assets where there would be none of both spouses filed.
- Bankruptcy filed after divorce also must contend with a potential fraudulent conveyance issue. Were the assets in divorce split roughly 50-50? If not, why? If the non-filing spouse got the house, both cars, and all the jewelry, and the filing spouse got stuck with nothing, there could be a fraud issue. It is not unheard of for a married couple to get divorced just to protect assets from unsecured creditors (in fact, I had a client once myself who tried to pull this stunt, and I fired her as a client).
- In the event that a single filer has enough exemptions on his own to cover the assets of both spouses, then the question becomes whether the filing spouse can exempt the non-filing spouse’s interest. If that seems strange to you in light of what I said earlier about community property, you’re not alone. It seems that this is where the “whole and undivided interest” standard breaks down into a 50-50 theory, again for reasons beyond my comprehension. At any rate, the court then looks at the non-exempt asset. Is it readily divisible – like a bank account? If yes, the debtor can only exempt their half share. If it is not readily divisible (like a house or single vehicle), then the debtor can exempt both spouse’s share in the asset, provided enough exemptions exist to cover the asset.
- Once a divorce is final, former spouses can no longer file a joint petition. A joint bankruptcy petition must be filed before the divorce is finalized.
- As you may have gathered, it is quite simple for one spouse to adversely impact the spouse by filing for bankruptcy. Some people would say this is unfair. I agree. But it is also part of the cost of marriage that too few people understand and appreciate before they get married.
- I get a number of clients who cannot provide me with the information of their non-filing spouse because they have been estranged for so long. They may not be on speaking terms, or they may not even know how to contact the spouse anymore. Does that mean the filing spouse is off the hook for disclosing the information of the non-filing spouse? Unfortunately, no. As stated earlier, unreported assets could potentially be liquidated by the trustee, and even if the filing spouse doesn’t care, it would impact the divorce proceedings when they come. The solution – if you are unable or unwilling to work with your spouse in a joint filing is to file for divorce first. Newspaper publication resolves any problems with being unable to locate/contact the other spouse. Just remember that in filing divorce before filing bankruptcy, to be on the lookout for “hold harmless” clauses that can affect your discharge.