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What are the effects of bankruptcy and divorce?

Many couples contemplate bankruptcy and divorce. Before making a decision regarding either you should know how a bankruptcy and divorce impact each other.

Impact of Bankruptcy on Divorce

Upon the filing of bankruptcy by one or both spouses all community property becomes property of the bankruptcy estate. Generally speaking, community property is any property accumulated during the marriage. Any property that is property of the bankruptcy estate cannot be sold or transferred without prior court approval with some very limited exceptions. Thus, if one or both spouses filed bankruptcy prior to or during a divorce proceeding, a family court cannot award any property settlement pursuant to a divorce without first receiving bankruptcy court approval.

Further, once a bankruptcy is filed an automatic stay immediately protects the debtor from various activities including any action by a creditor to collect on their debt. In this regard, the automatic stay prevents a family court from awarding any property distribution in a divorce proceeding. However, the automatic stay does not prevent a spouse from seeking and obtaining a divorce or a court granting the award of child support or alimony.

If a spouse files for bankruptcy during the impendency of a divorce proceeding, the non-filing spouse can ask the bankruptcy court for relief from the automa tic stay. The relief sought will be simple, allowing the divorce proceeding to continue and the family court to adjudicate property distributions.

Impact of Divorce on Bankruptcy

As a result of a divorce proceeding one spouse may be awarded alimony, child support and a property settlement. First, alimony and child support debts are not dischargeable in bankruptcy. In other words, these debts will survive bankruptcy. Further, any separation agreement whereby a spouse agrees to be obligated to certain debt, or agrees to pay a certain amount to keep an asset, is also not dischargeable.

For example, in a separation agreement, the ex-husband agrees to pay $15,000 for equity in the house and he keeps the house. However, after paying only $7,500, the ex-husband files for bankruptcy. The remaining debt of $7,500 is not dischargeable. Also, if the property settlement is actually meant to be or acts like alimony or child support, it's unlikely the obligation would be discharged in a post-divorce bankruptcy. To determine whether a property settlement is alimony or child support, a bankruptcy court will look at the following criteria:

  • do payments end or decrease after certain events happen such as remarriage or a child turning 18;
  • whether the obligation must be paid in installments or a lump sum;
  • if there are minor children involved;
  • the relative health and education of the parties; and
  • whether a need for support exists at the time of the divorce.

Lastly, a hold harmless or indemnity clause written into the divorce decree can also protect you. It requires your spouse to pay certain debts or repay you if a creditor makes you pay the debt. If your ex-spouse later files bankruptcy you can ask the bankruptcy court to enforce the indemnity agreement.

Therefore, without proper counsel, going through divorce and bankruptcy at the same time can be both confusing and highly damaging.

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