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Impact of Bankruptcy Laws on Divorce Generally

by Danette R. Pahl on Sep. 11, 2017

Divorce & Family Law Bankruptcy & Debt  Bankruptcy 

Summary: Impact of Bankruptcy Laws on Divorce Generally

Traditionally, the entire gamut of matrimonial law has been a creature of state law, not federal law. As such, federal courts generally may not intervene in the marital area unless a particular issue comes into conflict with federal law. Bankruptcy is one such area, and it can arise because of the effect that divorce has on spouses' property ownership and financial situation. In divorces involving a complex asset structure or extensive and varied types of property, bankruptcy by both spouses certainly can affect marital property distribution, depending in part on what distribution scheme the forum state follows. Otherwise, it often is the bankruptcy of only one spouse initially that sets off the complicated bankruptcy-divorce scenario.

The only obligation accompanying divorce that bankruptcy generally cannot eliminate is a spouse or child support obligation that arises from a separation agreement or court order and that has not been assigned to a third party. Property settlement obligations may be dischargeable in bankruptcy, depending on the circumstances. That leaves a fair array of typical divorce-related duties and rights vulnerable to the effect of bankruptcy to some extent.

A typical problem in the "one bankrupt spouse" situation is the possibility that creditors holding obligations that the divorce decree allocates to the bankrupt spouse may pursue the non-bankrupt spouse for satisfaction. For asset-strapped spouses, that raises the potential that the non-bankrupt spouse might have to file bankruptcy as well. The cascade can have negative consequences on the non-bankrupt spouse's credit, among other things. A logistical problem can arise when a spouse living in another state while the divorce is pending files bankruptcy in that other state. If the bankruptcy affects the marital estate or the non-bankrupt spouse significantly, the non-bankrupt spouse is faced with having to manage his or her interests in the foreign state.

Divorce-related financial disruption can affect what type of bankruptcy relief a spouse can pursue. The Bankruptcy Abuse Prevention and Consumer Protection Act imposed a financial means test for consumer Chapter 7 eligibility. A divorce-related income reduction conceivably could leave a spouse, particularly one with childcare responsibility, with insufficient income to avoid bankruptcy, but still too much income to pass the Chapter 7 means test. Chapter 13 is the bankruptcy alternative, and the spouse contemplating bankruptcy should consider that choice-limiting possibility.

In cases where one spouse files bankruptcy while the divorce is in process, the automatic stay in bankruptcy can affect or disrupt the marriage unwinding process. It is possible that automatic stay in bankruptcy would require that financial and contract disputes be litigated in the bankruptcy court rather than in the divorce court or other state court, for example. Bankruptcy initially envelopes all assets, debts, and contractual obligations, and then sorts the non-exempt from the exempt, the dischargeable from the nondischargeable, and federal law issues from state law issues. Disputes over pension plans, tax liability, individual and marital debt, and matters involving a family business are examples of matters likely to be touched by a pre-divorce bankruptcy filing.

A detailed analysis of bankruptcy's potential effect on divorce is beyond this article's scope. The potentially complex relationship makes one thing clear: a divorcing spouse contemplating bankruptcy would do well to seek the advice of divorce counsel with knowledge of bankruptcy law, in addition to knowledge of the divorce and family law for the state where the divorce is, or will be, filed.

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