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When Bankruptcy Meets Family Law

Going through a divorce can cause tremendous financial strain, and long-term financial problems can test a relationship. Not surprisingly, divorce and bankruptcy are areas of law that often overlap. Both areas exist to address the realities that arise when a path has been taken as far as it can go and the time has come for a fresh start. What are the effects that each can have on the other and how do we address those effects?

Essential Bankruptcy Definitions

Chapter 7. This is what most people think of when they think of filing bankruptcy. It is usually a three-to-four-month process for a person or couple to show that they have no ability to even partially repay their creditors. In some cases, the debtor may have assets that will be sold and used to repay creditors, but in most cases a debtor will see most or all of their debts forgiven (discharged) with no losses.

Chapter 13. This is a much more complex process for debtors who have some ability to repay their creditors. Debtors propose a plan to the Bankruptcy Court detailing how they will use their disposable income to repay their creditors over a three-to-five-year period. If approved, this plan is binding on all creditors. Three to five years is enough time for debtors to experience substantial changes in their circumstances, including getting divorced, having children, and changes in support or custody. Filing amended plans is a regular occurrence.

Bankruptcy Trustee. This is an official appointed by the Bankruptcy Court to administer a case and estate.

Automatic Stay. Defined under 11 U.S. Code § 362, an automatic stay goes into effect the moment you file a bankruptcy case and bars most creditors from taking any action to collect on a debt. It can stop a foreclosure sale, require the return of a repossessed vehicle, or freeze an ongoing lawsuit. There are exceptions to what it can stop, especially within the area of family law, and it is vital to understand these exceptions.

Frequently Asked Questions

Should I File for Bankruptcy Before or After Getting a Divorce?

There are several factors to consider. The primary benefit to filing before getting divorced is that you can file a joint petition as a married couple. This means there is only one filing fee and, usually, one attorney’s fee. The problems that arise tend to come from eligibility issues based on your income and expenses. Eligibility to file under Chapter 7 will be more likely based on the expenses of two households. Child and spousal support are where the math truly changes. Filing as a couple, support is both an income and an expense to the couple for a zero-sum effect. Filing separate petitions, support payments will benefit one party and harm the other. Conflicts of interest are likely. If a filing party does have a duty to pay child or spousal support, the bankruptcy trustee is much more likely to accept these payments as an ongoing expense if there is a Final Order of Divorce, or at least a signed agreement stating the amounts to be paid.

We Are in the Middle of a Chapter 13 Case, and Now We Are Separating. What Should I Be Aware of?

The first thing needed is independent legal advice for both parties. Any ethical bankruptcy attorney will insist on each party having independent counsel available. The case will likely need to be bifurcated (split into two separate bankruptcy cases), and the probability of a conflict of interest is high. Depending on the post-separation finances, one or both parties may need or want to convert to Chapter 7. If Chapter 13 continues, the division of marital assets and responsibility for payments may be subject to court approval.

I’m Filing for Divorce and/or Seeking Support Payments. If my Spouse Files for Bankruptcy, Does That Stop My Case?

There is a common belief that filing for bankruptcy stops any court proceedings. Even some judges have this belief. The automatic stay is a powerful tool, but the Bankruptcy Code lists exceptions. Most important are the exceptions under 11 U.S. Code §362(b)(2), including actions to establish paternity or modify support obligations, or those concerning custody or visitation, obtaining a divorce, addressing domestic violence, or enforcing and collecting domestic support. The exception to the exception is if a divorce action seeks to divide property that is property of the bankruptcy estate. This includes any property in which the debtor has any interest at the time the case is filed. Even in such cases, a party may move the Bankruptcy Court to lift the stay if their interests are being harmed. In short, attempts by lay persons to weaponize a bankruptcy filing to evade accountability in family law matters are not likely to succeed.

My Divorce Has Been Finalized, and My Ex-Spouse Has Now Filed for Bankruptcy. What Will Happen?

This will depend on the kind of bankruptcy. If they file under Chapter 7, it will likely have no effect unless they have a debt in addition to domestic support. Domestic support obligations may not be discharged and the automatic stay does not affect actions to establish, modify or enforce them. If anything, being relieved of most of their debts will mean that they are in a better position to reliably pay their obligations. If any property is owned jointly with them, the joint owner’s rights may be affected by the bankruptcy case. Expect a notice of the filing and the creditor’s hearing. Creditors have the right to attend the hearing and ask questions of the debtor. Their bankruptcy petition, and other documents filed with the court, are public records so copies may be obtained from the court. If they have made false statements or concealed assets, it may be beneficial to attend the hearing or notify the trustee.

If they file under Chapter 13, there are several possible effects. First, their duty to pay support pursuant to an order or agreement will remain. However, if support is under a “handshake agreement,” a court order specifying their obligations can assure that funds will be going to support their children rather than paying old debts. If they owe an arrearage in support then the obligee will be a creditor with a claim on the funds distributed under the bankruptcy plan. Even better, under 11 U.S. Code § 507(a)(1)(A), domestic support obligations are “priority debt” paid ahead of most other creditors, and the plan will have to provide for arrearages to be resolved. The trustee will send a document called a Proof of Claim. It is vital to complete this form and submit it to the court before the deadline listed on the bankruptcy notice.

Where Chapter 13 could be a serious problem is if they have an obligation under an agreement or Final Order of Divorce that is not “in the nature of support.” Chapter 13 provides for what is commonly known as a “Super Discharge,” which allows for the discharge of debts not eligible for discharge under Chapter 7. 11 U.S. Code § 101(14A) defines a domestic support obligation as “in the nature of alimony, maintenance, or support (including assistance provided by a governmental unit) of such spouse, former spouse, or child of the debtor or such child’s parent, without regard to whether such debt is expressly so designated.” Marital debts that do not meet this definition may be discharged under a Chapter 13 case. An action with the Bankruptcy Court to clarify the status of a debt may be needed and the outcome will be extremely fact- and case-specific. This danger can be avoided during the drafting of a settlement agreement by making sure that the nature of a given obligation is expressly stated. Settlement negotiations should also consider which debts have the potential to be discharged, should one party file a Chapter 13 in the future.

How Are Support Payments Reported in a Bankruptcy Petition?

That depends on whether the payments are actually being made. If ordered payments are being reliably paid, they are simply reported as income or expenses, as appropriate. If there are arrearages and payments are sporadic or nonexistent, there are judgments to be made. An obligee who is not being paid will need to adjust their reported support in a good faith manner. An obligor who has not been paying but wants to use their “duty to pay” to support their eligibility will need to explain the sudden change (from nonpayment to payment). In both cases, an addendum to the Petition explaining the situation will be preferable to creating an impromptu explanation to the trustee at the creditor’s hearing. Also, any arrearage will need to be reported as a debt or an asset, as appropriate.

Can I Use Statements Made in My Spouse’s Bankruptcy Filings as Evidence in a Family Law Proceeding?

Bankruptcy documents are sworn statements filed under the penalties of perjury. They may be used as evidence in other cases. The debtor may be barred from making a claim in one court that is at odds with what they swore before the Bankruptcy Court. If they are claiming income or expenses different than a recent petition or they are claiming an interest in assets they did not report on their schedules, those documents may be useful to preclude claims or impeach their credibility. Grievous differences might even be grounds for the Department of Justice to reopen the bankruptcy case to act against a party.

If either party in your family law matter has filed or may file for bankruptcy, make sure to discuss these issues with an experienced family law attorney. Livesay & Myers, P.C. has a team of experienced family lawyers across offices in Fairfax, Arlington, Leesburg-Ashburn, Manassas and Fredericksburg-Stafford, representing clients throughout Northern Virginia. Contact us to schedule a consultation today.