As family law attorneys, the possibility of bankruptcy is one of our concerns when structuring a divorce settlement. You should be aware of some problem areas related to bankruptcy so you can help us structure your agreement. If bankruptcy is a possibility for you or your spouse, we encourage you to talk with an attorney who specializes in bankruptcy law to get complete legal advice tailored to your specific situation.

The affect of a bankruptcy is that the debts of the filer are “discharged”, that is they are rendered null and void, except insofar as the bankruptcy trustee determines that a portion shall be paid with the liquidation of the debtors assets or through a payment plan. If your divorce settlement establishes you as a creditor of your former spouse then you may stand in the same shoes as any other creditor.

Most people think that divorce terminates all of their joint financial obligations with the former spouse. It doesn't. A bankruptcy filed by your former spouse can leave you as the only one legally liable on a joint debt. Bankruptcy can sometimes void an agreement that one of you "buy out" the other spouse's interest in a house, business, or other property, particularly where the obligation is not secured. A bankruptcy after the divorce could significantly disrupt the equitable distribution of the divorce and have a tremendous financial impact on one or both of you. For these reasons, you should carefully consider your options in the settlement in the context of bankruptcy, if it is a realistic possibility.

CHILD SUPPORT AND ALIMONY

Child support and alimony are not dischargeable in bankruptcy. If the payments your spouse is supposed to make are for "support", then he or she still has to make them even if they go through a bankruptcy. By contrast, property settlements or similar payments ordered through a divorce ARE dischargeable in bankruptcy. This distinction can become very important if you are agreeing to take property instead of alimony or to take less alimony in exchange for payment of your joint debts by the other spouse.

If bankruptcy of the other spouse is imminent or obvious then it is in your interest to take immediate transfers of assets or money, or alimony or child support, rather than payments over time that could be discharged.

JOINT DEBT

Joint debts to third parties survive the divorce as joint debts, regardless of any agreement between the parties or order entered by the court. That is because the creditor contracted with both of you to repay the debt, and since the creditor is not a part of the divorce, there is nothing that binds them to the agreement or order.

If you and your spouse are jointly responsible for a debt, and one of you decides to file for bankruptcy and include that joint debt, the creditor will likely try to collect from the other spouse for full payment of the debt. This is true even if you agree in your Marital Settlement Agreement that the spouse declaring bankruptcy is supposed to pay for these debts. Bankruptcy eliminates the legal obligation to pay the debt.

However, you can agree that the spouse agreeing to pay the specific debt will indemnify the other spouse in the event the creditor ever comes to them for payment. Unfortunately this is not a perfect method of assuring payment, as even the agreement to indemnify is subject to discharge.

The preferred method of ensuring payment of a debt by a spouse is the have the payment made from the proceeds of the sale of a joint asset. There are other options as well, and they should be considered in your settlement

HOW TO PROTECT YOURSELF

You cannot prevent your former spouse from filing for bankruptcy or to totally protect yourself if you have joint debts with a former spouse, but there are a few methods that can help.

If you don’t believe that your spouse will pay a joint debt if he or she is ordered to pay it, then you should consider finding a way for the joint debt to be in your column rather than theirs. Your good credit is a valuable asset that is worth protecting, even if it may mean that you will take on the lion’s share of the marital debt. If your spouse declares bankruptcy, but only has personal and not joint debts, your credit and finances would not be affected by the bankruptcy.

If you are going to get a cash settlement to be paid over time by your spouse, it is extremely important to secure the payments. Secured creditors get priority in bankruptcy, meaning that they are first in line for liquidation and payment, or they can retain the security. Real property, such as a house or a lot, is usually excellent security, and personal property, such as stocks, bonds, jewelry, etc., can also be good to have as collateral.

You can also structure the agreement so that joint debts get paid first, as part of the divorce settlement. For example, if the marital home is to be sold, an agreement to pay off all joint debts from the proceeds before you split what is left will minimize your exposure. This could be applied to any source of funds, including the sale of another property, proceeds from a particular bank account, or otherwise. Or, if a spouse is refinancing a property, you could agree that out of that refinancing the joint debts would be satisfied. There are other options that your attorney can suggest as appropriate for your particular situation.

TALK WITH A BANKRUPTCY ATTORNEY IF NECESSARY

We hope this information has been helpful to you. If your spouse has already filed for bankruptcy, or if it is imminent or likely, we suggest that you consult with an experienced bankruptcy attorney who can advise you specifically about how to best handle your situation. Please let us know and we will be happy to provide you with the names of several attorneys we have worked with before.