Bankruptcy. Frankly, the adage that "honest but unfortunate debtors deserve an opportunity to escape the impossible pressures of debt and again become economically productive members of society" is a wistful sentiment lost in the every day applications of divorce court.
a) Chapter 7, which is liquidation or straight bankruptcy is available to any individual without limitation. Yet those persons whose debts are primarily consumer debts may find their cases dismissed, upon motion by the court or the United States Trustee if "the granting of relief would be a substantial abuse of the provisions of the chapter".
The primary question is whether the debtor's ability to repay creditors out of future income is indicative of such an abuse when the debtor proposes to liquidate under Chapter 7 rather than to implement a plan under Chapter 13.
b) Chapter 13 is the reorganization chapter for individuals, but its eligibility is more complicated. It is available only to individuals with regular income who have unsecured debts of less than $250,000.00 and secured debts of less than $750,000.00. The limitation to individuals might appear to exclude business debts, but such debts can be dealt with in a Chapter 13 case if the business was a sole proprietorship; in such a case, the debts are liabilities of the individual who is the sole proprietor.
The requirement that the debtor have regular income reflects an expectation that creditors will be repaid from a future stream of income. That income need not derive from wages or salary; income from sources as diverse as welfare benefits and child support payments have been found to meet the requirement.
The most significant consequence of a bankruptcy filing is the automatic stay. As the name suggests, it automatically halts any effort by a creditor to collect from the debtor without notice. Generally, any benefits obtained by creditors during this period must be forfeited.
Several types of actions by family claimants enjoy an exception to this stay. First, actions to establish paternity or to establish or modify an order for maintenance or support are not covered by the stay. Second, actions to collect alimony, maintenance or support from property that is not property of the estate are also excepted.
What about property that IS property of the estate? All too often a divorced spouse has witnessed their former spouse go bankrupt and secure a discharge of their obligations incurred as a result of a property settlement or court order concerning property. Thus, when a payor-spouse later files a bankruptcy action, property division debts are a common source of contention.
The Bankruptcy Reform Act of 1994 substantially altered the conflict between federal bankruptcy and state domestic relations laws by making certain debts arising out of property settlement and hold harmless agreements nondischargeable. It has now been said that all marital debts are presumed to be nondischargeable where "the potential benefit of discharge to the debtor-spouse is outweighed by the potential detriment to the non-debtor spouse".
It has also been held that an award of attorneys fees in a final divorce decree is nondischargeable under the Bankruptcy Code when the decree contains an award of child support, maintenance, or combination thereof.
Often, insolvency and family disputes go hand in hand, even when the parties don't.
Sometimes a well-planned bankruptcy for both parties contemplating a divorce can eliminate one source of conflict, discharging joint debts and avoiding the risk that one party will discharge them later, leaving the other with the debts and insufficient property to offset them. Even if a joint filing is not the avenue of choice, a skilled family attorney aware of the possible consequences of a subsequent bankruptcy of the opposing spouse can plan to reduce or eliminate the negative impact on their client.
A joint filing is most common for married debtors. However, there are legitimate reasons for a one spouse filing: only one spouse incurred the debts; most of the debts are premarital; or the non-filing spouse has significant non-exempt assets. An experienced trustee will generally inquire whether any of the non-filing spouse's significant assets had their source with the debtor spouse.
The Bankruptcy schedules - particularly questions relating to the transfer and payment of debts within a year of filing - are a logical place for the trustee to look for avoidable transfers. In other words, well advised debtors disclose everything; the consequences of not doing so are grave, such as being denied a discharge or running afoul of federal criminal law. If a transfer has been concealed, the statute of limitations does not being to run until the concealment ends.
Of course, entering into a marital settlement agreement in connection with a divorce shortly before bankruptcy does not necessarily mean the parties are engaging in fraudulent transfers. Most such agreements are negotiated by the parties and their attorneys in good faith from adversary positions, and are not subject to avoidance. But, the timing of the spouse's bankruptcy, as well as the legal and personal relationship of the parties, may be critical in whether a transfer is effective or is recovered for the parties' creditors.