Bankruptcy & Divorce

Potential Problems and Pitfalls with Marital Debts in Divorce and Bankruptcy
I have noticed in the last several years in domestic cases that I’ve been involved in that there is an increasing problem with the division of joint debts in a marital settlement agreement followed by the later bankruptcy of one of the parties. Routinely a married couple may have several credit card accounts, automobile loans, and even mortgages that are in both of their names. Most domestic relations attorney’s try their best to separate the debts by canceling joint accounts if possible or asking that the creditor allow the account to be put in one person’s name only. The problem arises in that very few lenders will allow you to take one person’s name off a joint account if money is still owed to the creditor.

As a result what happens in most martial settlement agreements is that one party agrees to be responsible for paying the credit card that is still in both parties’ names. This works fine until the party responsible for payment defaults on the payment, allows a vehicle to be repossessed, or files bankruptcy. When the responsible party fails to make payments to the creditor then the creditor attacks the former spouse who is not protected under Chapter 7 bankruptcy law threatening collection and litigation against the innocent party. If the person has filed a chapter 13 the former spouse is protected by the co-debtor stay as long as the Chapter 13 case is not closed. My experience has been that the credit card company or bank could care less what the marital settlement agreement stated, because they have the joint debtor still on the hook for the payment of the account. When a responsible party does not live up to their obligation, the other party in most cases has to file a motion for contempt with the court that has jurisdiction over the divorce. The party who has been hurt by the situation has to demonstrate to the court that the other side has not lived up to their obligations and should be found in willful contempt for their actions. In this situation, the Judge then orders the party who defaulted to get with the creditor to work out a repayment plan or face the possibility of going to jail for contempt. This is much more difficult if the responsible party for the debt has defaulted because of conditions beyond their control i.e. the loss of the job, illness, or the loss of income. The other difficulty arises with the fact that the Judge in the Domestic Relations Court can take very limited action against the non paying ex spouse because the party is protected under the provisions of the Automatic Stay of the U.S. Bankruptcy Code. It is highly unlikely that a State Court Judge will jail someone who is in bankruptcy. If the person filing the bankruptcy case has been discharged and the case closed, they can be subject to action by the Judge in the divorce case. They may have been discharged of their debts to the creditor, but they still have liability to pay under the terms of the settlement agreement.

In the current bankruptcy law, a debtor normally cannot discharge child-support obligations or alimony or property settlements that are owed to the ex-spouse. There is one exception in Chapter 7, but it is one where the debtor must demonstrate that it is more beneficial to the debtor that it is to the ex-spouse and children to discharge the support or alimony obligation. Obviously this is a very high hurdle for the debtor to accomplish with the bankruptcy court. A debtor in Chapter 13 previously under the old bankruptcy law was able able to discharge property settlement agreements to an ex-spouse but that provision has been taken out in the Bankruptcy laws enacted in October of 2005.

I have seem some marital settlement agreements that state that the parties agree that the assumption of debt by one party is actually support or alimony as defined by the U.S. Bankruptcy Code. This will never work if the debtor has a decent bankruptcy attorney who can prove that this is property distribution and not support or alimony as stated in the marital settlement agreement the Bankruptcy Court will discharge the party of the debt.

The best course of action if you are getting divorced to handle this situation of the joint debts is to immediately liquidate the assets of the marriage and pay the debts off. Instead of having one spouse assume the mortgage and sell the house in 2 years, it makes more sense to put the house on the market immediately and sell it as soon as possible. The equity in the house can be used to pay off these joint debts and the remainder can be distributed to the parties. The other course of action is to use other assets such as an automobile or other property that could be sold to liquidate the debt. I realize there are many situations where this is simply not possible given the debts of the parties. If the creditor will not agree to let the other party off, then the party assuming the debt can try to get another loan or credit card and transfer the debt from the joint account to the new account. If none of this possible then the party who not responsible for the payment of the debt will always be looking over their shoulder until the debt is paid to see if they will be held accountable for this debt.