Whether you or your spouse have filed for bankruptcy and then divorce, or divorce and then bankruptcy, you’ll need to know how bankruptcy and divorce affect each other.
It’s important to understand that there are two types of personal bankruptcies because the impact on a pending divorce depends on which kind of bankruptcy was filed.
A chapter 7 bankruptcy is where all of the filing party’s debts are discharged or erased. The chapter 7 bankruptcy filer’s assets beyond a few thousand are also given to the Bankruptcy Trustee. You end a chapter 7 bankruptcy with almost nothing: no debts and barely any assets.
The process for a chapter 7 bankruptcy is very simple and the process, start to finish, is just a few months.
A chapter 13 bankruptcy is where the filing party’s debts are slowly paid back at in manageable time period considering the debtor’s income and expenses. The advantage of a chapter 13 bankruptcy is that the debtor is allowed to keep his assets in this process whereas, in a chapter 7 bankruptcy, the debtor would turn over all of his assets in exchange for erasing the debtor’s debts.
Bankruptcy law allows married couples to file a single bankruptcy petition together. This saves on filing fees and saves on legal fees because the married couple will use the same lawyer. If the couple files for bankruptcy together and then either party files for divorce, the bankruptcy lawyer automatically has a conflict of interest because the bankruptcy lawyer is now representing two parties in opposition to each other. A lawyer with a conflict of interest is required to withdraw from the case unless the parties sign a waiver acknowledging the conflict.
If the divorce is acknowledged as agreed on all accounts, especially the division of assets and debts, in a chapter 7 bankruptcy, the divorcing parties can waive the conflict of interest and allow the lawyer to proceed. A chapter 7 bankruptcy only takes a few months to process and it would resolve many of the issues in the divorce because there would be no assets or debts to split.
A chapter 13 bankruptcy and a concurrent divorce can rarely be done together by both parties.
A chapter 13 bankruptcy can take from three to five years to resolve. The bankruptcy attorney would need to representing both of the parties for the time the chapter 13 bankruptcy plan is active. No divorcing couple is going to voluntarily freeze their divorce for years (even though some divorces take that long). The bankruptcy attorney would almost certainly have to withdraw from representing both parties.
In all personal bankruptcies an automatic stay is required in regards to all legal actions, including divorce.
“[A] petition [for bankruptcy] operates as a stay…any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate” 11 U.S.C. §362(a)(3)
An automatic stay means “every other legal action is put on hold until the bankruptcy is resolved.” Bankruptcies are supposed to resolve all of the debts and assets of the bankruptcy filer. In any bankruptcy there will be more claims on those assets than there are assets to distribute. Bankruptcy is therefore, a perfect system for distributing those limited assets to the numerous creditors (even if a creditor is a husband or wife).
Bankruptcies can use the automatic stay freeze a divorce because bankruptcy is based in federal law and divorce is based in state law. The United States Constitution’s supremacy clause requires that federal law be followed first when there is a conflict with state law.
When an automatic stay occurs in Cook County, Illinois, and there is a pending divorce action you must alert the judge and complete this “Order Regarding Bankruptcy Matter”
This does not mean that a divorce petitioner is stuck in limbo for five years in the case of a Chapter 13 bankruptcy. The Bankruptcy code provides exceptions for divorce and family matters:
- Establishment of paternity ; 11 U.S.C. §362(b)(2)(A)(i)
- Establishment or modification of an order for domestic support obligations (child support or alimony); 11 U.S.C. §362(b)(2)(A)(ii)
- Custody of visitation; 11 U.S.C. §362(b)(2)(A)(iii)
- Getting the actual divorce decree (unless the proceeding seeks equitable distribution of property of the estate); 11 U.S.C. §362(b)(2)(A)(iv),
- Domestic violence. 11 U.S.C. §362(b)(2)(A)(v).
In short, the only thing that gets frozen in an automatic stay is the distribution of debts and assets in a divorce…because the bankruptcy is taking care of those issues already. The issues based in income, like child support and maintenance remain in effect.
Debts To Each Other During A Bankruptcy During An Illinois Divorce
An Illinois divorce court will divide all marital property held by either or both parties to a divorce. Marital property includes debts.
“”marital property” means all property, including debts and other obligations, acquired by either spouse subsequent to the marriage” 750 ILCS 503(a)
Once determined to be marital, theIllinois divorce court “shall divide the marital property without regard to marital misconduct in just proportions considering all relevant factors.” 750 ILCS 5/503(d)
After each spouse is assigned responsibility for certain debts, what happens when an ex-spouse files for bankruptcy post-divorce?
A bankruptcy does not wipe out all financial obligations one spouse had to another. “The divorce decree does not create a debtor/creditor relationship between the debtor spouse and the nondebtor spouse.” In re Brown, 168 BR 331 – Bankr. Court, ND Illinois 1994
For a Chapter 7 Bankruptcy “[a] discharge under section 727, 1141, 1192 [1] 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt
…
to a spouse, former spouse, or child of the debtor and not of the kind described in paragraph (5) that is incurred by the debtor in the course of a divorce or separation or in connection with a separation agreement, divorce decree or other order of a court of record, or a determination made in accordance with State or territorial law by a governmental unit;” 11 U.S. Code § 523(a)(15)
So, debts TO your ex-spouse, are not dischargeable. Debts to a third party are dischargeable. If you want clarity as to what will happen to debts post-divorce, we have to specify who the debts are obligations towards, exactly.
One spouse cannot declare bankruptcy and liquidate the entire marital estate while they discharge all of their debts. Assets held by either spouse during a bankruptcy may not be subject to the bankruptcy….if the assets have already been awarded to the other spouse.
“Even if the debtor spouse has actual possession of the [asset], the nondebtor’s interest in the [asset] is still that nondebtor spouse’s separate property and does not become property of the [bankruptcy] estate.” In re Brown, 168 B.R. 331, 335 (Bankr. N.D. Ill. 1994)
Any attempt to file bankruptcy and liquidate marital assets must countered by a petition to declare the marital assets part of a constructive trust. The creation of a trust forces the bankrupting partner to preserve their spouse’s share.
“[T]he trustee’s holding of legal title to the property and his actions with respect to that property are determined by the instrument which creates the trust.” Shakman v. Department of Revenue, 2019 IL App (1st) 182197, ¶ 26
“It is a fundamental and wholesome provision of the law which requires a trustee must act in good faith in the administration of his trust, and that requirement means that he must act honestly and with finest and undivided loyalty to his trust” Sauvage v. Gallaway, 329 Ill. App. 38, 44 (Ill. App. Ct. 1946)
Furthermore, in a Chapter 13 Bankruptcy provides that “the court shall grant the debtor a discharge of all debts provided for by the plan or disallowed under section 502 of this title, except any debt— …of the kind specified in section 507(a)(8)(C) or in paragraph (1)(B), (1)(C), (2), (3), (4), (5), (8), or (9) of section 523(a);” 11 U.S. Code § 1328(a)(2)
The exception to a Chapter 13 discharging all debts is “for a domestic support obligation” 11 U.S. Code § 523(a)(15). Chapter 13 Bankruptcies allow for discharge of all debts that are essentially property distributions rather than domestic obligations. In a Chapter 13, any 3rd party obligation can be discharged regardless of another spouse’s indemnification thereof.
A bankruptcy filing by your spouse may be to your advantage in that it simplifies the divorce. When there’s no assets or debts there are probably no problems. The bankruptcy trustee is charged with ascertaining and distributing those assets and even verifying income. A bankruptcy trustee is an experienced lawyer who is double checking your spouse’s financial situation. You can then check with the bankruptcy trustee as to his or her findings.
If you or your spouse are considering bankruptcy or have filed and are also considering or have filed for divorce, contact my Chicago, Illinois law office to schedule a free consultation to learn more about your options.
If you want a great bankruptcy attorney, I strongly recommend Chicago Bankruptcy lawyer Joseph Lou. His office is just 12 miles from mine with directions below:
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