Bankruptcy and Divorce: What Should Come First?

Divorce is often a precursor to bankruptcy, for either one or both of the divorcing spouses find themselves in need of discharging debts in the face of earning only a single income once again. The difficult question is determining what should come first: the bankruptcy or the divorce.

The answer of course depends on a multitude of circumstances including whether the spouses can cooperate and agree to a joint (and amicable) bankruptcy filing before the divorce is finalized, how long it may be before a divorce decree is entered, which assets owned jointly versus individually, whether there are any joint debts, how the incomes of each of spouse may affect a joint bankruptcy both during a bankruptcy proceeding and after the divorce is final.

When divorce and bankruptcy overlap, the first question is timing. Often family  attorneys may advise their clients to file a bankruptcy before finalizing the divorce, which has the optimistic effect of clearing up those debts so the divorce decree has one less thing to divide up between the spouses. However, there are reasons why it may be better to wait to file bankruptcy until after the divorce is complete, especially for debtors that may owe monetary obligations to their ex-spouse as part of the divorce decree. While child support and alimony (or maintenance, as it is sometimes called) that are based on the financial need of the other spouse are not dischargeable in bankruptcy, certain other financial obligations to one’s ex-spouse may be dischargeable in bankruptcy, including property settlements and other financial obligations that are not based on the financial need of the other spouse. Under some situations, these types of divorce decree obligations can be discharged in a Minnesota consumer bankruptcy filed under Chapter 13.

Another reason to wait to file bankruptcy until after a divorce is finalized: a divorce decree can slap a debt back on one spouse, effectively mooting the entire reason for filing bankruptcy. In Minnesota—which is not a community property state—one spouse typically cannot be held liable for debts incurred solely by their spouse unless both spouses signed the credit agreement (there are some exceptions, such as medical debts which can be enforced against one’s spouse under state statute). A divorce decree usually divides all debts amongst the spouses. For example, the husband may assume the entire responsibility for all joint  and individual credit cards in his name while the wife will take over the homestead and accompanying home mortgages and individual credit cards in her name. If the husband files bankruptcy before the divorce is finalized and discharges his legal responsibility to his credit card companies, the divorce decree can still subject the husband to responsibility to his wife for any payments she is forced to make on the joint credit cards that she will still owe in spite of his bankruptcy because she did not file with him. In this example, while the credit card companies could not sue the husband because of his discharge received in bankruptcy, however they could still sue the wife for the joint debts and the wife, in turn, can then sue her ex-husband for indemnification under the divorce decree if she is forced to pay on the joint credit card debts that were otherwise assigned to him. The point is that you never know how the debts will be divided until the stamp is dry on the divorce decree, and you don’t want to waste a bankruptcy discharge (which you can only get once every 8 years) on debts that may be re-assigned to you in the divorce.

Other issues to be considered when bankruptcy and divorce intersect: equity in a  homestead may not be exempt if it is no longer one’s homestead (a marital lien alone does not satisfy “occupancy” to obtain a Minnesota homestead exemption); child support and spousal maintenance counts as income for the purposes of qualification for Chapter 7 under the means test; an indemnification clause in the divorce decree may undermine the effect of a bankruptcy discharge; unless a full disclosure is made and the divorcing spouses are cooperative, the bankruptcy attorney may have conflict of interest issues that prevent joint representation of divorcing spouses.

Lynn Wartchow is a bankruptcy attorney located in Edina, Minnesota and representing clients in both Chapter 7 and Chapter 13 consumer bankruptcy proceedings throughout Minneapolis and St. Paul in Minnesota.