How To Avoid Future Bankruptcy Problems In Your Divorce Case

Bankruptcy does not prevent people from getting divorced.

But it can affect how property is divided.

A bankruptcy trustee can recover unequal divisions of property.

For example, wife gets the million dollar house and husband gets the 18 year old Toyota Tercel.  If husband later files a Chapter 7 bankruptcy, the Trustee can sue the wife for what should have been husband’s 50% interest in the property.

Many people try to get divorced amicably.

They prefer not to get a court involved and drive up fees.

And that makes sense.

But there are benefits to getting a court ruling on property distribution and clarity on any post divorce obligations.

Get A Court Order Approving The Property Distribution

It is important to get a ruling from a judge in any dissolution case where property is being divided.

I frequently see cases where an amicable spouse gives up their interest in the family home to the other spouse.

And they receive nothing in return.

“It was the right thing  to do” they tell me.  Often it is so their children can continue to reside there.  Other times it is out of the goodness of their hearts, or due to guilt for something that perhaps caused the divorce.

Creditors Can Recover Divorce Property Transfers

Regardless of the motive, uneven distributions of property may be considered fraudulent transfers under bankruptcy and non-bankruptcy law.

This is a problem, particularly when money is owed to creditors at the time.

Under bankruptcy law, a Trustee can sue the party who got the benefit of the transfer for 2 years after the date of the transfer.

And if the state in which the bankruptcy case is filed has a different statute of limitations (lookback period), and most do, the recovery period can be even longer.  For example, in California the statute of limitations for fraudulent transfer actions is four (4) years.

A Court Order Prevents Transfer Issues

However, if a state court family law (divorce) court judge considers the property division and finds it to be proper, then it is safe from future bankruptcy trustee or creditor attempts to undo the transfers.

You may not expect to file bankruptcy in the future, but it is important to always get a signed Order from the divorce court judge that considers and approves the property division.

Make Sure Support and Equalization Payments Are Not Mixed

Another bankruptcy trap for those getting divorced comes from lack of clarity in the court orders regarding marital equalization payments.

Often marital dissolution orders mix together support obligations (e.g. alimony, child support) with property “equalization” obligations.

The latter arise where, for example, the Judge orders one spouse to pay for insurance, or take care of debts incurred during the marriage such as credit cards, or similar obligations.   Without a clear designation, it is unclear whether this Order is for domestic support owed to the other spouse, or if it is part of the overall property settlement.

Why does this matter?  Because in bankruptcy, domestic support obligations are never dischargeable.

But other debts owed to the other spouse from a marriage MAY be dischargeable in certain bankruptcy chapters (e.g. Chapter 13).

Thus, without clarity in the dissolution order (or without any court order), you may end up with expensive litigation in bankruptcy to determine the intent of the family law court judge.

Make sure to  spell out in the dissolution order whether any given obligation is for support, or part of the property settlement.