Bankruptcy and Divorce: What You Need to Know

Two of the most common reasons that marriages end in divorce are incompatibility and financial problems. Those two factors aren't mutually exclusive, of course, which means that many people are dealing with both financial pressure and a spouse who has a very different approach to money. Given that, it's a wonder that more people aren't facing bankruptcy shortly before, during, or soon after divorce. Since this is an important topic in divorce I wanted to give you some general information. However, this blog is not intended to take the place of a thorough analysis of your financial situation with an experienced attorney knowledgeable in this area of law.

If you need to file for bankruptcy, generally it's better to do so before a divorce than after one. But sometimes the divorce itself is what tips a party into needing bankruptcy protection. If you suspect your spouse might be headed for both divorce court and bankruptcy court, there are a few things that you should be aware of to protect your financial future and that of your family.

Protecting Your Minnesota Divorce Settlement in Bankruptcy

Any lawyer will tell you that the words you use to describe things matter, and this is especially true when you're trying to protect your divorce settlement from being gutted in bankruptcy. As a general rule, bankruptcy law respects divorce settlements—if they are worded clearly. Your intentions won't mean much if they're not spelled out in a way that allows a bankruptcy court to honor them.

Domestic support orders, known in bankruptcy circles as DSOs, are not generally dischargeable in any type of bankruptcy. Therefore, it's in your best interest to have anything in your divorce decree that qualifies as a DSO spelled out as such if you suspect your ex might file for bankruptcy after the divorce. To do this, the language of the Judgment and Decree need to be similar to language used by a bankruptcy judge or trustee who will decide if something is a DSO or not.

An award in a divorce settlement should be clear that it is intended for the support and maintenance of the ex-spouse and/or children. A spousal maintenance award clearly falls under this heading. But what if you decide to waive spousal maintenance in exchange for a larger property settlement, figuring that it's better to have assets now than wait to be paid later? Just know that using the proper language matters in whether the financial agreements you make in your divorce are nondischargeable in any subsequent bankruptcy.

Having something characterized as a DSO has a number of advantages in addition to making payments or an award of property nondischargeable. DSOs can be collected while the bankruptcy is ongoing. They cannot be "clawed back" by bankruptcy trustees as preference payments. And they are enforceable even against otherwise exempt property in a bankruptcy.

Dealing with Marital Debt in Bankruptcy

Often, Minnesota divorce decrees state which spouse will be responsible for certain marital debts. In a Chapter 7 "fresh start" bankruptcy, marital debt cannot be discharged (wiped out), but it can in a Chapter 13 'wage-earner's" bankruptcy. What happens if an an ex-spouse is able to discharge a marital debt in bankruptcy? Let's say Chris and Lee are divorced, and, as part of the divorce settlement, Lee agrees to be responsible for the $10,000 debt on the joint Visa card the couple had during the marriage.

Lee successfully discharges this debt in bankruptcy, and Visa now cannot go after Lee. But Chris signed a contract with Visa, too. Visa doesn't care that the divorce decree makes Lee responsible. They are not bound by a divorce decree. They do, however, have a contract with Chris, so they will go after Chris. Chris will have a cause of action against Lee, who IS bound by the divorce decree so theoretically Chris can pursue Lee for reimbursement. Chris may even be able to get the property settlement of the divorce decree reopened. But as a practical matter, this will be a cumbersome and expensive process.

A better course of action may be to get joint debt paid off as part of the divorce, or to secure the obligation to pay the debt in the divorce decree (bankruptcy generally does not affect secured debt). In some cases, it might make more sense for the couple to file bankruptcy jointly prior to divorcing. Talk to an experienced Minnesota divorce attorney before consulting a bankruptcy attorney, especially if there are unusual factors in your financial situation, such as small business ownership.

To learn more about Minnesota property division in divorce, and how the prospect of bankruptcy could affect a particular situation, contact Mundahl Law to schedule a consultation. We look forward to answering your questions.