The Legal Relationship Between Bankruptcy and Divorce Are Closer Than Most Realize

Article by: Larry Young

Bankruptcy and divorce.  Divorce and bankruptcy.  Either can be devastating.  Either can turn your life upside down.  Either will tax your budget and your support network of family and friends.  Yet, few realize the close legal relationship between bankruptcy and divorce.

From the stand point of causation, a study by the American Bar Association found that the single largest cause of marital disharmony is financial problems.  Not every couple that files for divorce also files for bankruptcy and not every bankruptcy by a married couple results in divorce.  Because of the fact that the two often occur together, however, there are numerous sections of the Bankruptcy Code, a Federal Law enacted by Congress and governing all 50 states, that recognize the interplay between Federal Bankruptcy Law and the separate Divorce Codes of each of the 50 states.

There are often good reasons to join a bankruptcy filing with a divorce filing.  A bankruptcy may discharge both spouses in divorce from debt burdens that were manageable when two incomes were maintaining one household, but are now impossible because of a separation and pending divorce.  Relief from debt, never to be undertaken lightly, may give a divorcing couple the ability to provide basic housing, food, clothing and transportation that just wouldn’t be possible if certain debts still had to be serviced.  Recognizing the importance of divorce and support, the Bankruptcy Code makes numerous concessions to the diverse divorce and support practices in the 50 states. 

The 2005 amendments to the Bankruptcy Code added the phrase “Domestic Support Obligation.” It is known by its initials as a DSO.   A DSO is defined as any payment obligation, whether by agreement or Court Order that covers past, present, or future payment on behalf of a spouse, former spouse, child or other dependent.  These obligations can not be discharged (forgiven) in a bankruptcy.  Regardless of which chapter is filed, an obligation that qualifies as a DSO survives a bankruptcy and remains an obligation to be paid by the bankrupt party to the one who is receiving the DSO payment.

An additional example of how the Bankruptcy Code acknowledges the unique status of certain Domestic Relations proceedings can be seen in the Automatic Stay provisions of the Bankruptcy Code.  A bankruptcy filing acts a Stay to prevent creditors from continuing collection actions against the person filing bankruptcy (a “Debtor”).  Even the IRS is prohibited from continuing to collect taxes or garnish wages once a Debtor files for bankruptcy.  But, recognizing the importance of related proceedings, the Bankruptcy Code specifically states that certain proceedings are not stayed:  divorce and paternity proceedings are not stayed by the bankruptcy filing; actions to determine paternity and actions to establish or modify a support obligation proceed even after a bankruptcy is filed; an action concerning child custody or visitation is also not stayed by a bankruptcy filing; certain interception of tax refunds for overdue support are also not stayed by a bankruptcy filing.

Although actions within a divorce to divide assets are stayed if one of the spouses files for bankruptcy, the Bankruptcy Court routinely grants requests to allow the State Court to procede with the division of assets (“equitable distribution” in divorce terminology).  The decision by the Divorce Court actually binds the Bankruptcy Court as to who owns which assets.  The Bankruptcy Court then will not administer or handle the assets awarded to the non-bankrupt party in the state divorce proceeding.

The right to collect support was made a priority when Congress enacted the 2005 amendments to the Bankruptcy Code.  If a bankruptcy case does result in assets becoming available for the payment of creditors, support arrears are one of the first obligations entitled to payment.

There were also significant amendments made to Chapter 13 as part of the 2005 Amendments.  Chapter 13 is a 3 to 5 year payment plan and can provide significant benefits to a debtor filing bankruptcy.  It is now a requirement of Chapter 13 that in order to have the payment plan approved, the debtor must file a statement with the Bankruptcy Court that all tax returns are filed and that all support obligations are current.  At the end of the 3 to 5 year payment plan, in order for the debtor to receive a discharge in bankruptcy, another statement must be filed that all support obligations continue to be current.  And, at any time during the Chapter 13, the failure to keep support obligations current can constitute a reason for the Bankruptcy court to dismiss the case even if all other payments are being timely made.

There are far more details involved in the interplay between bankruptcy and divorce, but the ones noted above give an idea of the depth and breadth of the interplay between the two.